As legislated in the Finance Act 2022, the government is reforming the way that trading profits are allocated to tax years for income tax purposes which is called the ‘Basis Period Reform’.
What is the basis period reform?
The basis period reform is a significant change which will affect all sole traders and partnerships who prepare their accounts to a year end date other than 31 March or 5 April (any dates between 31 March to 5 April are treated as 5 April).
Under the current rules, a business’s profit or loss for a tax year is usually the taxable profits or loss for the year up to the accounting date that falls within the tax year.
Under the new rules which take effect from the tax year 2024/25, all business profits will be taxable based on the 12 months from 6 April 2024 to 5 April 2025 regardless of their accounting year end date.
However, to bring the above rules into effect for 2024/25, the transitional rules of the reform apply to the tax year 2023/24.
Those businesses affected by the reform will be taxed on the following profits in the 2023/24 tax year:
- The standard profits – the 12 months profits to their accounting year end date, plus;
- The transition profits which are calculated as follows:
- The profits for the months remaining from the last accounts year end date to the end of the tax year (5 April), less;
- Any available overlap relief from the tax years when the business commenced will be offset against the above profits in 2023/24.
Example
To illustrate the effects of the reform, below is an example of a sole trader who prepares their annual accounts to 30 April each year with following taxable business profits:
- Year ended 30 April 2022 – £15,000.
- Year ended 30 April 2023 – £25,000.
- Year ended 30 April 2024 – £30,000.
- Year ended 30 April 2025 – £12,000.
They have available overlap relief of £5,000.
Current position 2022/23 – under the existing rules
For the 2022/23 tax year, the sole trader is taxed on the profits to 30 April 2022 of £15,000.
Transitional tax year 2023/24 – under the new rules
In 2023/24, the sole trader is taxed on the following profits:
- The standard part – Taxable profits to 30 April 2023 (12 months) – £25,000.
- Transition profits calculated as follows:
- Taxable profits from 1 May 2023 to 5 April 2024 (11 months x £30,000) – £27,500, less:
- Overlap profits available to offset – £(5,000).
- Total transition profits – £22,500 (£27,500 – £5,000).
To assist taxpayers with cashflow management of the above changes, the transitional period profits are spread equally over a period of five years from 2023/24 to 2027/28. Using the example above, this would spread the transitional profits of £22,500 over five years with the taxpayer being taxed on £4,500 per annum over the next five years instead of the full transition profits of £22,500 in the 2023/24 tax year.
Therefore, the taxpayer is taxed on the following profits in 2023/24:
- The standard part – Year end 30 April 2023 profits – £25,000.
- Transition profits – Spreading year 1 of 5 – £4,500.
- Total taxable profits in 2023/24 – £29,500 (£25,000 + £4,500).
2024/25 – Basis Period Reform rules in place
After the transitional year of 2023/24, the taxpayer is taxed on the profits arising in the tax year from 6 April 2024 to 5 April 2025 which is calculated as follows:-
- Taxable profits from 6 April 2024 to 30 April 2024 (1 month x £30,000) – £2,500, plus;
- Taxable profits from 1 May 2024 to 5 April 2025 (11 months x £12,000) – £11,000, plus;
- Transition profits – Spreading year 2 of 5 – £4,500.
- Total taxable profits in 2024/25 – £18,000 (£2,500 + £11,000 + £4,500).
Considerations
Business owners should consider the following:
- Changing your accounting year end date to 31 March or 5 April to simplify your assessable profits calculations.
- Timing of capital expenditure on plant & machinery.
- Timing of pension contributions.
- Expected future profits forecast.
- Year end tax planning before 5 April 2024.
- Consider if incorporation would be beneficial compared to your current sole trader or partnership business.
Get in touch
As the tax year for 2023/24 is already underway, we would advise business owners to consider their taxable profits position for the year ahead and get in touch with the McAleer Jackson team with any queries on the basis period reform. Our expert team can advise on the impact to your business and offer specific tax planning advice to help maximise the tax opportunities available to you and minimise your tax liabilities.
If you have any queries or require any assistance in relation to these charges, please contact the Omagh office:
The above article is for general guidance and informational purposes only and is not intended to constitute legal or professional advice. It should not be taken as specific advice for your own circumstances and relied upon. You are advised to take professional advice before taking any action in relation to the above matters.
