News - Tax

Basis period reform

4 April 2024

You may be aware that from 6 April 2024, HMRC will be changing the way that self-employment and partnership income is to be assessed due to basis period reform.

What is the current situation?

Currently, the accounting period ending within a particular tax year will be the basis of assessment for that tax year, each tax year running from 6 April to the following 5 April.

For example, accounts prepared for the year ended 31 October 2023 would fall within the 2023/2024 tax year and would therefore form the basis for that tax return.

What will change?

As a result of basis period reform, for the 2024/2025 tax year onwards, the profits HMRC assess will follow the tax year. Therefore, for any unincorporated business with a year end falling part way through the year, they will not only be assessed on the profits to their usual accounting year end date, but will also have a second period assessed up to 5 April 2025.

In our previous example, the assessable profit in 2024/2025 would be:-

Profits of the year ended 31 October 2024 plus profits of the period 1 November 2024 to 5 April 2025.

Who will be affected?

Any sole trader or partnership whose accounts are not drawn up to a year end between 31 March and 5 April. (HMRC accept that a 31 March accounting year end meets the criteria for this new regime).

How will this work in practical terms?

There are two options:

Option One

Continue with your traditional year end and time apportion profits from the second period. In our previous example this would mean assessable profits in 2024/2025 would be:-

Profits of the year ended 31 October 2024 plus 5/12ths of the profits of the year ended 31 October 2025.

The obvious problem with this is ensuring that the later set of accounts are prepared so close to the tax return filing date, which for the 2024/2025 tax return is 31 January 2026.

It is likely that estimates will need to be used (especially for accounting periods ending later in the tax year) and amended at a later date (effectively, meaning two tax returns each year instead of one!).

Option Two

Extend the accounts basis period to fall in line with the tax year. This would be more straight-forward and negate the need for estimated profits.

Should I change my accounting year end date?

You are not compelled to change your year end. You may have sound commercial or personal reasons for staying with your current year end. However, it may prove easier and more economical to align your accounts with the tax year.

I am being assessed on more than twelve months profits – that can’t be right?

Unfortunately, it is correct for 2024/2025. For subsequent years, you will again be assessed on just twelve months profits. However, for 2024/2025 you may be able to get the benefit of overlap relief. In addition, there may be the option to spread payment of the extra tax over a five year period.

What is overlap relief?

Where your accounting period does not follow the tax year, it is likely that in the early years of your trade or profession, some of your profits were taxed twice. The first year of assessment is always on actual basis (i.e. from the date you started to the next 5 April). In the second year, you were assessed on your first twelve months profit, which meant that the profits earned in the first period up to 5 April were effectively taxed twice. This overlap profit has historically been used to reduce assessable profits on a change of accounting date or a cessation of trade. It will now be used to reduce your profits in 2024/2025.

Due to the change in the basis period rules, if you do not use overlap relief in the 2023/24 tax year then you will lose it.

It is worth noting that some businesses with a non-5 April year end may not have any overlap relief to utilise. This is possibly due to the business making a loss in the first trading period, or where overlap relief may have already been used at an earlier date.

It can also be the case that businesses with a 5 April year end have unused overlap relief, due to a change of the accounting year end in an earlier year to 5 April where not all overlap relief was utilised. In these cases, 2023/24 taxable profits would simply be profits to 5 April 2024, less overlap relief.

For partnerships, it may be the case that different partners have varying amounts of overlap relief available.

Where can I find out whether I have overlap relief available?

Your previous self-assessment tax returns will show overlap relief available. If you do not have access to this information, you can obtain details of your overlap relief position from HMRC using their form. You will need to sign into your government gateway account to complete this form.

What should I do next?

Basis period reform is quite a technical subject, so we would recommend speaking to your tax adviser who will assist in quantifying what this means for you. For higher earners, cashflow is likely to be affected, so it is advisable to look into this sooner rather than later.

HMRC’s Business Income Manual contains detailed information on basis period reform and how profits are calculated. The guidance also covers what happens with losses and how basis period reform works when averaging rules apply for creatives and farmers.

If you would like our help with this, please get in touch.