If you are self-employed or part of a partnership, a significant change is coming that will affect how your business profits are taxed. The “Basis Period Reform” is a new system designed to align tax calculations with the standard tax year, making things simpler and more consistent. In this guide, we will break down what the reform entails, how it affects you, and what steps you should take to prepare.
What Is Basis Period Reform?
Previously, sole traders and partnerships had the flexibility to choose their accounting year-end. This meant businesses could select any 12-month period, and HMRC would tax profits based on the period ending in the tax year (April 6th to April 5th). However, this led to confusion and overlapping profits in some cases.
The Basis Period Reform simplifies this system by ensuring that all unincorporated businesses are taxed on profits earned during the tax year itself, from April 6th to April 5th. While this creates a clearer and more consistent process, there are transitional rules in place to help businesses adjust.
Who Is Affected?
This reform primarily affects:
- Sole traders and unincorporated partnerships
- Businesses that do not already have a year-end of either March 31st or April 5th
- Anyone who reports business income through Self-Assessment
If your business already operates on a tax year-aligned accounting date (March 31st or April 5th), you won’t face major changes. However, if your accounting year-end falls on a different date, such as December 31st or June 30th, you will need to adjust your accounting practices.
Basis Period Reform Transitional Year: 2023/24
The 2023/24 tax year serves as the transition period for the new system. During this time, businesses will be taxed on profits earned from the end of their current accounting period up until April 5, 2024.
To help with this transition, businesses can claim overlap relief. This allows you to offset profits that were previously taxed twice when you first started your business. You can spread these transition profits over five tax years, from 2023/24 to 2027/28.
Importantly, HMRC treats these transition profits separately, so they won’t negatively impact your eligibility for income-based benefits or allowances, such as child benefit or the personal allowance taper for higher earners.
Example
Let’s say your business year-end is December 31st. Under the previous system, your 2022/23 tax return would cover profits from January 1st, 2022, to December 31st, 2022. Under the new transitional rules, you’ll be taxed on profits from January 1st, 2023, to April 5th, 2024 (a 15-month period).
Basis Period Reform 2025: How Tax Will Work Going Forward
Starting from the 2024/25 tax year, your taxable profits will be calculated strictly according to the tax year, from April 6th to April 5th. This will be the new standard for all sole traders and partnerships under the reform.
If your business doesn’t use a year-end of March 31st or April 5th, you’ll need to split profits from two accounting periods to match the tax year. This means combining income from two separate periods to report the profits that fall between April 6th and April 5th.
If your accounts aren’t ready by the Self-Assessment deadline, you may need to use provisional figures on your tax return. Once your accounts are finalized, you’ll update your return with the actual numbers.
What Should You Do Now?
Now that you have a clear understanding of the Basis Period Reform, it’s time to take action:
- Check if Your Accounting Date is Affected: If your year-end is not between March 31st and April 5th, you will need to adjust your accounting practices to align with the new tax year system.
- Identify Unused Overlap Relief: Review whether you have any overlap relief from previous years that you can claim during the transitional period.
- Consider the Impact on Taxable Profits: Assess how the new system will affect your taxable profits in the transition year. Evaluate whether spreading the transition profits over five years is beneficial for you.
By taking these steps now, you can ensure that you are prepared for the upcoming changes to the tax system.
