The Basis Period Reform is a significant change for sole traders and partners, designed to align taxable profits with the tax year (6 April to 5 April). Previously, the profits taxed were based on the business’s accounting year, which didn’t always match the tax year, leading to complexity and confusion for both taxpayers and HMRC.
Why the Change? The reform aims to simplify the tax system by removing overlaps between accounting periods and tax years, which often caused errors or miscalculations. It also helps to modernise tax reporting as HMRC moves towards Making Tax Digital, streamlining how businesses report their income.
Impact on Taxpayers: For businesses with year-ends not aligned with 31 March or 5 April, the shift could mean paying tax earlier than expected during the transition year (2023/24), as profits will be calculated over a longer period. This could potentially increase traders’ tax liability.
Example 1: Trader with 31 October 2023 Year-End: Let’s say a trader’s accounting year ends on 31 October 2023. For the 2023/24 tax year under the new basis period reform, this trader will need to declare profits from the 12 months to 31 October 2023 (their normal accounting period) plus an additional five months’ worth of profits from 1 November 2023 to 5 April 2024. This essentially means they will be taxed on 17 months of profits in the 2023/24 tax year.
The extra five months’ profits can be offset with the use of overlap relief to reduce the tax burden if overlap profits were generated in earlier years. Additionally, any excess profits resulting from this change can be spread over five years to help ease cash flow pressures.
Example 2: Trader with 30 April 2023 Year-End: For a trader with a 30 April 2023 year-end, the situation is slightly different. In the 2023/24 tax year, they will need to declare profits from the 12 months to 30 April 2023 (as part of their normal reporting) plus an additional 11 months’ worth of profits from 1 May 2023 to 5 April 2024. This means they will be taxed on 23 months of profits in 2023/24.
Again, this longer period of taxation results in additional profits against which the trader can claim overlap relief to help reduce the tax liability. Additionally, the option to spread excess profits over five years can help ease the cash flow burden during the transition period.
Don’t Leave Filing Until the Last Minute! Understanding these changes is crucial, especially if you’re used to leaving your tax return until close to the deadline. With the reform, you’ll have a longer period of profits to report—which means more work to prepare accounts. This may take longer than usual to gather and process your financial information. Filing late could leave you scrambling to compile all the required details, increasing the risk of errors or missing out on valuable reliefs. Being proactive will help you avoid last-minute stress and ensure you take full advantage of available options like spreading excess profits or claiming overlap relief.
How to Navigate the Change:
- Review Your Accounting Date: Consider changing your year-end to 31 March or 5 April to simplify reporting and avoid potential complications.
- Plan for Increased Tax Liabilities: Start planning for potential higher tax bills and speak to an accountant to estimate your liabilities.
- Cash Flow Management: Ensure you have sufficient reserves to meet any additional tax due in the transition year.
- Claim Overlap Relief: Overlap relief allows you to claim back tax on profits taxed twice in previous years due to overlapping accounting periods. This relief can help offset the extra tax liability that may arise during the transition year.
- Spreading Excess Profits: If you face a large tax bill due to the reform, you can spread the resulting tax on excess profits over five years, easing the immediate cash flow burden.
- HMRC Overlap Profit Service: HMRC can provide details of your overlap profits, which can be used when claiming relief. You can request this information through the HMRC service here.
Need help understanding how Basis Period Reform affects you? Contact us at Ian Richmond Limited for expert advice on planning ahead, claiming overlap relief, and minimising any disruptions to your business finances.