27 Jun Changes to how self employed business profits are taxed from 2023/24 – Basis Period Reform
Are you self-employed or a partner in a trading partnership?
If so, you should be aware of how the ‘basis period reform’ may affect you.
A major change in tax is being introduced from 6 April 2024, resulting in self employed individuals being taxed on the profits made within the tax year irrespective of when their accounting year ends.
This will impact businesses who do not have a 31 March or 5 April year end and who previously have only been taxed on the profits of the accounting year which ended within the tax year.
Self employed people who have an accounting period that aligns with the tax year will continue as normal.
What is a ‘basis period’?
Self employed generally prepare accounts to the same fixed date each year. This is known as the ‘basis period’.
Specific rules determine the basis period in certain cases, including during the early years of trading. These rules can create overlapping basis periods which can result in profits being taxed twice which generate ‘overlap relief.’ This is usually released on cessation of the business or retirement. Overall, this basis of taxation is called the ‘current year basis.’
For example, currently, if a business draws up its accounts to 30 April, in the 2022/23 tax year, it will be taxed on the profits for the year ended 30 April 2022.
The change in ‘basis period’ will result in a significant impact for the tax year to 5 April 2024 as businesses without a 31 March (or 5 April) year end will be taxed on more than 12 months profit, being the profits to their current accounting year end plus the profit between that date and 5 April.
Transitional rules for the 2023/2024 tax year
In the transitional year, self employed businesses that do not have an accounting year end date between 31 March and 5 April will need to recognise two profit elements:
- The usual profits of the accounting period ending in the 2023/24 tax year; and
- The profits from the period starting immediately after the end of that accounting period to 5 April 2024, less any available overlap relief brought forward
A self employed business with a 30th April year end will be exposed to paying tax on nearly 2 years profit under the new rules, creating a significant cashflow disadvantage.
There are two ways that this can be managed:
- Where an individual has unused overlap relief available from the start of their trade (or a previous year end change), this can be offset against the profits of the additional period; and
- Businesses can elect to spread the additional profits over 5 years.
If you fall within the criteria which requires a change in the basis period for your business, it’s important to realise that you will not pay additional tax, but there may be an acceleration in the payments of tax you owe.
What to consider:
These changes are intended to simplify tax for the self employed but they can create complexity for those affected. The change to the basis period will simplify reporting requirements as the Making Tax Digital for Income Tax Self-Assessment (MTD ITSA) changes are eventually rolled out.
Think about the cashflow implications of the changes and how you will manage them.
Give some thought to changing your year end to 31 March to make the calculation of taxable profits from 2024/25 clearer.
The changes may result in significant tax balances owing through the transitional period, so it pays to plan ahead and be prepared for the change.
For further information visit: https://www.gov.uk/government/news/how-hmrc-assesses-profits-for-some-sole-traders-and-partnerships-to-change#:~:text=Changing%20your%20accounting%20period,31%20March%20or%205%20April.