Basis Period Reforms – FAQs

Understanding the Basis Period Reforms

Basis Period Reforms affect how profits are taxed for unincorporated businesses (like sole-traders, partnerships and LLPs). The aim of the reform to basis period rules is to make the basic assessment for trading profits simpler and aligned with other sources of income which link in with the government’s plans for Making Tax Digital (MTD).

The key reform involves the move from the ‘current year’ basis to a ‘tax year’ basis’. Therefore, the business’s profits (for tax purposes) will be calculated for the tax year rather than for the period of account (i.e. the accounting year) ending in that tax year. Although these reforms take effect from 6 April 2024, the tax year 2023-24 is being treated as a ‘transitional year’.

Further detail on these rules and their consequences can be found here.

What impact will the Basis Period Reforms have?

As a reminder, these changes throw up several challenges:

• Businesses whose accounting period does not match the tax year will be required to apportion profits to adjust their taxable results to the tax year basis. The apportionment exercise is likely to require a degree of estimation which can be a challenge in itself. Thereafter, once the accounts have been finalised, the tax return will need subsequent amendment, resulting in additional work.
• The estimation of profits and subsequent amendments of the tax returns can lead to interest charges (which currently stands at 7.75% pa) and potentially late payment penalties should the final reported profit by higher.
• Whilst any unused overlap relief brought forward must be utilised in the transitional year (i.e. tax year 2023-24), this is likely to result in significantly higher tax bills. Depending on the accounting date of the business, this could potentially bring almost up to two years’ profits into charge for the tax year 2023-24.
• If there is not a record of the overlap relief brought forward, this can be requested from HMRC who have set up an online request form available here.
• These reforms permit the transitional profit to be spread evenly over 5 tax years (as the default position). However, individuals can elect for the transitional profit to be taxed in full in the transitional year. Alternatively, they can also elect for the additional profit to be ‘accelerated’ during the 5 years. Events like retirement from a partnership, emigration from the UK, cessation of a business, or death will invariably accelerate the tax charge on the transitional profit.
• The transitional profit will affect the personal allowance which could result in the allowance being tapered down.
• For all taxpayers, this will be a hit to cashflow and may present particular challenges for those who have recently re-financed their mortgages at higher interest costs.

Future considerations for the Basis Period Reforms

On a positive note, the transitional profit will not adversely affect the level of taxpayer’s income that is used to calculate the Annual Allowance for pension contributions and Child Benefit, and the transitional profit will be included as ‘relevant UK earnings’ for pension contributions.

A potential solution for the estimation and apportionment problem will be to consider changing the accounting end date so that it is coterminous with the tax year end being say 31 March or 5 April. However, some international partnerships may still have a preference for say a 31 December for the USA, or 30 June for Australian headquartered entities.

In the longer term, these reforms may remove some of the cashflow advantages of operating through a partnership model and make it harder for partnerships to finance their working capital.

How will these rules affect you and your business?

These rules are complex and can have far-reaching consequences. Please contact us today and we can provide further clarification on how these rules impact you, based on your individual circumstances.