Basis Period Reform: Simplifying Tax Reporting for Businesses

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The introduction of basis period reform represents a major shift in how unincorporated businesses report their taxable profits. From the 2024/25 tax year, sole traders and partners must align their assessable profit reporting with the tax year (6 April to 5 April). This reform, brought in by the Finance Act 2022, aims to simplify the process while ensuring greater consistency in tax reporting.

For many, this change will be straightforward, especially for businesses already using a 31 March or 5 April accounting date. However, those with different year-ends may need to adapt, as profits will now be apportioned across two periods. This article outlines the key aspects of the reform, providing practical insights and actionable steps to help businesses navigate the transition.

Contents

• Overview of Basis Period Reform
• Key Changes and Implications
• Transition Year - Overview
• Transition Year - Assessable Profits
• Practical Steps for Businesses
• What Should You Do?

Overview of Basis Period Reform

Basis period reform changes the rules for how unincorporated businesses report taxable profits. Instead of the previous current year basis (CYB), businesses will now use a tax year basis. This means profits will align with the tax year, regardless of the business’ chosen accounting date.

What This Means for Businesses

• Businesses already using a year-end between 31 March - 5 April will be largely unaffected by these changes.
• Businesses with different year-ends will need to apportion assessable profits from two sets of accounts to align with the tax year.

While businesses can retain their preferred accounting date, those not aligned to 31 March or 5 April will likely face additional administrative work, as they must apportion taxable profits across two accounting periods for each tax year. For example, a business with a 30 June year-end would need to calculate:

• Accounts Year 1 - three months of profits from the year ending 30 June that fall within the tax year (April - June); and
• Accounts Year 2 - nine months of profits from the subsequent accounting year (July to March) to complete the tax year.

Consequently, impacted businesses may need to rely on provisional figures if their accounts are not finalised before the self-assessment filing deadline. Provisional figures must then be corrected later by submitting an amended return, increasing the annual compliance burden and exposing businesses to the risks of interest and/or penalties if estimates are deemed unreasonable.

Key Changes and Implications

From the 2024/25 tax year:

• Tax Year Basis: Reported profits must be aligned with the tax year. For most businesses, opting for an accounting year-end of 31 March or 5 April will reduce complexity and avoid the need to apportion profits annually.
• Overlap Relief: Businesses can deduct overlap profits—amounts taxed twice under the previous CYB rules—in the 2023/24 transition year, which is detailed further below.
• Profit Apportionment: Businesses with year-end dates not between 31 March – 5 April will need to apportion profits from two accounting periods to align with the tax year. This involves calculating proportions of profits from two sets of accounts, based on the number of days falling within the tax year.

This reform introduces notable simplifications in the long term but presents temporary challenges during the transition period.

Transition Year - Overview

The 2023/24 tax year is a transitional period designed to bridge the gap between the CYB and the tax year basis. During this year, businesses must account for profits covering:

• The Standard Part: The 12 months following the end of the 2022/23 basis period.
• The Transition Part: The period from the end of the standard part to 5 April 2024.

For example, a business with a 31 December year-end will report:

• Profits for the year ended 31 December 2023 (the standard part), and
• Profits for 1 January to 5 April 2024 (the transition part).

This process ensures a clean transition to the tax year basis from 2024/25 onwards. For businesses not already aligned with the tax year, assessable profits during this period will likely cover a period exceeding 12 months.

In this case, traders must calculate the ‘additional’ profits relating to the Transition Part of the period, which are classified as ‘transition profits’ – these are subject to specific rules designed to mitigate the resulting tax impact.

Importance of Transition Profits

Transition profits are governed by specific rules to manage the tax implications of transitioning to the tax year basis. These rules ensure fairness while minimising undue financial strain on impacted businesses. The key takeaways for transition profits are:

• Overlap Relief: Transition profits are first reduced by overlap relief, which offsets amounts previously taxed twice under the CYB rules.
• Spreading: Any remaining transition profits are automatically spread and assessed evenly over five years (2023/24 to 2027/28). This default approach helps businesses manage cash flow by smoothing the additional tax burden across multiple years.
• Option to Accelerate: Businesses may also elect to accelerate the taxation of transition profits, bringing a larger portion into account in earlier years. This flexibility can be advantageous when traders experience income fluctuations or have unused reliefs.
• Separate Income Component: Transition profits are treated as a separate component of income, impacting the calculation of personal allowances and pensionable earnings. However, they are not considered when calculating the high-income child benefit charge or the pension annual allowance restriction.

These special rules emphasise the importance of early preparation and strategic planning. By understanding and applying these measures effectively, businesses can better manage both immediate and future tax liabilities while ensuring compliance with the new reporting basis.

Transition Year - Assessable Profits

Finance Act 2022 sets out the 6-step process used to calculate the assessable profits for 2023/24:

1. Standard Part: Calculate profits/losses for the first 12 months of the basis period.
2. Transition Part: Calculate profits/losses for the remainder of the basis period to 5 April 2024.
3. Overlap Relief: Deduct any unrelieved overlap profits from the transition part (step 2).
4. Combine Profits: Add the results of Step 1 and Step 3. If either Step 3 or Step 4 is nil or a loss, the total profit/loss for the period is the result of Step 4.
5. Transition Profits: Calculate the transition profits for spreading or acceleration. This is the lower of the results of Step 3 and Step 4.
6. Spread or Accelerate:
   • If Step 1 is nil or a loss, the profit of 2023/24 is the appropriate amount of the transition profits (20%, or more if elected).
   • If Step 1 is a profit, the profit of 2023/24 is the result of Step 1 + the appropriate amount of the transition profits (20%, or more if elected).

Example:

A sole trader with a 31 December year-end has the following annual profits:

• Dec-23: £25,000
• Dec-24: £40,000
• Overlap Profits: £2,500

For the transition year (2023/24):

• Standard Part: £25,000 (profits to 31 December 2023).
• Transition Part: £10,000 (3/12 of 2024 profits).
• Adjusted Transition Part: £7,500 (£10,000 - £2,500).
• Total Profits: £32,500 (£25,000 + £7,500).
• Transition Profits: £7,500, spread over five years (£1,500 annually).
• Assessable Profits: £26,500 for 2023/24 (£25,000 Standard Profits + £1,500 Transition Profits).

In this example, the remaining Transition Profits (£6,000) will be evenly spread over the following 4 tax years, unless an election to accelerate the profits is made.

Practical Steps for Businesses

To prepare for basis period reform and manage the transition effectively:

1. Review Your Accounting Date: Consider aligning your year-end with 31 March or 5 April to simplify compliance.
2. Identify Overlap Relief: Ensure accurate records of overlap profits and request figures from HMRC if necessary.
3. Plan for Cash Flow: Understand how transition profits impact your tax liabilities and assess whether spreading or accelerating transition profits is most beneficial.
4. Seek Expert Advice: Work with a tax advisor to navigate these changes and ensure compliance with the new rules.
5. Monitor Filing Deadlines: Stay vigilant about self-assessment deadlines and amend provisional figures promptly if necessary.

What Should You Do?

Basis period reform introduces significant changes to how unincorporated businesses report profits, streamlining reporting and aligning assessable profits with the tax year. While the reforms aim to simplify compliance in the long term, the transition period presents challenges that require careful planning and attention.

By understanding the rules, preparing early, and seeking professional advice, businesses can minimise disruptions, manage their tax liabilities effectively, and ensure a smooth transition to the tax year basis.

Get in Touch

For more information on basis period reform and how it affects your business, contact us today to arrange a free initial consultation.

This article provides general information and should not be considered professional advice. It reflects legislation and practices at the time of writing, which may change. Individual circumstances vary, so please consult us before taking any action. We accept no responsibility for financial loss arising from actions taken without our written advice.

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AUTHOR

Liam O'Riordan

As Principal at Veritas ATS, I help start-ups, owner-managed businesses, and individuals simplify accounting and tax, providing clear, practical solutions tailored to their needs.

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