Basis period reform will impact business income tax self-assessment

5 May 2022

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In the 2021 Autumn Budget, the government confirmed their plans for basis period reform which will change the rules that decide when income is taxed for businesses, including the self-employed, partnerships and trusts.

The tax year runs to 5 April every year, and for those who draw up their accounts to this date or to 31 March, calculating the basis period for tax is straightforward as it aligns with the tax year. However, for those who draw up their accounts to a different date, there is currently a “basis period” set of rules to calculate what and when the profits are taxed. These can be complex, and can mean that some profits are taxed twice in the early years of trading where the basis periods overlaps the tax year. These profits are then carried forward as ‘overlap relief’ to be relieved when the trade ceases or the accounting date changes.

In an effort to simplify this, the government will legislate to replace these rules with a regime that calculates business profits or losses for a tax year as arising in the tax year. They plan to change the rules ahead of mandating Making Tax Digital for income tax (MTD ITSA), which will require quarterly reporting of tax data to HM Revenue & Customs (HMRC). This is on the basis that aligning the reporting of business profits and losses to the tax year will make reporting easier. Following delays announced in September 2021, MTD ITSA will now be introduced from 6 April 2024. The new basis period rules will also apply from that date, with a transitional year in the tax year commencing 6 April 2023.

How will profits be apportioned?

Under the new rules, businesses will still be able to choose their accounting date, but for tax purposes they will need to apportion their profits and losses into each tax year. The draft legislation states that apportionment will be on a time basis. This will be an additional administrative step for businesses, and may be difficult for businesses with fluctuating profits. Although the draft legislation says that an alternative apportionment method could be used (if the method is both reasonable and applied consistently), this will be subject to challenge by HMRC. As part of this simplification, an accounting date between 31 March and 5 April will be deemed to be equivalent to 5 April, to prevent businesses from having to apportion only a few days of their profit or loss across 2 tax years.

For businesses whose accounting date is later in the year, they are unlikely to have profit figures available to apportion before the filing deadline for income tax. Under the proposed new rules, these businesses will have to file their returns using provisional figures and then amend their returns once the final profit or loss figures are known. This will cause an additional administrative burden for, and while HMRC states that this can be resolved by changing accounting date, this may not be possible for many.

How will the transition work?

A move to the tax year basis will potentially bring forward tax liabilities for some businesses. The draft legislation includes a one-year transition period in the year commencing 6 April 2023. In that year, taxpayers will be taxed on their profits for the 12 months starting from the end of the last basis period falling within the 2022-23 tax year, and then an additional ’transition’ component running from the end of that period to 5 April 2024. To ease the burden, the ’transition’ profits will be automatically spread over five years, with the taxpayer being able to elect to bring forward some or all of those profits if they wish. Alongside this, any overlap relief outstanding from the opening years of trade will need to be used in the transition period – none will be carried forward or generated in the future.

Change of accounting date

The consultation document assumed that many businesses affected by the change would alter their accounting date to match the tax year, in order to reduce the impact of the changes. However, this is not practical for many businesses whose accounting date is commercially driven, and the proposals raise some complex questions about how these businesses would identify the relevant profits. This was one of the issues which came up repeatedly in responses to the original consultation, and the government is now consulting with stakeholders on the best approach to reduce the burden on affected businesses.

If you have any questions about what these changes might mean for you and your business, please get in touch with your usual Saffery Champness contact or with Robert Langston, National Tax Partner.

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