After questions from some of our clients we have created a comprehensive guide on HMRC’s Basis Period reform, transitional rules for 2023/24, and its extension of Making Tax Digital (MTD) for Income Tax. We understand the importance of staying informed about tax reforms and initiatives to provide our clients with accurate and timely advice. This guide aims to provide you with a clear understanding of the Basis Period Reform, the transitional rules for the tax year 2023/24, and how it connects to the MTD extension.
Understanding HMRC’s Basis Period Reform
The Basis Period reform is a significant update by HM Revenue & Customs (HMRC), requiring unincorporated businesses (including partnerships and LLPs) to report their financial data on the basis of the tax year, rather than their accounting period (which historically may not have run in April to March each year as the tax year does). This change is being implemented as part of the Making Tax Digital programme that will also change the traditional annual tax reporting, so that unincorporated businesses will be required to submit their financial information on a quarterly basis from April 2026.
What does this mean for me?
If your business trades as a sole trader, partnership or LLP then there are two options to address this:
- Leave the year end where it is and create estimates of future year profits when calculating taxable profits each tax year which will then need to be corrected once the final figures are known.
- Change your year end to 31 March to align with the tax year
Transitional Rules in 2023/24
Many businesses may decide therefore to change their year end to 31 March (although this will not be an option for all businesses). For businesses that do decide to make the change 2023/24 has been designated as the transitional year. By changing your year end you will bring extra profits into the charge of tax and accelerate the tax payments but there are two factors that can be used to offset this.
- You can offset overlap profits. When you first started to trade you may well have been “double taxed” on profits arising in the first years. HMRC have committed to providing assistance in this area by making their records available to allow individuals to claim for these if you can’t locate the relevant files from when you first started
- The draft legislation published in the summer provided for the transition profits (after the offset of overlap relief) to be spread over five tax years, beginning with the transitional year itself, thus spreading the extra tax over 5 years
During the consultation, it was noted that the acceleration of profits for five years could lead to anomalies for allowances and tax charges dependent on the individual’s income. Legislation was introduced to mitigate this impact by separating transitional profits from the main tax computation and creating a standalone income tax charge. This effectively prevents some anomalies, such as the High Income Child Benefit Charge and pension annual allowance taper. However, the personal allowance taper anomaly remains.
Losses may arise in the transitional year if unrelieved overlap profits exceed the profits for the extended basis period. Extended loss reliefs may be available, allowing the loss to be treated as a “terminal loss” and carried back to set against profits from the same trade in the previous three tax years. Other loss reliefs may also be applicable.
Interaction with Making Tax Digital for Income Tax
HMRC states that the Year End Change is necessary to implement Making Tax Digital for Income Tax (MTD). Under MTD, businesses will need to submit quarterly digital updates to HMRC, based on transactions in tax year quarters. They will also provide a digital “End of Period Statement” to finalise the taxable profit for the tax year. For partnerships, this includes the allocation of profits to relevant partners.
MTD for Income Tax currently mandates most sole traders with a turnover exceeding £50,000 to comply from 6 April 2026. This will be extended to sole traders with a turnover exceeding £30,000 from 6 April 2027. The government is consulting on how the MTD regime should apply to smaller businesses. Partnerships will be brought into MTD at a later, undefined date.
What if I don’t do anything?
If you don’t change your year end you will be left with the permanent administrative burden of estimated profits every year and then back correcting when producing accounts. When MTD is eventually brought in that will also require reporting based on the tax year and it is for that reason that this change is being made. If you stick to a year end that is not aligned with the tax year it will undoubtedly make your MTD responsibilities more difficult as well. If you don’t change your year end you will still have to deal with the issue of accelerated tax payments anyway as you will have to report all of the profits as you would if you change your year end, but you won’t be able to spread the tax cost over 5 years using the transitional relief.
The Basis Period Reform, along with the transitional rules for 2023/24, marks a significant step towards a more digitised and efficient tax administration system. As an accounting firm, we recommend businesses to adapt to the changes promptly, invest in digital accounting solutions, and seek professional guidance to ensure compliance with both the Basis Period Reform and the forthcoming extension of Making Tax Digital for Income Tax. By doing so, businesses can stay ahead of tax obligations, make informed financial decisions, and maintain seamless tax compliance throughout the year.