Navigating the basis period reform: What do self-employed business owners need to know?

Accounts and business advisors often hold the compass for businesses and those who are self-employed amidst the turbulent waters of complex legislative changes.

Compliance, of course, is key - but you first need to know where you stand. And as HMRC aim to bring their vision for productivity, confidence, and lower administration costs into action with the basis period reform, Ian Haynes discusses how you can get to grips with the upcoming changes.

There’s no doubt that adapting to change is difficult. Learning a new basis period (a time period that determines which profits will be taxed in a particular year) can feel like adapting to a new time zone; there’ll be plenty of confusion and guaranteed lag.  Once a system where unincorporated business owners paid income taxes according to their own accounting period, often defined by the date the business started trading, but that is now a thing of the past.

Under the new legislation, businesses will be taxed on a fixed basis. Regardless of when profits are earned, businesses that usually make their accounts up to a date other than March 31 or April 5 may face a higher liability in the 2023–24 transitional year. This means that there is a potential for almost 24 months of profit to be taxed in one single period.

HMRC's aim is for a fairer and simpler tax system, but the impact on self-assessment reporting and income tax calculation will be complex for those running unincorporated businesses, whether as a sole trader or in a partnership.

With this in mind, here are 5 things to consider.

1. Know the old rules, and then unlearn the old rules

Basis period 

Knowing the basics of what a basis period is will certainly help you navigate the changes. The basis period, as mentioned earlier, is a period of time that determines which profits will be taxed in a particular year.

Once you have been established for a couple of years, this will tend to be in line with your usual accounting year-end. Soon, this will change to taxing businesses on the profits arising within one standard tax year.

2. Learn the new rules 

Transition profit

The transitional year introduces an element of transition profit for the 2023–2024 tax year for those who fall outside of the 31 March or 5 April accounting periods.

A new transition profit on top of your normal profits will mean that you could potentially be paying more tax from the end of your usual accounting period up to April 5 2024. This will span from the end of your usual accounting date to April 5, 2024, and be taxed in addition to your usual profits. The transition profit will be apportioned by default over five years up to the financial year 2027-2028, with 20% taxed each year.

Going forward, you’ll need to consider any transition profit alongside normal profit with the option to pay tax on a transition profit sooner.

3. Assessing how the transition period will impact you

Next, you’ll need to assess what impact these have on your income tax during the transition period.

Additional taxes are attributed to the 2023–24 transitional period

This is the profit accrued in the period beginning immediately after the end of your usual basis period (so most likely your normal account year-end) and ending on April 5, 2024.

If you find that you fall outside of the 31 March or 5 April accounting periods, you should speak to a trusted advisor to determine how best to navigate the upcoming transition period. 

Estimated profits

The new system may allocate profits from two different accounting periods. So, profits generated in the latter period may not be known by the time it comes to filing tax returns. 

For example, if you have a December year-end, you would only have a month to get your bookkeeping finalised for the year, passed to your accountant for your accounts to be prepared, and agreed upon—all before the filing deadline of January 31.

If this is ever the case, profits for the post-year-end period may need to be estimated, and it goes without saying that if you can avoid this, then you should.

Overlap relief 

Despite the added transitional profit, there is some good news here. Taxes on the transition profits generated by self-employed business owners will initially be spread over the course of five years. The impact of this may be lessened further by utilising overlap profit relief in the current year. Normally, this is only available when you either stop trading or change your year end, and it effectively reduces your taxable profits in the relevant tax year.

It’s important to note that any overlap profits available must be set against the results for the 2023–24 tax year, with no option to defer use. Even if you have the transition profit spread over the full five years, 100% of the overlap is used, first against the transition profits and then against other profits.

Depending on the circumstances, the use of overlap profit relief may result in a loss claim. For more information on how to use such losses, you should speak to a tax advisor.

4. Review your tax approach

Reviewing your approach with a tax advisor can add value to your cash flow in the long term during this complex transition period. Here are a few areas that might be relevant:

Amending your accounting period

Changing your accounting date to conform to the basis period reform ahead of the transition period might be a good option for some, but this won’t work for all businesses. If this is something you’re considering, speak to an advisor.

Recognition of additional profits

Reviewing the utilisation of the additional profit allocation over the 5 year period may be beneficial, helping you take more strategic control over your taxes.

Spreading the transition profits

Thinking about your cash flow is important. Spreading transition profits will allow you to mitigate unmanageable tax liabilities. 

Extending your loss period

If a loss occurs within the transitional year, a business can treat it as ceasing on April 5, 2024, for the purposes of terminal loss relief rules, meaning you’re able to carry a loss back for up to three years rather than just twelve months under normal rules.

Timing of income and costs

The opportunity may arise to control or alter the date on which income is generated or expenditure is incurred or recognised. If so, some thought should be given to accelerating or deferring transactions with the transition period in mind.

5. Stay informed

Although the wheels are already in motion for the basis period reform, further guidance from HMRC is expected, and anything up to this point is provisional. 

Staying informed and discussing any changes with a trusted tax advisor is the best way to stay on top of the complex legislative changes.

Supporting you during the transition

As with any new legislation or reform, navigating the transition can be a minefield. Our team of experts is always on hand to guide you through the upcoming changes and provide valuable advice on your tax position going forward.