Basis period reform: new rules need forethought

For many, managing your tax responsibilities is going to require more forethought over the next 12 months, as plans to change the tax period go ahead this year.

Until now, sole traders and partnerships have been able to choose the dates on which their income tax year begins and ends. However, the rules are now being changed by HMRC so that everyone’s tax year has to run from April to April.

This is going to cause some disruption during the forthcoming transition period, in particular for businesses who may have to pay income tax and National Insurance for up to 23 months, all in one go.

The bigger picture of all of this is HMRC’s ambitious Making Tax Digital programme, attempting to get everyone operating under the same accounting timescale and reporting more regularly. Although that programme has recently been pushed back, this Basis Period Reform is still going ahead as planned.

What are the new rules?

From April 2024, all unincorporated businesses will need to pay tax based on profits earned in a tax year running from 6 April to 5 April (or the 31 March, which is deemed equivalent).

However, for businesses which have accounting periods falling outside that window, they will have to apportion profits from two accounting periods or change their accounting periods so that they fall within the timeline.

The transition period

This year, 2023/24, is being treated as the transition period. So in the current tax year, all unincorporated businesses will be taxed as per their usual accounting reference date, in addition to further profits arising up to 5th April or 31st March 2024. This extra-long tax period could hypothetically run up to almost two years, for example if the tax year of the business normally begins and ends at the end of April.

In order to provide relief, to cushion the additional tax burden the new rules are going to create in the 2023/24 transitional year. HMRC will allow for additional transitional profits (less any overlap relief available from when the business started) to be spread over a period of up to five years.

It’s important to note that you can be flexible with those five years. In theory the spread should be 20 per cent each year, but the new rules allow you to bring forward your payments to allow for any reduction in income. This allows businesses to plan for an even keel, rather than dealing in peaks and troughs.

Our advice

In most circumstances, we would recommend businesses charge their year end to 31st March or 5th April, although this does need to be considered carefully because it can depend on your business results during the effected period, future projections and other factors that may influence your decision to use a certain year end.

Businesses need to plan ahead for the potential that the January 2025 tax bill – the date on which the tax for the transition period is due – is likely to be bigger than usual. Transitional profit relief calculations are intricate and complex, so we recommend you get in touch with your accountant as soon as possible.

Worst case scenario

At the extreme end of the potential spectrum, those who are being taxed over a 23-month period in one go may end up in a higher rate tax band.

For example, if you make a profit of £50k per year, normally you’d pay no tax on the first £12.5k as this is covered by your tax free personal allowance, and 20 per cent on £37.5k up to the £50k mark. However over a 23-month period, you’ll be looking at closer to £95k of profit during that period. That extra £45k will be taxable at 40%. This will rise even further if you go over the £100k threshold as you will lose some of your tax free personal allowance, due to tapering.

In such cases, spreading the burden under the transitional rules is really important so you need to think carefully about how this can work best for you.

HMRC has put provisions in place to stop the reform causing problems with the Child Benefit High Income Charge (CBHIC), which relates to profits over £50k and the pension annual allowance taper at £260k.

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.