11 June 2024
Since 6 April 2024, a new ‘tax year basis’ of assessment applies to trading profits subject to income tax. Richard Hattersley, managing editor of AccountingWEB, explores the changes and what they could mean for certain organisations
The basis period reform is a fundamental change in the way unincorporated businesses calculate their trading profits for tax purposes. As a result, all unincorporated businesses will now use the UK tax year of 6 April to 5 April as their basis period for income tax assessment.
This is the first year in which profits need to be reported to the tax year end, as basis period reform kicks off with the 2023/24 ‘transition year’.
Simple, right? Not quite. As one AccountingWEB reader noted in an article on the site about the changes ahead for unincorporated businesses: “Now, I’m not uneducated, but given my day job is not in compliance, I’m not sure where I would begin to understand the rules.”
The change will also present extra administration for businesses that don’t draw accounts up to 31 March or 5 April.
What, who, why and when?
So let’s look at what’s changing, when it’s changing and who it’s going to impact.
Incorporated businesses have reported their profits and losses under the ‘current year basis’ since 1996/97, when they could calculate their taxable profits based on their accounting period wherever that fell in the tax year. So, the switch from the current year basis of assessment to this new tax year basis is quite the transition for some businesses.
These reforms have come into force to make the basic assessment of trading profits more straightforward and align with other sources of income. One benefactor of this change is making tax digital for income tax self-assessment (MTD ITSA), since the tax year will now be aligned to all unincorporated businesses’ accounting periods.
Those that draw their accounts up to and between 31 March to 5 April breathed a sigh of relief as these changes don’t affect them, as those periods are treated as the 5 April. The businesses affected by this change are those subject to income tax, such as sole traders and individual partners.
Seasonal businesses like farmers or even creative artists are good examples of those affected. Farmers typically have an accounting period which falls just after the majority of their income for the year has been realised. The reforms mean they will instead have to switch to drawing up their accounts to a date in the middle of their busy season.
Repercussions of the reform
The tax year 2023/24 marked a transition to the new tax year basis of assessment, with specific rules applying during this period that could lead to additional ‘transition profits’.
In a recent article on AccountingWEB, Emma Rawson outlined some of the tax implications in the transition year.
Transitionary head scratchers
Transition profits resulting from the basis period reform aren’t included in net income when carrying out the income tax calculation for the year; instead, they‘re subject to a separate tax charge. This exclusion prevents potential impacts on other tax aspects like the high income child benefit charge threshold and the pension annual allowance taper calculation, although transition profits do count towards relevant UK earnings for pension tax relief.
Personal allowance
Transition profits, although excluded from net income, can still affect personal allowance tapering if they push a taxpayer’s net income over £100,000, impacting the loss of personal allowance.
Tax payments
Basis period reform doesn’t alter tax payment deadlines but may impact payments on account (POAs), potentially increasing them if transition profits inflate the previous year’s tax liability, requiring taxpayers to ensure POAs remain appropriate.
How does the basis period interact with capital gains tax (CGT)?
HM Revenue and Customs (HMRC) clarified that basis period reform doesn’t affect CGT rates, as transition profits are subject to a separate tax charge and not tied to specific income tax rates.
Benefits and the basis period
Taxpayers receiving tax credits or universal credit should not include transition profits when reporting earnings to the Department for Work and Pensions, but additional tax or National Insurance contributions due to basis period reform could impact universal credit eligibility, requiring careful consideration.
Student loan repayments
Basis period reform affects student loans as transition profits impact loan repayments and household income assessments, potentially pushing taxpayers over repayment thresholds unexpectedly.
Confusion for sole traders
While the agent community has been aware of these changes for some time, many unrepresented taxpayers only realised the change recently ahead of the 2023/24 transitional year as a result of HMRC’s targeted campaign in February.
As the article has probably already
set out, the implications of the reform aren’t the easiest to understand so many taxpayers may have been left scratching their heads when the brown envelope from HMRC dropped on their doormat.
However, HMRC also launched an interactive tool to help taxpayers navigate the changes ahead. The tool is designed to assist sole traders in completing their 2023/24 self-assessment tax return correctly.
But it wasn’t a completely smooth ride from there. When AccountingWEB’s tax editor Amy Chin tested the tool in April, she discovered that once the tool spits out the figures, the guidance on where on the self-employment pages of the tax return they should go is hard to find and unclear. “This, as well as ambiguous and inconsistent wording of some of the questions within the tool, is likely to cause confusion for taxpayers and accountants”, wrote Chin.
Next steps
That’s a whistle-stop tour through the story so far with the basis period reform. The first POA will be due on 31 July 2024 for the next tax year. And so, although it’s not in the first quarter, people are going to have to start thinking about cashflow and spreading the overlap relief.
The basis period reform should remove some of the complexity around taxable profits. But as agents and taxpayers start to prepare and file tax returns for 2023/24, there will likely be further headaches and tricky interactions that come to light.
This article featured in the July - August 2024 issue of Professional.