This measure will only affect businesses which operate as self-employed traders, partnerships or other unincorporated entities such as trusts and estates and non-resident companies and which draw up annual accounts to a date different to 31 March or 5 April, and businesses that commence from 6 April 2024.

It will represent a significant change for these businesses and for those whose profits are significantly higher than when they first started in business, will result in additional tax charges being crystallised, which will therefore need careful planning and understanding.

This measure changes the way trading income is allocated to tax years.

What is Basis Period Reform?

Generally, businesses draw up annual accounts to the same date each year, called their ‘accounting date’. Currently, a business’s profit or loss for a tax year is usually the profit or loss for the year up to the accounting date in the tax year, called the ‘basis period’. Specific rules determine the basis period in certain cases, including during the early years of trading. These rules can create overlapping basis periods, which charge tax on profits twice and generate corresponding ‘overlap relief’ which is usually given on cessation of the business. Overall, this basis of taxation is called the ‘current year basis’.

From the tax year 2023/24 this changes this to a ‘tax year basis’ , so that a business’s profit or loss for a tax year is the profit or loss arising in the tax year itself, regardless of its accounting date. This removes the basis period rules and prevents the creation of further overlap relief. On transition to the new tax year basis all businesses’ basis periods would be aligned to the tax year and all outstanding overlap relief given. The amount of overlap relief is an historic figure based on your early years of trading. We can assist you in obtaining this figure, but as below HMRC may be able to supply;

https://www.gov.uk/guidance/get-your-overlap-relief-figure

How does Basis Period Reform work?

In the tax year 2023/24, the “transitional year” for basis period reform, many businesses will have additional taxable profits to report. The taxable profits for 2023/24 are split into two parts:

• the standard part: taxable profit for the accounting period (AP) ending in 2023/24, and
• the transitional part: taxable profit between the end of the AP in 2023/24 and 5 April 2024.

So for a business with a 31 December AP end that means:

• standard part: 1 January 2023 to 31 December 2023
• transitional part: 1 January 2024 to 5 April 2024.

Any unused overlap relief will be included on the 2024 tax return and automatically deducted from the transitional part.

The net transitional profit is then spread over the five tax years 2023/24 to 2027/28. Although the default will be to allocate the transitional part evenly over those five years, this is not compulsory. The allocation can be accelerated by bringing in more than the minimum additional profit in any of the five years, as best suits the taxpayer’s situation, and careful consideration needs to be given as to the likely income levels in these tax years. If say income in 2027/28 is likely to be over £100,000 but income before that lower at say £60,000 it may be worth taking more of the transitional profits into the years 2023/24 to 2026/27, reducing the amount added in 2027/28. 

Cashflow considerations

Although the above can result in absolute reductions in tax payable, the way the transitional profits are allocated can also be key to the taxpayer’s cashflow.

For the current tax year, payments on account are based on tax year 2022/23, so not affected. But over the five following years, the amounts payable at 31 July and 31 January will fluctuate depending on how the transitional profit is spread and some taxpayers will want to be aware of their options.

Cessation and Incorporation

It may be that some businesses with high profits could consider incorporation to shelter some profits in the transitional years from higher rates of income tax. Perhaps using company pension contributions to minimise Corporation Tax also.

If considering incorporation or otherwise ceasing a Partnership or Sole Trader business the timing of the cessation needs to be considered. When a business ceases on or before 5 April 2024, “old rules” apply. Any overlap relief brought forward will be deducted from the final year’s profits and there will be no spreading of the transitional part.

Further details can be found at the link below;

https://www.gov.uk/government/publications/basis-period-reform/basis-period-reform