A Budget policy paper confirms that the switch from currently a basis to the tax year basis will happen for all self-employed individuals and partners from 6 April 2024.
Despite calls for the government to drop its plans to move away from the basis period rules, the Autumn Budget announcements confirmed that it will go ahead, although implementation has been pushed back to 2024.
The announcement brings the timing of the reform in line with the one-year delay to Making Tax Digital for income tax (MTD ITSA) announced in September.
How will it work?
Under the government's proposals, all unincorporated businesses will be taxed on the profits arising in the tax year, rather than the profits that are made in the accounting period that end in that tax year (the “current year” basis).
The reform will remove all existing requirements of the basis period rules such as double taxation of early years of trading profit and maintaining accurate records of overlap profits and relief, which are often lost and not utilised by taxpayers.
The change will affect unincorporated businesses that do not currently draw up their accounts to 31 March, 5 April, or a date in between, and they will find their taxable income is accelerated. For businesses with an accounting year end between 31 March and 5 April, this will mean no change.
It will also require estimates to be made of the profits generated in the latter part of a tax year (unless a business reverts to an accounting year that corresponds with the tax year) as the profits for a tax year will continue to be determined with reference to the business’ accounting periods.
the abolition of the current year basis was originally proposed to take place in 2023 /24 with the transitional year in 2022 / 23, to align with the start of MTD ITSA. However, with MTD ITSA Delayed for another year to 2024 / 25, as requested by the Chartered Institute of Tax, The Association of Taxation Technicians and the Low Income Tax Reforms Group, so has the commencement of the tax year basis.
If the business has any overlap relief from when the business started, or changed accounting., these overlap profits will be available to offset against profits in the transitional year.
According to HMRC, the reform aims to “create a simpler, fairer and more transparent set of rules for the allocation of trading income to tax years”.
Transitional issues
The Institute for the Chartered Accountants in England and Wales (ICAEW) understands that a mechanism is required for existing businesses to transition from the old to the new regime and so special rules will apply in the transitional tax year 2023 / 24. in this tax year, some businesses will experience double taxation as they will be taxed not only on 12 months’ worth of profits from the end of the basis period for 2022 / 23, but there will also be transitional profit based on the period from the end of those twelve months to 5 April 2024.
If the business has any overlap relief it will be able to use this against the additional profits arising in the transitional tax year, to mitigate the enhanced tax charge arising in that year. ICAEW understands that there will be more flexibility to use this overlap relief than was set out in the draught legislation published in July.
Where additional taxable profits remain even after deduction of overlap relief, business owners will have the option to spread that additional profit over five years.
Some respondents to the consultation on this measure, including ICAEW’s Tax Faculty, expressed concern that this additional profit could have a knock-on effect for other tax purposes in those years, such as the impact on personal allowances, high income child benefit tax charge and allowances for the purposes of contributions to registered pension schemes.
The faculty understands that the government is seeking to address these unintended consequences through changes to the draught legislation published in July.