HMRC Basis periods

Executive Summary

  • Basis period reform will see unincorporated businesses taxed on their profits arising in the actual tax year, rather than the on the profits of an accounting period ending in a tax year.
  • Although meant to create a simpler, fairer and transparent system, in the short-term it does create additional complexity and potentially temporarily higher tax bills/cash-flow impacts.

For most of us, the HMRC basis period is something that will rarely grab our attention.  It is simply the method by which HMRC ascertain the tax that a sole trader or partnership will be charged for a period.  The rules will however be changing from April 2023 and so now might just be the opportunity to consider how this might impact your own, or your client’s taxable profits.

Current year basis to tax year basis

Let’s just remind ourselves of the existing rules. At present, an unincorporated business’ tax is calculated on the profits arising in the accounting period ending in that tax year.  So for example, an accounting year to 30 June 2022, will have its profits taxed in the tax year 2022/23 (6th April 2022 to 5th April 2023).  Under the new rules, the tax will be calculated on the actual profits arising in the tax year itself, rather than the accounting period ending therein.  For many businesses the basis period reform will have no impact, as they already draw up accounts to either 31 March or 5 April.

Why change?

HMRC’s rationale for the change, is “to create a simpler, fairer and more transparent set of rules for the allocation of trading income to tax years”.  This does indeed seem to hold true in that it aligns trading income with property income and savings income, which are already taxed on a tax year basis and it will bring the payment of tax closer to the time that the profits are earned.  This reasoning does however hide the fact that there will be some particularly complex rules around calculating taxable profits in the transitional year (2023/24), as we switch from the old to the new.

Transition year

The taxable profits for 2023/24 will be comprised of a basis period, made up of two parts

  • a standard part, which is the 12 months following the end of the basis period for 2022/23, and
  • a transition part, from the end of the standard part to 5 April 2024.

Following on from the example given earlier, a business with an accounting year to 30 June 2023, would see a basis period comprising the 12 months profits to 30 June 2023 (the standard part) and the nine months and five days profits from 1 July 2023 to 5 April 2024 (the transition part).  This does therefore result in extra profits being brought into account in the transition year.  The new rules do however have two possible measures to reduce and the spread the extra tax arising.  Firstly, any overlap profits (from an earlier year) can be deducted from the profit and secondly, remaining transition profits can be spread over a period of up to 5 years.  This article has not delved further into the complexities of calculating the taxable profits after applying both measures, however HMRC’s Business Income Manual (BIM81200) should be consulted for additional guidance.

Summary    

Beyond the transitional year, business will continue to incur administrative issues with having to apportion profits each year.  This may therefore be good reason to consider changing the accounting date to 31 March or 5 April, from 2023 and avoiding the need to apportion the profits (after the transition year) from two separate accounting years.  Businesses who don’t change their accounting period, may also find they have a shorter time to finalise their year-end accounts.  A 30th June year-end for example, would currently have 19 months before the self-assessment deadline, whereas in future this would be just seven months.