What is the basis period?
The basis period is the accounting period on which a business calculates their tax each year.
Ordinarily the basis period on which a business is taxed is the 12 month accounting period that ends within that tax year (“current year basis”) however from 2024/25 all unincorporated businesses (sole traders, partnerships and LLPs) will have to use the tax year as their basis period (“tax year basis”).
For those with an accounting date of 31 March / 5 April, there will be minor impact. Individuals and partnerships with a different year end will be affected.
2023/24 Transitional Year
To allow everyone who does not have 31 March / 5 April year end to move onto the “tax year basis” there is a transitional year in which more than 12 months of profit will be taxed. The transitional year is 2023/24 i.e. the current tax year.
In the current tax year taxpayers will report the profits from their business to their usual accounts year end. Also for the period from the end of this accounts year until the end of the tax year. A business with an October year end will show their profits in the accounting year to October 2023 plus the 5 month period to 31 March 2024.
Most individuals with non tax year end accounts will have overlap relief available to set against these additional profits. For many, as the overlap would have been created when the business was in its first few years the likelihood is that the overlap relief is low. This will not cover the additional profits that have been brought into the scope of tax.
With this in mind, and with the potential for substantial tax bills as a result, HMRC are allowing for the additional profits that are being brought within the scope of tax in the 2023/24 tax year to be spread over five tax years.
Careful consideration will need to be paid to the amount of additional profits being taxed and the timing of this. Whilst the additional profits do not affect income for the purpose of pension annual allowance or high income child benefit charges it will impact on personal allowances and tax rate bands. Business owners could find themselves paying tax at higher rate (42%) or even the additional rate (47%) where they haven’t before. Some may also find that a previously unrestricted personal allowance is now being tapered as a result of the additional earnings being taxed.
Apportionments & Estimates
Given the need for income to be reported from two different sets of accounts going forward there is going to be an increased administrative burden on business owners and their advisors.
Clients who have accounting dates falling in the latter part of the tax year (e.g. 31 December) may not have their second set of accounts and tax computations prepared by the filing deadline for the tax year in question. As a result, these clients, whether sole traders or partners, will need to submit estimated figures for next year’s accounts on their self-assessment tax return. Amended tax returns would then have to be submitted when the accounts are finalised.
One of the potential solutions for businesses would be to change their accounting year end so that it is aligned with the tax year, however in many cases, there will be commercial reasons that override the desire for the simplicity that a change of accounting date may bring. In other cases, it is worth having the conversation with your advisors early to determine whether a change of accounting date would be beneficial, and if so when it should take place.
The change to the timing of tax payments may result in a cashflow issue for some businesses. Therefore, it’s essential that business owners consider the new basis period reform rules. Ensuring adequate reserves are in place to meet these accelerated liabilities.
Timing on capital expenditure should also be considered in the current year. If business owners are keen to ensure relief is given at the earliest possibly opportunity. In the example above of a business with a 31 October year end they would want to ensure any large purchases are made in the accounting year to 31 October 2023 as these will be included in full in the 2023/24 tax year. If the purchase falls into the next accounting year only 5/12ths will be relieved in the 2023/24 tax year with the remaining 7/12ths being a year later in the 2024/25 tax return.
Given the many changes that the basis period reform will bring it is important to understand how these changes will impact your personal tax position and the options available to mitigate any additional taxes as far as possible under this new regime.
If you require further information on the changes to basis periods, please do not hesitate to contact Charlie Dunning, any member of our dedicated Private Client team or your usual AAB contact.