Changes to the tax basis period coming in the tax year 2023/24 will alter the way tax liability is calculated for unincorporated businesses (sole traders and partnerships). Here we answer your questions about basis period reform.
Who will be affected by basis period reform?
If you operate as a sole trader or in partnership, with an accounting year end date other than 31 March or 5 April (or any date between the two) the changes will affect you.
What’s actually happening?
To summarise: what is called the ‘current year basis of assessment’ will change to the ‘tax year basis’.
At present, your profit or loss is calculated with reference to your accounting year ending in the tax year. This is your individual ‘basis’ period.
With the tax year basis, you will be taxed on the profits earned in the tax year, without any reference to your accounting year end.
Why are the changes happening?
The new system is being introduced because of another major change: Making Tax Digital for Income Tax Self Assessment (MTD ITSA). This new phase of MTD is scheduled to begin for most sole traders and landlords from 6 April 2024. MTD ITSA will not apply for partnerships until later but they are affected by basis period reform.
When will the tax year basis come into effect?
The tax year basis will begin properly from 6 April 2024. However, the changes will start in the tax year from 6 April 2023 to 5 April 2024. This is the transition year.
Why does this matter?
Add basis period reform to MTD ITSA and you have two big changes landing together at the same time, the impact of which could be considerable.
Firstly, there is the question of whether you should change your accounting year end. Unless there are specific business or other reasons to keep your current year end, there may be a case for changing it to 31 March or 5 April, to get the best outcome from basis period reform and MTD ITSA. Your RfM advisor would be happy to help you review the best strategy going forwards.
Secondly, there’s the impact on tax bills. Calculating your tax bill in the transitional year (2023/24) will be different as it will use two sets of figures. The first set will use the 12 months running from your last set of accounts; the second will use the profit for the period running from the end of your normal accounting period to 5 April 2024.
Introducing this second set of figures will bring additional profits into charge to tax. And, depending on your year end, it could bring up to 11 months’ more profit into charge. The likely outcome of this is 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.
What action should I take?
As a first step, please talk to your RfM advisor who can advise on a strategy to mitigate the impact of the changes and explain the tax reliefs available.
A new relief, called spreading relief, allows you to spread transition profits over a period of up to five years. You may also have access to overlap relief. With partnerships, the position here can be complex, where each partner stands to have a different amount of overlap relief available. Things will also be more complex where there are losses.
Finally, the timing of any change to accounting year end, could affect the availability of spreading relief. Please get in touch to discuss the best approach and timings for your business.