We are currently in the transition period for the basis period reform, which is set to come into full effect from the 2024/25 tax year.
So, if you run an unincorporated business, you need to be prepared for the upcoming changes.
What are the current rules?
If you run an unincorporated business, such as being a self-employed sole trader, you are taxed on profits within your accounting period in a particular tax year.
This basis period can start from any date within the tax year, so you are currently able to choose your accounting date.
However, in your initial trading years, your basis period will be impacted by certain regulations.
When the accounting period end date doesn't align with 5 April or 31 March—which are treated as equivalent for the first three years of trading—existing rules may generate overlapping basis periods.
This can lead to double taxation on profits, prompting the provision of "overlap relief" when the business ceases operations.
The distinct rules for trading profits compared to other income types, like dividends and property income, which are taxed on a tax-year basis, could create confusion for some taxpayers.
What is changing?
From 6 April 2024, the basis period for all unincorporated businesses will move to the end of the tax year.
This means that if your current year-end does not fall between 31 March and 5 April, you need to get ready for the shift.
How could this impact your business?
If your current year-end falls between the above dates, you could also face a large singular tax bill when the year-end is updated.
This may arise from being required to pay taxes on up to 23 months of profits, from the 2023/24 tax year of profits within one year.
You may also need to use provisional figures in tax returns if you have not prepared your accounts and tax computations before the deadline.
Whilst tax bands and allowances will not change and will be pro-rated, which could result in you moving into a higher tax band and being unable to benefit from certain annual reliefs and allowances, such as child benefits.
Cash flow implications may also arise due to a shorter period between profit generation and tax payment.
What support can you get?
HMRC is considering options to mitigate the impact of these changes, such as allowing businesses to distribute additional profits over five years or offering extended payment schedules.
Businesses can use any accumulated overlap relief during the transition year (2023/24).
This means that these businesses will only be liable for 12 months' profits, though the relief may be based on less profitable years. After the transition period ends, overlapping relief will be abolished.
If your profits are small, it may be possible to bring forward your year-end into the previous tax year via your 2022/23 tax return so that it is more in line with the new set year-end, and you aren’t significantly penalised by the change in rules.
Preparing for this reform requires careful tax planning. Get in touch with our team for support.