In January 2022, HM Revenue and Customs and the government announced a number of proposed changes to the way basis period reform transitional rules will work from April 2024.
The new proposals are designed to alleviate the most unfair impacts of the transitional rules and simplify the process – however they’ll still accelerate tax charges for many individuals in partnerships.
One of the core reforms will involve moving from the ‘current year’ basis to a ‘tax year’ basis. This will allow business profits to be calculated for the tax year rather than for the period of account ending in the tax year.
Moving to the new tax year basis will involve a transitional year for sole traders and partnerships that do not use 5 April or 31 March as their accounting date, as we switch from the current rules to this new basis of assessment. This will subsequently advance tax liabilities for many.
These changes will make little difference to businesses already drawing up accounts to 31 March or 5 April but will be significant for those that do not.
It’s hoped these reforms will put an end to the complex rules relating to basis periods and overlap profit and to tax traders closer to the point at which their profits are generated. The Finance Act 2022, if successfully passed as a bill, will detail how the profit or loss for the transitional period should be calculated and will provide further information on loss relief and the protection of allowances and benefits.
Businesses will be required to report for the 6 April to 5 April tax year for trading purposes when moving to the new tax year basis period, regardless of their actual period of account.
The proposed rules will allow the periods to be divided by reference to months if it is reasonable to do so and it is applied consistently. Businesses with non-tax year periods of account would have to assign profits or losses across periods of account to adjust their results to the tax year basis.
The tax year of transition will be 6 April 2023 to 5 April 2024, and by 2023/24, continuing businesses will be taxable on their profits on the current year basis as well as a catch-up on the tax year basis.
This could bring up to two years’ profits into charge for the year – and businesses with 30 April year-ends could be significantly impacted with a hugely increased tax bill.
The basis period reform will allow the excess profit to be spread over a period of five tax years, in order to mitigate the cash flow impact (although individuals can elect to be taxed on the full amount in the transition year if preferred).
The latest draft legislation also includes clauses that intend to remove some of the more unfair impacts of this transitional catch-up. While transitional profits will be taxed on individuals in the five-year “spreading” period, these new rules will not affect the level of the taxpayer’s income that is used to calculate things like their entitlement to certain reliefs and benefits. The new transitional profit will create a ‘stand-alone tax charge’ – however – the transitional rules may still push some taxpayers into a higher income tax band, especially if they opt-out of spreading.
The new measures will affect self-employed traders (including individuals with a profession or vocation); partners in trading partnerships; other unincorporated entities with trading income, such as trading trusts and estates, and non-resident companies with trading income charged to Income Tax. These groups are collectively referred to as ‘businesses’ in this document.
Whilst the reform may simplify certain technical and practical matters, firms that do not make their accounts up to 31 March/5 April will need to seriously consider the impact of the proposed changes on their cash flow – particularly for the transitional year 2023/24.
There’s also a risk of these changes becoming additionally challenging for large professional service firms with more complex financial and tax affairs. The impacts for these organisations will need to be carefully considered and prepared for ahead of the transitional year – we’d advise businesses to ensure they make use of the extra time available.
It’s thought the longer-term implications will also remove some of the profit advantages of operating through a partnership model, making it harder for partnerships to finance their working capital. Many firms will need to consider whether making the transition to a corporate structure is more feasible for them.
If you need help analysing the impact that the reforms will have on your business, contact our team.