Basis Period reform; removing the complexities

HMRC is changing how trading profits and losses are measured on tax returns. From 6 April 2024, taxable trading profits and losses must be accounted for on a Tax Year Basis.

Why is it happening?

The stated aim of HMRC is to make the taxation of unincorporated trading profits/losses simpler and fairer, whilst having a more transparent set of rules for taxpayers to follow.

In their view, the current rules for the measurement of profits and losses are excessively complex as they require special rules for: the opening years; overlap profits and relief (which is often lost or not utilised by taxpayers); and the closing years.  Under the new rules, these complexities are removed.

Who does it affect?

You must meet both of the following criteria in order to impacted by the new rules:

1. You are an unincorporated trading business (predominantly sole traders and partnerships, but others are affected too); and
2. You prepare accounts that DO NOT end on either:

1. 1. 31 March; or
   2. 5 April

For these purposes, HMRC treats a 31 March Accounting Period as being identical to a 5 April Accounting Period

When do the rules come into effect?

The changes come into effect from 6 April 2024, so it will be relevant to the tax years 2024-25 onwards however, it will affect the tax year 2023-24 (the Transition Period).

What do the new rules mean?

Current rules – the Current Year Basis (“CYB”)

Businesses generally prepare annual accounts to the same date each year – the Accounting Date. 

The CYB means that the taxable profit or allowable loss for a tax year is based on the profit or loss for the year to the Accounting Date that ends in that tax year. 

i.e. in the 2022-23 tax year, the measurement basis for taxable profits or losses would have been accounts prepared to an Accounting Date that falls between 6 April 2022 and 5 April 2023.  For example, accounts for the year ended 30 April 2022 would have formed the basis of the 2022-23 Income Tax charge.

New rules from 6 April 2024 – the Tax Year Basis (“TYB”)

Business profits or losses for a tax year are measured as the profit or loss arising in the tax year itself, regardless of its Accounting Date.  This will replace the CYB rules and will prevent any further overlap profits being created.

Transition Period – tax year 2023-24

In the Transition Period, all businesses’ basis periods will be aligned.  This means that the taxable profits for the year are likely to be higher, however any overlap relief can be claimed against these additional profits.

In 2023-24, the taxable profit/loss will be measured as:

• the period to the Accounting Date ending in 2023-24; plus
• the period from that Accounting Date up to 31 March 2024

Example – currently accounts are prepared annually to 30 April.  For 2023-24, the taxable profit/loss is measured as:

• the Standard Part - 12 months to 30 April 2023; plus
• the Transition Part - 11 months from 1 May 2023 to 31 March 2024; less
• any overlap relief available

Spreading

HMRC will allow profits for the Transition Part to be spread over a period of up to five years.

An election can be made to tax all Transition Part profits in 2023-24, if preferred

If a business ceases to trade within this five-year period, the balance of profits yet to be taxed is deemed to be taxable in the tax year of cessation.

Other points

The Transition Part profits will not form part of an individual’s adjusted net income for the purpose of the High-Income Child Benefit Charge or pension contributions.

Do you need to change your accounting year end date?

You are not required to change your Accounting Period date, but you may wish to do so because it may avoid complications and additional costs.

For example, for an Accounting Period year-end of 31 December, in the 2024-25 tax year you will report and be taxed on the profits/losses for:

• 6 April 2024 to 31 December 2024 (270/365 days of the profits to 31 December 2024); plus
• 1 January 2025 to 5 April 2025 (95/365 days of the profits to 31 December 2025)

Under self-assessment, you will have to report the profits by 31 January 2026 (at the latest) which is only one month after the end of the Accounting Period. 

It is therefore more likely that, by keeping an Accounting Period that does not align to 31 March/5 April:

• Your tax return is more complicated and therefore expensive to prepare
• There will be greater time pressures to get the work done on time
• There is a risk that provisional figures will have to be used and then corrected at a later date
• You will have less warning as to your likely tax bill

How can Haines Watts help?

As ever, it makes sense to get advice on how you can best manage this situation. We advise clients with a broad range of tax and compliance matters throughout the South West region.

If you would like to have a conversation to understand the complexities of the above, please get in touch with your usual Haines Watts contact.