Basis Period Reform new rules
Generally, businesses draw up annual accounts to the same date each year, called their ‘accounting date’. Currently, a business’s profit or loss for a tax year is usually the profit or loss for the year up to the accounting date in the tax year, called the ‘basis period’.
Specific rules determine the basis period in certain cases, including during the early years of trading. These rules can create overlapping basis periods, which charge tax on profits twice and generate corresponding ‘overlap relief’ which is usually given on cessation of the business. Overall, this basis of taxation is called the ‘current year basis‘.
Basis period reform is part of the MTD for ITSA rules that will apply from April 2024, but you could save time in the long run by start preparing for upcoming changes and the transition is likely to run more smoothly if you start preparing ASAP. We have covered those upcoming changes in a separate article here.
HMRC’s proposal changes this to a ‘tax year basis’ with effect from 2024 to 2025 which is referred to as basis period reform, so 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 date.
This removes the basis period rules and prevents the creation of further overlap relief. On transition to the proposed tax year basis in the tax year 2023 to 2024, all businesses’ basis periods would be aligned to the tax year and all outstanding overlap relief given.
The overall objective of the basis period reform proposal is to simplify the taxation of trading profits. This is in line with stakeholder requests to simplify this part of the tax system.
At present, 2 businesses that are identical except for their accounting date may have very different taxable profits for a tax year. The tax year basis would remove this difference, leading to fairer outcomes between businesses.
Businesses with non-tax year basis periods currently experience double taxation in the early years of trading, with relief generally given on cessation. Using the tax year basis would remove this distortion and lead to a closer relationship between the profits arising in a tax year and the tax liability related to them hence the need for basis period reform.
All other forms of income are taxed on a tax year basis for individuals, including property income, interest and dividends. This policy aligns trading income with these other forms of income. This could also help to align reporting requirements for different forms of income in Making Tax Digital (MTD).
Introducing the tax year basis for trading income would bring the payment of tax closer to the time that profits are earned, making it easier for businesses to save for their tax obligations, improve compliance, and reduce tax debt write-off.
Bringing the payment of tax closer to the time profits are earned would also make the Income Tax system more responsive, giving effect to changes in rates and rules sooner for self-employed people and allowing support to be better targeted.
Legislation in Finance Bill 2021-22 will also introduce special rules for the transition year in 2023 to 2024. The basis period for the year will be 12 months from the end of the basis period from 2022 to 2023, plus a transition component running from the end of this 12 months to 5 April 2024. Any overlap profits brought forward and/or generated will be relieved in full in 2023 to 2024 and not carried forward into the tax year basis.
For businesses with higher profits in 2023 to 2024 due to the change in basis, the government is legislating to automatically spread the transitional period additional profits over a period of five years. The government is also legislating to allow a business to elect out of spreading and accelerate the charge, to treat additional amounts as arising in the tax year. The draft legislation published on 20 July 2021 will also be revised to reduce the impact of transition profits on allowances and benefits, alongside other changes.
Recent amendments to Basis Period Reform rules
HMRC has released its response to feedback on proposals for basis period reform rules, making some amendments to the rules as a result.
The reform’s implementation has been delayed by a year, meaning the transition to the new rules will take place in 2023 to 2024 and the new rules will come into force on 6 April 2024.
There are a number of changes to the original proposals following feedback from accountants.
First, the government has decided to treat any excess profits arising during the transition year as a one-off separate item of taxable income, rather than as part of a business’s normal trading income. This treatment will minimise the impacts on allowances and means-tested benefits that were raised during the consultation.
There will also be an extension to the carry-back of loss relief arising due to excess overlap relief in the transition year from one to three years. This treatment will mirror the current rules for loss relief when a business ceases and provides greater flexibility around use of excess overlap relief.
Transition issues yet to be finalised
Finally, the government will explore carefully with stakeholders whether to introduce administrative or policy easements to minimise burdens caused by having to submit tax returns containing provisional figures, ahead of the transition year in 2023 to 2024. Here’s a link to the policy paper objective.
The options being considered are:
- allowing taxpayers to amend a provisional figure at the same time as they file their return for the following tax year;
- allowing an extension of the filing deadline for some groups of taxpayers, such as more complex partnerships or seasonal trades;
- allowing taxpayers to include in the next year’s tax return any differences between provisional and actual figures in the previous year; and
- leaving the current rules on provisional figures unchanged, whereby profits can be estimated in a return and amended as soon as final figures become available.
How can MCL Accountants help?
Contact MCL Accountants on 01702 593 029 if you have any queries on the basis period reform or if you need any assistance with the preparation and submission of your business accounts or self-assessment tax returns to HMRC.
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Ishan provides financial management, taxation and transactional advice to business entities of all sizes. His expert areas include statutory compliance, business taxation, personal tax & transactional processing and systems. Industry sectors include professional services, retail, hospitality and entertaining & media and advertising services.