Introduction
With effect from 2023/2024 tax year, the basis period for annual accounts will change for self-employed traders, partners in trading partnerships and other unincorporated bodies with trading income, such as trading trusts and estates.
Currently, the legislation adopts the Current Year Basis (CYB) rule which taxes the profits of the 12-month accounting period ending in the tax year. This has proven to be an overly complicated part of the tax legislation which HMRC are finally looking to change.
Before we detail the changes, it is good to understand how the current tax legislation works to see why it so desperately needs altering.
The Changes
The Current Rules – an example
Sole Trader started trading on 1st January 2022 and has chosen an accounting period end of 31st December 2022.
The First Tax Year – Tax Year Basis
The current rules detail that in the first year of trading the Sole Trader would have to declare his profits for tax year only. In this case, profits for the period of 1 January 2022 to 5 April 2022 would be declared on the 21/22 tax return.
The Second Tax Year – Current Year Basis
The Sole Trader would then have to declare his profits for the 12-month accounting period of 1st January 2022 to 31 December 2022 on the tax return for 22/23.
Overlap Profits
This would essentially mean he would be taxed twice on 3 months of his income (Jan to Apr 22). This is classed as overlap profits. The Sole trader could only claim overlap relief on the extra tax paid when he either moves his accounting period closer to the tax year end or ceases to trade. The overlap profits are to be declared on each tax return henceforth until reclaimed. However, for those who started trading when all tax returns were manually completed, you can see how it is easy it is for the overlap profits to be omitted and forgotten.
Additional Rules
There are then further rules to deal with early years (as shown in the above example), final years and changes of accounting date. Trust us – It all gets very overly complicated.
The New Basis Period
As you can see, the current legislation can prove to be very painful both in brainpower for the tax advisor and in tax for the trader. To make things much simpler, HMRC has now decided to change the ‘Current Year Basis’ to a ‘Tax Year Basis’. This means that like property income, dividends or interest, the business’s profit or loss for a tax year is the profit or loss arising in the tax year itself. We have detailed the nitty gritty of what is to be expected below.
2023/2024 – Transitional Rules
For traders who do not hold an accounting period of either 31 March or 5 April, the basis period for their tax return ending 5 April 2024 will be the first to change. Using the above example, if the trader has an accounting year end of 31 December, the 2023/2024 tax year profits will be based on the whole of the 12-month period to December 2023 and 96/366 of the December 2024 period (to 5 April 2024). The overlap profits that arose in the earlier years will also be utilised against this profit.
If the trader had a good year to December 2024 and their profit for the 3-month period to 5 April exceeds the profits for the first 12-months to December 2023, spreading provisions apply. The allocated profits from 1 January to 5 April would be classed as ‘Transition Profits’. These profits can be spread equally over five tax years, including 2023/2024, but they can be taxed on them sooner if elected. Naturally, any untaxed transition profits are taxed automatically on cessation of the trade.
These profits will show as a standalone tax charge and will not affect income for High Income Child Tax Benefit Charge or the pension annual allowance. However, it will still affect personal allowance tapering and student loan calculations. If losses arise in the transitional year due to overlap profits exceeding the trading profits, the loss can be treated as a terminal loss and carried back to prior periods of the same trade.
2024/2025 – Tax Year Basis
From 2024/2025, all taxable profits will be based on time-apportioned profits of the accounting year that falls within the tax year. For example, if a trader continues to draw their accounts to 31 December every year, their 2024/2025 taxable profits will be based on 270/366 of 31 December 2024 and 95/365 of the 31 December 2025 year. If the accounts haven’t yet been prepared by the filing date, provisional figures would be used and then revised at a later period once the true figures are known. This exercise will be repeated every year.
For new businesses, it’s looking to be advisable to use the tax year period (to 31 March or to 5 April) as your accounting period, unless you require different for just cause.
Making Tax Digital for Income Tax
These changes are being made in preparation for the Making Tax Digital for Income Tax (MTD) which is due to be initially mandated from 6 April 2026 for sole traders turning over £50,000. Traders with a turnover exceeding £30,000 will be expected to enrol from 6 April 2027 whereas, the date for both smaller sole traders and partnerships is yet to be decided.
Under MTD for Income Tax business will be expected to send quarterly digital updates to HMRC, based on transactions within the tax year quarters (Jan/Apr/Jul/Oct). They would then be expected to provide an ‘end of period statement’ to finalise the taxable profit for the tax year. Partnerships would be required to include he allocation of the profits of the tax year to the relevant partners within this end of period statement.
