Ben Brookes, Partner at Wellers

Ben Brookes, Partner at Wellers, the small business accountants to SMEs, discusses how the basis period for taxation is changing, and explores what sole traders and the self-employed need to do next.

What is Basis Period Reform?

I think it is fair to say that doing accounts is not something many sole traders, or the self-employed, look forward to. Nevertheless, it is a necessity. It has to be done. This means being regimented about calculating profits and knowing when to submit those all-important tax returns. However, the process that has been drilled into so many is about to change.

From the year ending 5 April 2024, HMRC will require profits to be reported based on the UK tax year rather than the accounting year, which it previously enforced.

This change will impact many sole traders and self-employed, who have been operating to a different accounting year, known as the ‘basis period’. It means they will now be taxed on the profits generated from 6 April to 5 April of the following year.

But why is this change happening? Under the current regulations, all unincorporated businesses with overlapping accounting and tax years are potentially taxed twice on earnings during the first years of trading. This double taxed profit is called “overlap profit”. When there is a change in your year end, or you cease to trade any more, you then apply for overlap relief on those profits. The basis period reform aims to reduce the complexity of tax reporting, and therefore the admin involved with the tax return process.

What Do I Need to Do to Comply?

You might not need to do anything. If your accounting year aligns with the tax year, ending between 31 March and 5 April, then you can sit back and relax, as you already conform to the new regulations. If you are unsure, consult with a tax advisor.

If your basis period doesn’t align with the tax year, there are two ways you can meet the new regulations:

by calculating profits in the transition period
by moving your accounting year

The Transition Period

Profits now need to be calculated solely for the tax year. So, any profits made during overlapping accounting periods must be included, meaning two sets of accounts will be required to complete a tax return.

However, the self-assessment tax return deadline is 31 January, so some sole traders might not be able to complete the second years’ worth of accounts in time and will instead need to include an estimated figure for the remainder of the tax year. Estimates will need to be amended and should be changed within 12 months of the filing deadline.

During the transition period the profits of the basis 12 month accounting period will be taxed, along with the additional profits for the period between the end of your basis period and 5 April.

To compensate for this extended accounting period, any overlap profits the individual is carrying can be relieved. If additional tax still arises on this period of profits then there are various payment options available to help spread the liability.

In future tax years you would then be taxed on the 12 month period ending on 5 April.

Moving Accounting Year

While basis period reform should make tax payments more affordable for sole traders and the self-employed, the transition process is complex and time-consuming. A more straightforward option is to move your accounting year to align with the tax year, meaning no additional calculations are required.

Should the change of accounting period occur in the 2023 – 2024 tax year then you may be able to spread the additional profits and tax under the basis period reform rules.

Even though moving your accounting year will be much easier in the long run, making the change can be complicated and is often done incorrectly. To make sure the shift runs smoothly, it’s best to acquire help from a tax advisor.

What to Do Next?

Changes to tax rules and regulations can always feel daunting. If you are unsure of what to action, ask yourself these five questions:

When does my accounting year begin, and end?
Do I have any overlap profits?
Can I calculate my profits in the transition period?
Would it be a better use of my time to move my accounting year?
Do I need advice on this from a trusted advisor?

Find out more about basis period reform from Wellers.

>> Read more guidance on tax in the news

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