Basis Period Reform

What is Basis Period Reform & Will I have to pay more tax?

What does it mean?

Current rules around the payment of income tax are based on a business’s accounting date, and can create overlapping basis periods, which charge tax on profits twice and generate corresponding ‘overlap profit’.

What are the changes?

The proposed changes simplify the basis period rules for the self-employed and partnerships 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 complex basis period rules and prevents the creation of further overlap profit.

Who will it affect?

Self-employed sole traders, partnerships (including LLPs) and other unincorporated entities with trading income, particularly those with an accounting year end other than 31 March or 5 April. Incorporated entities such as limited or unlimited companies will not be affected.

When do the changes come into effect?

The aim is to have basis periods aligned with the tax year ahead of the introduction of Making Tax Digital (MTD). The introduction of MTD for income tax was intended to start in 2023-24, but this has now been deferred to 2024-25. The transitional year to align basis periods with the tax year is planned to be one year ahead of this and is now proposed to be 2023-24.

How will the changes affect me/my business?

HMRC say that the changes will be tax neutral. In the majority of cases, this may be true, if taken over the entire life of a business, but there are situations where this will not be the case and there will certainly be cash flow implications for many. 
HMRC estimate that actual income tax received in the years immediately following the basis period reform will increase by around £1.8 billion as a result of these measures, largely due to individuals paying tax sooner than under the old system – so clearly some cash flow issues for those paying the tax.

What will happen during the transition year?

In the transition year (2023-24), the taxable income for sole traders and partners with year ends other than 31 March or 5 April will be based as usual on the profits of their accounting period that ends within that tax year, PLUS the profits from the end of that accounting year up to 31 March 2024. 
For a business with a year end of 30 April, this means they will be taxed on 23 months of profits rather than 12. It is true that any overlap profit carried forward will be deducted from these profits, but if the business has significantly increased in profitability since the overlap profit was created - this could go back as far as 30 years! - then the amount of overlap profit could be very small compared to 11 months of current profit levels. 
Businesses that made losses in the early years of trading will have no overlap profit and there are concerns that in some cases records of overlap profit may not be available. HMRC have suggested that this extra profit in 2023-24 could be spread over five years to help avoid higher rates of tax than usual and to assist with cash flow. Details of exactly how this might work are not yet clear, and while this is a welcome provision it will not fully remove cash flow issues, nor ensure that some individuals won’t pay some tax at higher rates than they normally would.

What should I do?

Consider changing your year end

If you are a sole trader or partner with any other year end, consider whether to change your year end to align with the tax year. This won’t avoid the basis period change or its tax consequences but is likely to make reporting much simpler. 
Any sole trader or partnership businesses with year ends not aligned to the tax year will still have to account for the profits between their year end and 31 March/5 April from 2023-24 onwards. This could mean having to prepare estimated figures and then amending the figures once the true profits are known.

Is your structure working for you? 

This could be a good time to review your business structure. If you have previously wondered about incorporation (or are now after reading this) then this could be a very opportune time to seriously consider it.
Before making any changes, it’s essential to take professional advice as to your specific circumstances. Decisions such as changing accounting year ends and spreading the extra profits of the transition year need careful consideration, in view of maximising lower rate tax bands and mitigating the impact on cash flow. 
If you are considering incorporation, then taking professional advice is paramount to ensure the timing gives the optimum results and that you end up with the best business structure for your situation.

Starting from scratch

If you are starting a sole trader or partnership business, then it is strongly recommended you set your accounting year end as 31 March or 5 April to avoid the complications.

No action is necessary if...

You are a sole trader or partner with an accounting year end of 31 March or 5 April, as the tax impact should be nil, and no specific action should be required.

Finally, it is vital to start thinking about this NOW, 2023-24 may still seem a long way off, but the best solutions can take time and planning to arrive at. Implementing changes on this scale hurriedly or at the last minute is not a wise option. Our tax team are happy to receive any questions on this, so to find out how we can help you prepare, contact us at info@oldfieldadvsory.com or call 02476673160

Please note: This article is provided for information only and was correct as at time of writing (01/02/22). Any lists and details provided above are not exhaustive and are not intended to be full and complete guidance.  No action should be taken without consulting detailed legislation or seeking independent professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material contained in this article can be accepted.