Basis period reform is coming - the planning starts now!

A topic currently being given significant consideration by accountants, but not yet widely publicised by HMRC, is basis period reform for unincorporated businesses such as sole traders and partnerships. This is likely to affect an estimated 400,000 businesses across the UK, but what is a basis period and how will the changes affect those businesses concerned.

What is a basis period?

Put simply, the basis period for your business is usually the period for which your business accounts are drawn up. This “accounting” date is not necessarily the same date as the end of the tax year.

To illustrate this, where a business prepares a set of accounts covering the year ended 31^st December 2021, the end of that “accounting” period is 31^st December 2021.

As 31^st December 2021 falls into the tax year ended 5^th April 2022, the profits to 31^st December 2021 will be reported on the tax return for the year ended 5^th April 2022 and the tax liability for the year calculated based on those profits.

Special rules apply on the commencement of self-employment, and this can result in the same profits being subjected to tax twice in the opening years.

The profits that have been taxed twice are known as “overlap profits”. Tax relief is given for these by allowing them to be deducted from the profits of a later period, when either the self-employment has come to an end or the annual date that the accounts are made up to is changed.

What is changing?

Going forward, as part of their move towards income being reported digitally under the Making Tax Digital regime for Income Tax, HMRC are looking for all unincorporated businesses to begin reporting and paying tax on their profits on a tax year basis, i.e., for the 12-month period ending 5^th April, regardless of the date that their annual accounts are made up to.

This will be compulsory from the tax year ending 5^th April 2025 with special transitional rules introduced to prepare for this in the tax year ending 5^th April 2024.

How will this affect my business?

Those businesses that already draw up accounts to 5^th April (31st March is treated as 5^th April for this purpose) will not be affected by the changes.

Those businesses that are affected will have a choice of either changing their accounting year end to 5^th April or apportioning their profits for the two accounting periods which span 5^th April each year to reach a figure for the year ended 5^th April.

Changing the accounting date

In most cases, the change of accounting date will take place during the tax year ending 5^th April 2024.

This will result in additional profits becoming taxable in that year, subject to the deduction of any available overlap profits available (profits taxed twice when the business first started).

HMRC is aware that, in many cases, this could result in an unusually high tax bill arising for that year. To help with this, the additional profits will automatically be spread over 5 years for tax purposes, with an option to bring forward and spread over fewer years if that would be beneficial to the individual concerned.

To continue with our example of a 31^st December year end, the tax return for the year ending 5^th April 2024 will include the business profits for the year ending 31^st December 2023 and the business profits for the period from 1^st January 2024 to 5^th April 2024, after the deduction of any overlap profits available, i.e., the profits included on the tax return will cover 15 months rather than 12 months.

The net profits for the 3-month period from 1^st January 2024 to 5^th April 2024 will then automatically be spread over the 5 tax years ending 5^th April 2024 to 5^th April 2028 for tax purposes, e.g., if the net profits for the period amount to £100,000, then £20,000 of these will be taxed in each of the 5 years from 5^th April 2024, in addition to the usual 12-month profits for each year, unless the individual elects to tax these earlier.

Where losses arise in the transitional period, special rules have been introduced to provide more flexibility in the way that these can be used.

What if I don’t want to change my accounting date?

Keeping the existing accounting date is an option and will be considered alongside the option to change the accounting date as it may be better for some businesses from a commercial perspective.

Whilst in some cases, apportioning profits, rather than changing the accounting date, could be a reasonably straightforward process, for others it may present a challenge, for example, the figures for the later period may not be available in time to meet the tax return filing deadline. In this instance estimates would need to be used, with the tax return and liability amended later, when actual figures are available.

For those making pension contributions during the year, a delay in actual profit figures becoming available may make tax planning in this area difficult.

What should I do?

Start planning!

For some businesses, where there are significant overlap profits brought forward, it may be beneficial to change the accounting date of the business earlier to make best use of these overlap profits and perhaps even obtain a tax repayment.

Where a business is expected to incur significant expenditure on capital items, such as plant and machinery, it may be worth considering the timing of this to take full advantage of the capital allowances available and help reduce the additional profits taxable in the period of change.

The basis period reform may have implications for those making pension contributions, for example, increased profits may bring with them the opportunity to make additional contributions to help reduce tax liabilities, whilst reduced profits, due to the availability of relief for overlap profits, may restrict the amount of contributions that can be made, or that it would be beneficial to make, for that tax year.

There will also be cashflow issues to consider.

We are currently considering the position on a case-by-case basis for all existing clients who are affected by these changes and your usual contact within the firm will discuss this with you.

In the meantime, if you are anticipating any significant changes to your usual income levels or sources, pension contributions, your business, such as scaling up or down, retirement etc. or any capital expenditure, such as large items of plant and machinery, please let us know so that we can take this into account.

We would also be very happy to provide advice to new clients upon hearing from you. Please feel free to contact us by email at lynn.miller@renniewelch.co.uk or by telephone on 01289 330311 (Berwick) or 01573 224391 (Kelso) to arrange a discussion.