Helpsheet Basis Period Reform

Basis period reform explained

In 2021, HMRC announced reforms to the basis period rules that will be relevant to the following businesses:

• Sole traders
• Partners of an unincorporated partnership or LLP
• Trading trusts and estates
• Non-resident companies with profits charged to income tax

For short hand, we hereinafter refer to these businesses as “non-corporate businesses”.

The proposals are intended to simplify the tax system, but come with the added bonus for the Treasury of bringing forward the timing of tax payments.

A non-corporate business will generally prepare annual accounts to the same date each year and this is called the ‘accounting date’. The reforms will impact non-corporate businesses if their accounting date does not fall between 31 March or 5 April each year.

This helpsheet provides a general overview of the changes and, as always, we will be happy to advise you on how these changes may impact on your tax position.

Existing basis period rules

At present, profits or losses disclosed on tax returns filed by the affected non-corporate businesses are based on the set of accounts ending in the tax year – this is known as the ‘current year basis’. Under this basis, the taxable income for the tax year is usually the profit or loss up to the accounting date that falls within the tax year. For example, where the accounts are prepared to 31 October 2022 then this will be used for the 5 April 2023 (2022/23).

However, in the early years of trading, there are specific rules that determine the period which is taxed in each tax year. This can lead to the same period being taxed twice, with these amounts known as overlap profits. These overlap profits are carried forward until the cessation of business or potentially on a change of accounting date, at which point ‘overlap relief’ is given, allowing a deduction for the overlap profits in the year of cessation or change.

Those of us old enough to remember the pre-self assessment days will also remember that non-corporate businesses will also have in their history some overlap profits from when the last big changed happened to their basis period – namely the shift into the current year basis and the self assessment tax system in 1996/7.

Historically there has been some merit for many professional firms in having a 30 April year end as there was an initial timing advantage in when the payment of tax became due. However, this timing advantage will come to an abrupt end under the basis period reform.

New basis period reform rules – outline

The basis period reform replaces the ‘current year basis’ with a ‘tax year basis’. As such, non-corporate businesses will be taxed on the profits which arise in the tax year, regardless of its accounting date, therefore removing the need for overlap profits and overlap relief.

If the non-corporate business has an accounting date of 31 December, for the tax year ended 5 April 2025, they will be taxed on 9 months of the profits for the year ended 31 December 2024 and 3 months for the year ended 31 December 2026.

In some cases, where the filing deadline for a tax year falls before the accounts for the period being assessed have been completed, this will require the inclusion of provisional figures, and therefore amendments may be required once the final figures are available. The mechanism for such amendments has not yet been announced.

Transition year

The transition year will be the year ended 5 April 2024. In the transition year, a non-corporate business will be taxed on the current year basis plus on their profits for the period from the end of that accounting period to 5 April 2024.

As a result, non-corporate businesses with a year end other than 31 March or 5 April will be taxed on more than 12 month’s profits in the transition year. Overlap profits brought forward under the current year basis will be relieved in the 2023/24 transitional year.

For example, where a business has an accounting date of 31 October the basis period for the 2023/24 transitional year would be as follows:

• Profit for the year ended 31 October 2023 (12 months)
• Plus, profit from 1 November 2023 to 5 April 2024 (5 months)
• Less, overlap profits brought forward.

Assuming that the profits of an unincorporated business have increased over time, the overlap relief may do little to offset the additional profits in the transition year. In cases where profits in the transition year are higher than those that would have been calculated under the current year basis, the ‘transition profits’ are automatically spread over a period of 5 years.

There is however, the option to elect out of spreading and accelerate the charge, treating the transition profits as arising in the tax year ended 5 April 2024 in full. Whether such an election should be made will need to be considered on a case-by-case basis.

In the event that there is excess overlap relief arising in the transition year, the time period for these losses to be carried-back will be extended from one to three years.

Should the trade cease before the whole of the transition period profits have been charged to tax, the balance will be immediately brought into charge in the tax year of cessation.

The transition profits are taxable, however, they are ringfenced in the income tax calculation so not to affect net income for the purposes of calculating certain reliefs and benefits, such as pension annual allowance, loss of personal allowance and High Income Child Benefit Charge.

Identification of overlap profits

The identification of overlap profits may prove difficult for some taxpayers where a record of this has not been kept. There is a box on the self-assessment return to show these and the taxpayer should see if the amount has been reflected there historically.

If not, the overlap profits may need to be recalculated (if it is possible to create the records to do so).

When self-assessment was introduced in 1996/97, the period between the end of the basis period for 1996/97 and 6 April 1997 is the overlap period.

For non-corporate businesses that commenced post 1996/97, copies of tax returns from the earlier years of trade should enable the overlap profits to be calculated. By reviewing the multiple years of tax returns, the period taxed twice should be identifiable with the profits then pro-rated to calculate the relief.

Practical and other impacts

The most immediate and apparent impact is the cash flow impact of earlier tax payments. Other areas of concern are:

• The interaction with MTD quarterly reporting where the accounting period does not align with the tax year end.
• The administrative impact on traders who cannot align their accounting period to the tax year and being forced to file provisional returns each year.
• The impact on large and international firms who are subject to audit and/or where partners are subject to taxes in multiple jurisdictions, including how local tax authorities will seek to tax transition profits and impact on claiming double tax relief.
• Additional costs in finalising accounts and tax computations earlier.
• Impact on partners leaving or joining partnerships.
• The treatment of creditable foreign taxes in the year of transition and on historic overlap profits.

Non-corporate businesses may also wish to consider whether to change their accounting date to 31 march or 5 April in the transition year, or a later year.

Contact us

For more information, or to discuss how these changes may affect your tax position, please contact Emma Cheeseman at emma.cheeseman@charter-tax.com or Daniel Thompson at daniel.thompson@chartertax.com or call us on +44(0) 20 7084 5771 or +44(0) 1580 313108.

CHARTER TAX CONSULTING LIMITED
11 ST JAMES'S PLACE LONDON SW1A 1NP
+44 (0)20 7084 5771
www.charter-tax.com
4 April 2023

Disclaimer: The information provided by Charter Tax Consulting Limited is general in nature and does not constitute specific tax advice. Professional advice should be sought before deciding on a course of action, or refraining from a certain action, arising from the above information. Tax legislation changes regularly and the information contained herein is provided based on legislation as at 4 April 2023. Taxation planning concerns the application of complex statute and case law to future events. Accordingly, however expert the opinion given, it is always possible that the Courts will take a different view of the application of the law. We undertake to apply reasonable care and skill in the provision of advice. We do not guarantee that tax planning steps will in all circumstances achieve a certain legal effect.