The government announced in the Autumn Budget 2021 that it would reform the way that trading profits are allocated to tax years for income tax purposes. These changes are commonly referred to as the ‘Basis Period Reform’. The changes were legislated in Finance Act 2022.
If you are self-employed or a member of a partnership, the new tax year may be longer than usual
If you are self-employed or a member of a partnership, until 2023/24, you have historically been taxed on the profits made in the accounting year that ends in the tax year. For example, if your accounting year ran to 30 April, then in the last tax year, 2022/23, you are taxed on the profits for your accounting year ending on 30 April 2022 – a few weeks after the start of the tax year.
A change in the rules means that all the self-employed taxpayers will have to pay tax on the profits earned in the tax year going forward. Overall you will still be taxed once on all your earnings, and in the long run you will still just be taxed on 12 months of profit each year. However, moving from the accounting year system to a tax year one requires a catch-up exercise that theoretically can result in more than 12 months’ profits being taxed in a single tax year.
Unless your accounting year ends on 31 March or 5 April, that is what will start happening in this tax year. Taking the example of a 30 April year end again, in 2023/24 the default position will be that your taxable profits are:
1. The “normal” calculation of profits for the accounting year ending 30 April 2023, plus
2. One fifth of a catch-up element equal to:
- Your profits from 1 May 2023 to 5 April 2024 (341/366ths of the profits in your account year ending 30 April 2024), less
- Any overlap relief because of double taxation that occurred earlier (typically when you started trading).
In the following four tax years (during which the personal allowance and higher rate threshold are frozen), your taxable profits will be those earned across the 12 months of the tax year (with pro-rated calculations, if necessary), plus that one fifth catch-up element. As an alternative, you can opt for any amount more than a fifth up to the full catch-up element to be taxed in 2023/24 with corresponding adjustments for later years.
Basis period and the periods for which a self-employed individual is taxed can be tricky and we do expect that in most cases, things will be easier to understand once people are taxed on the profits of the tax year, especially if they choose to move their accounting date to 31 March or 5 April. However, we anticipate complexity and confusion in the transitional years and where a business or partnership does not have a 31 March or 5 April accounting date. We suggest it would be sensible to use the early part of the current tax year to plan ahead and prepare for what is likely to be a larger tax bill (as more income is being taxed) come January 2025. Make sure you take advice about the planning opportunities that arise – for example, 2023/24 could be the right time to make a large pension contribution so as to reduce your taxable profits.
If you are self-employed or a member of a partnership, we can assist you with both the tax implications of these changes and we can assist you in exploring whether changing the business’ accounting date is appropriate from a tax and accounting perspective. If you would like tax or accounting advice on this matter please contact us.
