Income tax basis periods – What unincorporated businesses need to know

All unincorporated businesses, including sole traders, the self-employed and trading partnerships, will be taxed on profits generated in the 12 months to 5 April (or 31 March) each year from 2024-25.

Here is what you need to know:

• The Government has proposed changes that will move the tax basis period for all unincorporated businesses
• This will affect sole traders, partnerships and LLP’s who do not have an accounting year-end at that date
• It may cause additional tax to be payable
• Extra tax due can be spread over up to five years or by using Time to Pay arrangements
• Overlap relief that has been accrued can also be used to offset a larger tax bill
• It will affect accounting periods from 6 April 2023, as there will be a transition period during 2023-2024 when all businesses will have their basis period moved to the end of the tax year.

These changes were meant to be brought in a year earlier but were delayed by the Government in September 2021 to give those businesses affected more time to prepare.

The current system

Currently, unincorporated businesses are taxed on profits arising in the accounting period ending in a given tax year.

By law, unincorporated businesses do not have to produce accounts. They are, therefore, free to choose any accounting date they like.

This means that a business’s profit or loss for a tax year is usually the profit or loss for the year up to the accounting date – this is known as the basis period.

Specific rules determine the basis period during the early years of trading. Where the accounting end date is not 5 April or 31 March, which is the equivalent of 5 April for the first three years of trade, the rules can create overlapping basis periods, which charge tax on profits twice and generate ‘overlap relief’, given when the business ceases.

As other forms of income such as dividends and income from property are taxed based on the tax year, the different rules for trading profits can confuse some taxpayers.

What is changing?

The proposed reforms will change the basis period for all unincorporated businesses to the end of the tax year, currently 5 April.

This will create the need for interim arrangements for businesses that do not currently have year-ends falling between 31 March and 5 April each year.

These businesses will potentially face a single, higher tax bill from their profits arising in the year-end falling in the 2023-24 tax year to 5 April 2024.

According to HMRC, businesses with a different accounting period end date to the end of the tax year:

• Will need to apportion profits/losses.
• May need to use provisional figures in their tax returns if the accounts and tax computations for later accounting periods in the tax year are not prepared before the tax return filing deadline (later amending their returns once figures are finalised).
• The statutory rule that deems 31 March to be the 5 April in the first three years of a trade would be extended to apply to all years including the transition period and potentially also to property businesses.

Reliefs, allowances and tax band thresholds will remain unchanged and will not be pro-rated. This could also move some taxpayers into higher tax bands, while also reducing their ability to benefit from various annual reliefs and allowances.

In addition to the direct impact of the transitional arrangements, businesses with year ends that have not aligned with the tax year will have a much shorter time between when they generate profits and when the tax falls due, which could have cash flow implications.

What help is available?

Recognising the impact that this may have on taxpayers, HM Revenue & Customs (HMRC) is considering an election to allow businesses with higher profits, due to the change, to spread those additional profits equally over five years.

HMRC will also offer regular Time to Pay arrangements for those that need to spread the costs further.

Businesses will also be able to use all overlap relief accrued when they began trading during the transition year (2023-24). This would mean that businesses in this position will only have tax to pay on 12 months’ profits.

In the future, once these new rules are in place, new businesses will not generate overlap relief and there will be no special rules required for starting or ceasing trading or for a change in the accounting period end date.

For the many unincorporated businesses that already have year-ends aligning with the tax year (which includes those falling between 31 March and 5 April), nothing will change.

However, for those with year-ends that are not synchronised with the tax year, there are several considerations and careful tax planning may be necessary.

How we can help

These changes, when implemented, are likely to have a significant impact on unincorporated businesses, leading to substantial tax bills and costs without careful planning.

Worried you may be affected by these reforms? Find out how we can assist you.

Link: Basis period reform