The procedure for assessing when trading profits are taxed is changing radically. The change is called basis period reform.
Essentially, means there’s a different time period underpinning the tax assessment. Using the new tax year basis, tax calculations will apportion accounting profits to the tax year (unless the accounting year ends between 31 March and 5 April). They will have no direct link to a business’ accounting year end.
It’s a change that could mean higher tax bills for sole traders and partnerships.
Do I need to know about this?
Yes, if you operate as a sole trader or in partnership, and your accounting year end is anything other than 31 March or 5 April (or any date between the two). Basis period reform will affect all unincorporated businesses using year ends different from these.
What’s actually happening?
In a nutshell, there’s a change from what is called the current year basis of assessment to the tax year basis.
With the tax year basis, you are taxed on the profits earned in the tax year, without any reference to your accounting year end. At present, your profit or loss is calculated with reference to your accounting year ending in the tax year: your ‘basis’ period.
Bringing profits into tax faster
The change came into force at the start of this tax year, 6 April 2023. 2023/24 is a transition year, in which a longer period of profits falls to be taxed. Rather than assessing to tax just the profits for the 12 months of the usual accounting year, profits for the period to 5 April 2024 are also included.
In other words, the timescale for taxing those particular business profits is accelerated. Many businesses will benefit from the automatic application of what is called spreading relief, which means that 20% of the additional profit will be taxed in 2023/24, with the balance spread over the following four years. Provisions exist to minimise the impact on benefits and allowances, such as liability for High Income Benefit Charge. We can advise on the likely impact in your circumstances.
Permanent change
Apart from potentially higher tax bills in the shorter term for businesses whose year ends do not fall between 31 March and 5 April, the new basis of assessment brings permanent change to procedure.
With effect from 2023/24, taxable profits for such businesses will have to be calculated by apportioning profits for the accounting periods either side of the tax year. To do so, accounts preparation will need to follow swiftly at the end of the accounting period. The use of provisional figures, followed by the filing of amendments, will be required where year ends do not permit accounts to be finalised before tax returns are submitted. The issue will be most acute for businesses with year ends later in the calendar year, such as those with accounting dates after 30 September.
Meeting the challenge
The impact of this could be considerable, and we shall be pleased to help you review the best strategy going forwards. Unless, for example, there are particular business or other reasons to keep your current year end, there may be a case for looking at changing the accounting year end to 31 March or 5 April, in order to get the best outcome from basis period reform.
Then there’s the impact on tax bills to consider. Calculating your tax bill in the transitional year will be different. It will use two sets of figures: the first using 12 months running from your last set of accounts: and the second using the profit for the period running from the end of your normal accounting period to 5 April 2024.
Introducing this second part to the mix means bringing additional profits into charge to tax. Depending on your year end, it could bring up to 11 months’ more profit into charge. This is likely to result in higher tax bills in 2023/24.
There are other practical implications, as well, in terms of needing two sets of figures to work out transition figures.
Next steps
Talk to us. We can discuss the new system with you, and help you plan to meet the challenge:
- Changing the accounting year end to align with the tax year may be advantageous in some circumstances.
- Many businesses may also benefit from planning around cash flow to meet higher tax bills.
- We can advise on possible mitigation strategies and the tax reliefs available.
If you have any further questions / would like to discuss please get in touch with one of our experts via the contact us page.
See also our previous article on basis period reform.