Basis Period Reform Explained

In the 2021 Autumn Budget, the Government announced a reform of the way that trading profits are allocated to tax years for income tax purposes. These changes are known as Basis Period Reform. The premise is to help simplify the tax system while creating a fairer tax landscape.

These changes impact individuals who are self-employed, such as sole traders or partners in a partnership, where there is a trading year end other than 31 March or 5 April.

If this does not apply to you, then you will not be affected by Basis Period Reform.  Companies are not affected and remain subject to the normal Corporation Tax rules.

Previous System

Until now, the ‘basis period’ of taxable profits for an unincorporated business has been the accounting year. This may already be 31 March/5 April but for many businesses a different accounting date has been used.

Example one: For an accounting year end of 30 June 2022, this forms the ‘basis period’ for the 2022/23 tax return.

As the timing of tax returns and payments is relative to the end of the tax year rather than the basis period, an accounting year end early in the tax year can cause a significant time delay between when profits are made and when the tax on those profits is due. For example, the tax return for the accounting year end of 30 June 2022 is not due for submission until 31 January 2024.

New System

A reform to the basis period of assessment means that from tax year 2024/25 individuals will be taxed on the accounting profits that fall within the tax year, regardless of the accounting year end date. For example, if a sole trader has an accounting year end of 30 September, this means taxable profits from two years would need to be apportioned, with taxable profits based on the period from 6 April to 30 September of one accounting year, plus 1 October to 5 May of the next. This may result in estimating profits since figures from the later of the two accounting years may not be available by the time the tax return needs to be submitted.

Transition to the New Rules

For individuals impacted by Basis Period Reform, the tax year 2023/24 is a ‘transitional’ year to the new rules. The taxable profit for 2023/24 will be taken as the normal 12 month accounting period, plus an apportionment of profits from the end of the accounting period to 5 April 2024.

For example, with a 30 September year end, this would be the 12 month profits to September 2023 plus six months of apportioned profits to 5 April 2024.  As the tax return is due for submission by 31 January 2025, these apportioned profits may be estimated, unless the September 2024 accounts have been finalised which is unlikely.

Reliefs Available for Transition

The change in rules mean that for many individuals, more than 12 months of profits may be taxed in the 2023/24 tax year. This could be almost as much as two years’ profits for those with an accounting year end which falls just after 5 April. These additional profits are called ‘transition profits’.

In acknowledgement of this, HMRC allow for the deduction of ‘overlap relief’. This relief is the deduction of profits that were taxed twice in the first years of a business trading. Your accountant will either have a record of what these overlap profits are or can now request details on your overlap profits from HMRC. All overlap relief must be used within the transition year, even if this then results in an overall loss.

A taxpayer’s basis period and any existing overlap profits are unique to them and are reported on the individual’s personal tax return. For example, members of the same trading partnership may have different overlap profits, depending on their profit sharing or when they joined the trading partnership. Each affected individual needs to consider the impact of Basis Period Reform on their personal tax affairs.

Secondly, the remaining transition profits, after the deduction of overlap relief, can be spread equally across five years from the tax year 2023/24 to the tax year 2027/28.

Options Available

To avoid the complications of apportioning and estimating profits each year, a business’ accounting year end could be changed to 31 March/5 April (treated as the same for tax purposes to aid simplicity). This would mean that while the transition year would see a taxable period longer than 12 months, it would be based on finalised figures and going forward the accounting year would match with the tax year. This avoids any estimations or uncertainties alongside the additional administrative burden involved.

Alternatively, a business may choose to maintain its current year end. There is no requirement to change accounting year end date. However, this means that an apportionment and estimation of profits would need to be carried out every year, with a revision of the return submitted once actual profits were known as demonstrated in the example below.

Example two: A diagram to outline the transition for a 30 September year end trade that decides to maintain a September accounting year end.