Are you prepared for changes to the income tax basis?

Unincorporated businesses, including sole traders, the self-employed and trading partnerships, will be taxed on profits generated in the 12 months to 5 April each year from 2024/25.

This is a significant change to taxation, which removes the basis period rules and prevents the creation of further overlap relief in a new system known as the ‘tax year basis’.

These changes were meant to be brought in a year earlier but were delayed by the Government in September 2021 to give those businesses affected more time to prepare. 

Now the clock is ticking once again on these changes and unincorporated businesses must start preparing now.

The basis period system

Unincorporated businesses are not required by law to produce accounts, or to produce them to a particular date, meaning they can choose any accounting date they like.

Instead, they are currently taxed on profits or losses arising in the accounting period for the 12 months ending with the accounting date which falls in the tax year, known as the ‘current year basis’.

For example, an accounting period ending on 31 December 2022 would be taxed on profits arising in the 2022 calendar year, rather than the 2022/23 tax year.

As a result of this, an unincorporated 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’.

However, specific rules do determine the basis period during the early years of trading.

Where the accounting end date is not 5 April or 31 March, which is the equivalent of 5 April for the first three years of trade, the rules can create overlapping basis periods.

This creates a tax charge on profits twice and generates ‘overlap relief’, which is received when the unincorporated business eventually ceases trading.

The new tax year basis

The latest reforms will change the basis period for all unincorporated businesses to the end of the tax year (5 April) from 2024/25, regardless of their current accounting period.

This will create the need for interim arrangements for businesses that do not currently have year-ends falling between 31 March and 5 April each year.

These businesses will potentially face a single, higher tax bill from their profits arising in the year-end falling in the 2023/24 tax year to 5 April 2024.

According to HM Revenue & Customs (HMRC), businesses with a different accounting period end date to the end of the tax year: 

  • Will need to apportion profits/losses
  • May need to use provisional figures in their tax returns
  • The statutory rule that deems 31 March to be the 5 April in the first three years of a trade would be extended to apply to all years.

Despite the changeover, reliefs, allowances and tax band thresholds will remain unchanged and will not be pro-rated.

As a result, some taxpayers could move into higher tax bands, while also reducing their ability to benefit from various annual reliefs and allowances during the transition year.

Businesses with year ends not aligned with the tax year will also have a much shorter time between when they generate profits and when tax is due, which could have cash flow implications.

What help is available? 

HMRC is still considering an election to allow businesses with higher profits, due to the change, to spread those additional profits equally over five years. The tax authority will also provide ‘Time to Pay’ arrangements for those needing to spread the costs further. 

Businesses can also use all overlap relief accrued when they began trading during the transition year (2023/24) to soften the blow. This would mean that businesses in this position will only have tax to pay on 12 months’ profits.

However, overlap relief dates back to the first year a business traded, when it is likely to have been much less profitable.

Due to the introduction of these rules, new businesses will not generate overlap relief from 2024/25 and there will be no special rules required for starting or ceasing trading or for a change in the accounting period end date.

For the many unincorporated businesses that already have year-ends aligning with the tax year, nothing will change.

However, for those with year-ends that are not synchronised with the tax year, there are several considerations and careful tax planning may be necessary.

Link: Basis period reform