Basis period rules (Part 2): How business profits are taxed from 2023/24

Updated: Jan 14

5 January 2022

If you have any questions regarding the existing basis period rules or how things will change for your business, from 6 April 2024, our team of experts, on a no obligation basis, will be glad to guide you.


Recap

HMRC (HM Revenue & Customs) has proposed to change the basis period rules from a ‘current year basis’ to a ‘tax year basis’ with effect from 6 April 2024 (tax year 2024/25). It is proposed that business profits will be calculated for the tax year rather than for the period of account (i.e., the accounting year) ending in the tax year. As a result, this will change the way trading income is allocated to tax years. A one-year transition period is proposed with two components that will determine the basis of taxable profits for the 2023/24 tax year.


HMRC have provided examples of how the changes will look in practice, one of which being:


EXAMPLE 1

A sole trader draws up their accounts to 30 April. The profits for the year ended 30 April 2023 are £55,000, and for the year ended 30 April 2024 £66,000. They have overlap profits brought forward of £20,000.


The profits for the tax year 2023 to 2024 are as follows:


· Current year basis element – year ended 30 April 2023 – 55,000

· Plus, transitional element – 1 May 2023 to 5 April 2024 – 66,000 x 11/12 = 60,500

· Less overlap profits (20,000)

· Total profits for tax year 2023 to 2024 = £95,500


These profits exceed the profits under the current year basis by £40,500 (i.e., the transitional element less overlap profits). The sole trader can therefore elect to spread the excess over up to 5 years.


The minimum amount per year to be added is 40,500 / 5 = £8,100. Under this election, assuming the sole trader chooses to add the minimum amount, the profits for the tax year 2023 to 2024 are reduced to 55,000 + 8,100 = £63,100. A minimum adjustment of £8,100 per year will be required to the profits of each of the tax years from 2023 to 2024 onwards (until 2027 to 2028 at the latest) until the £40,500 is extinguished.


As you can see, depending on a business’ accounting date, the changes may cause higher profits to be taxable than the business would usually be expecting.


EXAMPLE 2

Partner LLP (Limited Liability Partnership) is a professional services company with 5 partners. It draws up its accounts to 30 April and profit for the 12 months to 30 April 2023 is £1,000,000.00.


Current rules

For the 2023/24 tax year, assuming all members are on the current year basis:

  • Partners’ basis period would be - 12 months to 30 April 2023, and

  • Partners would be taxed on their shares of the profit of £ 1,000,000.00 (paying approximately £435,000 income tax and NIC (National Insurance Contributions)).


New transitional rules

Under the proposal, on transition to the tax year basis in 2023/24 (i.e., continuing members would be taxable on:

  • Their share of profits of the 12 months to 30 April 2023, plus

  • Their share of 11/12s of the profits to 30 April 2024.

This brings the profits taxed into line with the tax year basis to 31 March 2024 but results in 23 months of profit being taxed in the transitional 2023/24 tax year.


The partnership estimates its profits for the additional 11 months to be a further £1,000,000.00, which, added to the £1,000,000.00 for the period of account to 30 April 2023, brings a total of £2,000,000.00 millions of partnership profits into charge in the transitional year.


The partners have an aggregate of £250,000 overlap relief which will be required to be claimed in the transition year, leaving them taxable on their shares of £1, 750 000. Without the automatic five year spreading of profits rule this would result in approximately £770,000 total income tax and NIC due - £335,000 more than on the current year basis – an average of £67,000 more per partner.


Care should be given to partnerships as each partner may have a different amount of overlap relief depending on when they started.


Another positive move is that the updated legislation appears to allow for transitional profits to be calculated for 2023/24 and to be spread over five years even if the business changes its accounting date in that year: something many businesses are considering is moving their accounting date to 31 March or 5 April to make future annual administrative processes easier.


Lef Basis period rules in line for reform 2
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For further information on any of the points above, please contact:

Kseniya Devlekanova at: kseniya@lexefiscal.com , or

Dr Frank J Clifford at: clifford.frank@lexefiscal.com.

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