Are you one of those unincorporated businesses that don’t have a 31st March or 5th April Accounts year end? Then beware, following the basis period reform, the tax man wants more tax from you, and you may already be taking decisions and earning profits that will lead to that increased tax bill.
For the 2023/24 tax year, HMRC expects to net an additional £2billion from sole traders and partnerships by changing the way in which taxable profits are calculated and it only applies to those businesses that don’t have the “standard” financial year end – that is the 31 March or 5th April.
At present a sole trader – let’s say Farmer Jim – with a financial year end of (say) 30 June 2022 (that year being called the basis period) will be taxed on all their taxable profits for that year in the tax year 2022/23.
From 2024/25, the basis period used for that tax year is changing, so that for 2024/25 the taxable profits for Farmer Jim for that tax year will be:
3 months to 30 June 2024 plus 9 months to 31 March 2025.
In practice that means, if Farmer Jim doesn’t change his year end to 31 March (or 5 April) then his profits taxed will be:
3/12th of the year to 30 June 2024 and 9/12th of the year to 30 June 2025.
Note that it is 3/12th and 9/12th of the respective years, even if he knew exactly how much he had earned in those 3 months and 9 months periods, his taxable profits will be based on the relevant proportion of each of the 2 years .
Note also that the year to 30 June 2025 is used to measure profits for the 24/25 tax year, causing increased pressure on him and his accountants who still must submit his tax return for 2024/25 by 31 January 2026. (In practice HMRC will allow an estimate to be used for the second financial year – pending accurate figures being supplied either as an update to your tax return sometime after 31 January, or as a reportable event on next year’s tax return).
But it is 2023/2024, called the transition year, that will result in a high tax bill for Farmer Jim, and that is why planning should start now.
For the 2023/2024 tax year profits will be assessed on, using the same example as above,
The year to 30 June 2023 plus the 9 months to 31 March 2024 (i.e. 9/12ths of the year to 30 June 2024) – less any overlap relief.
NB overlap relief relates to those profits that have been taxed twice – he probably didn’t realise at the time – either when self-assessment was introduced in 1995/96 or when he first started trading and chose 30 June (or anything but 31 March – 5 April) as his chosen accounts date. For many people, particularly those that have continued to trade since the inception of self-assessment in 1995/96, inflation will have significantly eroded the value of that overlap relief and for many others their overlap figures will have been lost, – either when they changed accountants or when their accountants changed their software.
So, Farmer Jim is going to have to pay tax on 21 months of profits in 2023/24 less any (probably devalued by inflation) overlap relief. A significant “one off” increase in his taxable profits for the tax year 2023/2024.
HMRC are aware of the impact that such a tax liability will have on businesses and will therefore allow “surplus” profits to be spread over 2023/2024 and the next 5 years. However, this still means considerable extra taxable profits for Farmer Jim for the next 5 years – and all possibly at 40% or higher.
What are the options?
What can Farmer Jim – or anyone else in similar circumstances – do to mitigate the effect of this change of basis period? Well, he could consider any of the following options: –
- Incorporate his business so that no more than one year of self-employed taxable profits fall into the 2023/24 year.
- Arrange a significant capital investment in that 2023/24 lengthened basis period – so that he has significant capital allowances to offset against his extended profits.
- Make an increased contribution to his pension fund, perhaps over 5 years, to reduce any amounts taxable at 40% or higher.
- If taxable profits drop at any time from 20/21 then consider lengthening an accounting period before 23/24 – to reduce the impact of the lengthened 23/24 basis period.
None of these decisions should be taken lightly and without full consultation with an Accountant or tax professional. For further guidance please contact us.