Sometimes it takes an almost superhuman effort to understand government press releases. A case in point is one that was released in June 2021. It is entitled Government announces simplified tax reporting for self-employed and small businesses. After delving into the detail, it turned out to be an announcement about something called ‘Basis Period Reform’. If you are self-employed, a sole trader or in a partnership – and your accounting year isn’t the same as the tax year – you need to understand what this reform entails.
What are current ‘basis period’ rules?
A ‘basis period’ is the period of the year during which a business pays tax. It is normally the same as the tax year (i.e. 6th April to 5th April the following year).
Things get more complicated if your business decides to use a different accounting year. Let’s take the example of a new business that started trading on 1st January 2021. It wants to use 1st to 31st December as its basis period.
The traditional rules mean that, to do this, the business has to have two basis periods during its first year of trading. The first one always has to end with the tax year – i.e. 5th April 2021.
Added to this is the second basis period, which runs from 1st January 2021 to 31st December.
This means that, for the period 1st January 2021 to 5th April 2021, the business’s profits are taxed twice. In subsequent years, only the profits made between 1st January and 31st December are taxed – this is the new basis period.
You may be wondering what happens after a business is taxed twice because of two basis periods running concurrently. In short, HMRC keeps the extra taxation until the business either changes its basis period again, or it winds up.
When either of these things happen, something called Overlap Relief comes into play. This is a method of getting the extra taxation back. However, this system has led to thousands of errors and mistakes in tax returns. The Treasury says that more than half of those entitled to Overlap Relief don’t claim it.
What is the proposed Basis Period Reform?
The change will mean that “businesses will be taxed in profits arising in a tax year, rather than profits of accounts ending in the tax year”.
The reform will take effect for the 2024 to 2025 tax year with a transition year in the 2023 to 2024 tax year.
The Treasury gives this example:
Example: A business draws up accounts to 30 June every year.
Currently, income tax for 24/25 would be based on the profits in the business’s accounts for the year ended 30 June 2024.
Our proposed reform would mean the income tax for 24/25 would be based on: 3/12 of the income for the y/e 30 June 2024, plus 9/12 of the income for the y/e June 2025
The Treasury wants this new way of accounting to be integrated with Making Tax Digital (MTD) for Income Tax. One benefit will be for people who have several sources of income – the reforms will reduce the number of times they need to report their income under MTD for Income Tax.
What should I do now?
If you think the new Basis Period Reforms will affect you, please do talk to your account manager. Similarly, if you’d like help preparing for Making Tax Digital for Income Tax, we’d be delighted to help.
About Ben Locker
Ben Locker is a copywriter who specialises in business-to-business marketing, writing about everything from software and accountancy to construction and power tools. He co-founded the Professional Copywriters’ Network, the UK’s association for commercial writers, and is named in Direct Marketing Association research as ‘one of the copywriters who copywriters rate’.