Basis Period Rules – the way in which incorporated businesses are taxed on accounting profits – is changing from 6th April 2023
Currently unincorporated businesses can choose an annual reporting date and draw up accounts to that date every year. The profits from those accounts are taxed depending on the tax year in which the final day of the year falls. For example, Mrs Smith draws up accounts to 31st December each year, her profits for the year to December 2022 will be taxed on the 2022/23 return.
From 2023/24, HMRC are changing these fundamental rules so that unincorporated businesses must instead report profits relating specifically to the tax year running 6th April to the following 5th April (or 1st April to 31st March). This was previously scheduled to coincide with the introduction of MTD for Income Tax, but whilst MTD has been delayed for at least two years, basis period reform is set to go ahead.
To facilitate this, businesses have two options; change their accounting year end to the tax year end or retain their current accounting date and apportion figures from two sets of accounting years into one tax return.
Going back to Mrs Smith, changing her accounting year would mean drawing up accounts for the period January-23 to March-24, a 15-month period, to be reported on, and taxed in, the 2023/24 tax year. Clearly this would result in a higher tax liability than the usual 12-month period.
If the taxpayer has any Overlap Profits (these arise at the commencement of a trade where accounts are drawn up to a date other than the end of a tax year and can result in an element of profits being taxed twice), these can be deducted from profits in the transitional year.
In addition, taxpayers have the option to spread any additional transitional profits over five tax years. For example, if Mrs Smith generates steady profits of £20,000 per year, a 15-month period to March-24 would create £25,000 of profits. If she has £1,000 of overlap profits, the excess taxable profit is now £4,000. Spreading this over five years would mean an additional £800 taxed in the years 2023/24 to 2027/28.
However, businesses won’t always have full control over their reporting date, which may be fixed for a variety of reasons, and will have to apportion figures each year. If actual figures for the second accounting year are not available before the tax return submission deadline, provisional figures can be submitted and amended the following year. This does however create a significant delay before the taxpayer can finalise their tax affairs and be sure of their tax liabilities.
Forward planning and an awareness of how this might affect your business is key, to ensure you are fully aware of any potential additional tax liabilities.