Ever since HMRC announced basis period reforms, there has been much discussion and confusion around it amongst those who are most likely to be affected by the measure, i.e., self-employed traders, including individuals with a vocation or profession, partners in trading partnerships, and other incorporated entities, such as trading trusts and estates.
If you are not sure what these reforms will mean to you, then read on.
So, what is the basis period reform?
In simple words, the reform aims at moving to tax sole traders, partnerships and limited liability partnerships (LLPs) on the profits arising in a tax year from taxing such businesses on the profits arising to an accounting date (basis period) ending in a tax year.
The reform is pretty straightforward and changes how trading income is allocated to tax years. In general, businesses draw up annual business accounts on the same date every year, which is known as their “accounting date.”
Their profit or loss for a tax year is usually the profit or loss for the year leading up to the accounting date in a tax year, which is called the “basis period.” Often, the current arrangement creates overlapping basis periods that charge tax twice on profits and generate corresponding “overlap relief”, usually given on the termination of business operations.
Who does the basis reform period affect?
This measure affects sole traders, partnerships and limited liability partnerships (LLPs) that draw up annual accounts to a date different from 31 March or 5 April, such as 1 January to 31 December. This could include large partnerships or seasonal businesses, or any other type of businesses starting their operations from 6 April 2024.
From the 2024/25 tax year, all affected businesses have to use the tax year as their basis period. That means their profit or loss for a tax year is the profit or loss arising in the tax year, irrespective of the accounting date. Outstanding overlap relief will no longer exist.
This particular basis period will be longer than 12 months for those businesses with accounting periods that do not match the tax year. Around 400,000 unincorporated businesses will be affected by the tax year basis switch in April 2024.
What is the basis period for tax?
The basis period of tax is 12 months long, which ends with the accounting date in that tax year.
What is the difference between the basis period and the accounting period?
The accounting period is the time period (often a year) an individual or business chooses to run accounts to. The basis period is the time period HMRC uses for tax.
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Who does the basis reform period not affect?
Those sole traders, partnerships and limited liability partnerships (LLPs) that have already drawn up accounts by 5 April will not see any difference in their tax reporting. And those with a 31 March year-end will not be significantly affected.
Accounting periods ending on 31 March or any day between 1 to 4 April will be treated as ending on 5 April. All incomes and expenses earned or incurred during the last few days of the tax year will be treated as arising in the next tax year.
How is the basis period for the first tax year assessed?
The first basis period runs from the date the business starts until the end of the tax year. For example, for a business which begins operating on 1st January, the basis period will run from 1 January to 5 April as the first basis period always ends on the tax year-end. The next basis period will be 1 January to 31 December of the same year, as the first accounting period is longer than 12 months. The basis period ends on the same date as the accounting year.
However, in the first year, the profits made in the period 1st January – 5th April will be double taxed from both the January – April and the January – December basis periods.
Will the basis period reform impact capital allowances?
No. Capital allowances will continue being determined on an accounting period rather than a tax year period basis. The legislation regarding the allowances has not changed. Businesses will continue accounting for disposals, capital additions, and writing down allowances for every accounting period.
What are the key dates of the basis period reform?
Is the basis period reform necessary?
HMRC insists the tax year basis is critical to the operation of MTD ITSA because the tax year basis switch to 2024/25 coincides with the sole traders being mandated into MTD ITSA from 6 April 2024. Without the switch, the quarterly update figures will not provide a meaningful estimation of the tax due by the business for the year.
How can Bradleys Accountants help you?
Whether you are a self-employed trader, a partner in a trading partnership or any other incorporated entity, we can work with you to understand the impact of the new reform. You may need to finalize annual accounts and tax computations earlier, leading to additional costs.
While there is no hard and fast rule to adopt an accounting date aligned with the tax year, many businesses are choosing to adopt a 31 March year-end in the transition year 2023/24. Besides, there will be a cash flow impact because of extra tax in the transition year.