HMRC have published a new consultation ‘Basis period reform’ alongside a policy paper and draft legislation that propose a simplification of the Income Tax rules for the self-employed by allocating trading profit to tax years regardless of the business’ accounting period end date.
At a glance
Current position
Currently, an unincorporated business is taxed on the profit or loss for the 12 months ending with the accounting date which falls in the tax year, known as the ‘current year basis’. The period for which profits/losses are taxed under this current year basis is the ‘Basis period’.
- Unincorporated businesses are not required by law to produce accounts or to produce them to a particular date meaning they can choose any accounting date they like.
- 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 cause confusion for some taxpayers
Proposed changes
HMRC are proposing to change the basis period for all unincorporated businesses to the end of the tax year, currently 5 April, with effect from 2023-2024. This will be known as the ‘tax year basis’.
In a ministerial statement issued in September 2021, the government announced that the reform will now take place in 2024 and the transitional period will run between 2023-24.
- This will mean that a business's profit or loss for a tax year is the profit or loss arising in the tax year itself, regardless of its accounting end date.
- 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. They will then have to amend 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 (see below) and potentially also to property businesses. This will avoid the need to apportion profits/loss for a five day period.
- There would be a transition period during 2022-2023 when all businesses will have their basis period moved to the end of the tax year and overlap relief will be given.
- The government is considering an election to allow businesses that will have higher profits in 2022-2023 due to the change to spread those additional profits equally over a period of up to five years. The normal Time to pay arrangements would also be available by default for those that need it.
- In the future, new businesses will not generate Overlap relief. There will be no special rules required for starting or ceasing trading or for a change in the accounting period end date.
- The new rules would apply to sole traders, trading partnerships and other unincorporated businesses such as trading trusts and estates.
If introduced the proposed changes would become effective before Making Tax Digital for Income Tax becomes mandatory. The consultation will run alongside a review by the Office of Tax Simplification about moving the end of the tax year to 31 March or 31 December though currently no indication has been given of when this might take effect.
There is currently no proposal to make businesses align their accounting periods with the end of the tax year. HMRC recognise that for some types of business this would be difficult, but expect that many may choose to do so to avoid apportionment calculations or the use of provisional figures. HRMC are taking opinions on this point as well as an alternative option of a Corporation Tax approach where payment and filing deadlines are driven by the business’ accounting date.
HMRC estimates that 93% of sole traders and 67% of partnerships already draw up accounts to 5 April or 31 March and will be unaffected by the proposed changes.
The consultation ends on 31 August 2021 and responses should be sent to
Useful guides on this topic
Accounting periods and tax basis periods
Which date do I choose? Does it matter? Can I change my accounting date?
A new business? Start here...
Starting in business? Our 'At a glance' guide takes you through the key steps in getting started for tax, with links helping you drill down for more detail.
New business: Sole trader compliance checklist
Starting in business? A new business registration checklist.
Accounts: Tax health check (self-employed)
This is a checklist that will provide you with a lot of pointers to key areas of discussion with sole trader clients.
Partnerships: How to prepare partnership and partners tax returns
How to prepare partnership returns. How are partnership profits calculated? How are corporate members of partnerships taxed? Are there anti-avoidance provisions to consider?
Will I pay less tax if I trade in partnership??
Will I pay less tax if I trade via a partnership or an LLP compared to if I trade via a company or as a sole trader?
MTD: Income Tax Pilot Tool
Making Tax Digital (MTD) for Income Tax. Are you eligible to take part in the MTD Pilot?
MTD: Toolkit for accountants
What is the current timetable for Making Tax Digital (MTD)? How will it work? Which clients will be excluded? What planning needs to be undertaken?
External links
Policy paper: Income tax basis period reform
Consultation questions
Consultation questions
Q1: Do you think that the proposed ‘tax year basis’ for trading income is the best option for simplifying the basis period rules, and the best way to achieve simplicity and fairness between businesses? If not, do you think there is a better option?
Q2: Will the proposed tax year basis have an effect on how businesses choose their accounting date, and whether they choose 31 March or 5 April?
Q3: For businesses with a non-tax year accounting date, what would be the cost of the additional administrative burden of apportioning profits into tax years? Are there any simpler alternative approaches to apportionment?
Q4a: Businesses with accounting dates later in the tax year will have to estimate profits for a proportion of the tax year, before accounts are prepared. For which accounting dates do you think this would be necessary? Do you expect that businesses that have accounting dates earlier in the tax year than 30 September will have to estimate profits? If so, which types of business would be affected?
Q4b: Will estimation be a significant burden for those businesses affected, and what will the cost be? Are there any simpler alternative methods of estimating profit or finalising estimates, which could mitigate any extra administrative burden?
Q5: Would the proposed equivalence of 31 March to 5 April help businesses that would have to make apportionments to work out their profit or loss under the tax year basis? Would extending this equivalence to property income help property businesses, which would otherwise have to apportion profit or loss each year? Are there any problems with this equivalence proposal?
Q6: Are there any specific issues, costs, or benefits to the tax year basis for partners in trading partnerships?
Q7: Are there any other issues and interactions to consider for the tax year basis, or the transition, in the areas of tax outlined in paragraph 3.33?
Q8a: Does the proposed method of transitioning to the tax year basis using a long basis period combined with allowing all unused overlap relief achieve the best balance between simplicity and fairness? If not, is there a better option for transition?
Q8b: Are there any other specific circumstances on the transition to the tax year basis that would require additional rules?
Q9a: Would the proposals for spreading excess profit mitigate the impact of transition without affecting the simplification of moving to the tax year basis? If not, are there any other ways of mitigating the transition impact that you would suggest?
Q9b: Would the proposal to spread excess transitional profits over five years be enough to resolve the cash flow impacts of the proposed reform? Are there any situations that would need additional rules or anti-avoidance provisions?
Q10: Are there any other impacts, benefits, or costs in the core policy, transition, or mitigation proposals that we have not considered above?
Q11: Please tell us if you think there are any other specific impacts on other groups or businesses that we have not considered above.
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