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Does basis period reform mean a 23-month tax year?

If you’re self-employed and have to submit your own Self-Assessment tax returns, the new tax year might be longer than you were expecting.

Normally, self-employed taxpayers are taxed on their profits made in their accounting year ending within the tax year. However, the government wants to speed up the tax return process by making self-employed earners pay tax on their profits made in the tax year instead.

Moving from the individual’s accounting year system – or ‘current year basis’ – to a tax year basis means catching up by paying tax on more than twelve months of profits in one tax year.

Unless your accounting year ends on 31st March or 5th April, more or less aligning with the tax year already, this will begin to take effect in the current 2023–2024 tax year. Read on to learn about why this is happening and how it could impact your self-employed business.

What is basis period reform?

All business owners, including the self-employed, have an accounting year which runs for twelve months. The start and end date of their accounting year may be different to the UK tax year, which runs from 6th April each year to 5th April the following year.

Now that HMRC plans to use the tax year as the basis period for all taxes, rather than letting businesses use their own accounting year, there is a new set of rules for when this basis period reform is likely to cause an overlap in taxable profits and relief eligibility.

To make tax returns more straightforward, shifting all accounting periods to the standard tax year was intended to apply from April 2024 along with the mandatory introduction of Making Tax Digital (MTD) for Income Tax Self-Assessment (ITSA),
but the launch of this digital platform has been pushed back until April 2026.

However, the basis period reform is still going ahead from April 2024, enforcing a transitional period that starts with the current tax year from April 2023. This means those with different accounting periods will not only be taxed on profits for the last basis period within the 2022–2023 tax year, but will also be charged an extra ‘transitional’ component from the end of that period to April 2024.

Theoretically, this will stretch out the tax year for up to 23 months, though the additional tax liability from this period can be spread over several years.

What if you don’t adjust your accounting period?

While self-employed taxpayers are still allowed to choose their own accounting periods for now, adjusting them to comply with the tax year basis for tax returns will be complicated, and is likely to cause problems with reporting profits and losses and claiming reliefs.

It’s not always practical for accounting periods to immediately switch to the tax year, as many businesses design their accounting year around commercial dates relevant to their work. However, if they don’t, they’ll have to take the extra administrative step of apportioning profits and losses.

For example, if a self-employed trader ran their accounts according to the calendar year (from the first day of January to the last day of December), they would have to calculate 270/366ths of profits from the 2023 calendar year and combine it with 95/365ths of profits from the 2024 calendar year to report their profits for the 2023–2024 tax year.

This obviously involves a lot more work, but there’s also the problem of those with accounting year end dates falling later in the year not having available profit figures to use before the tax return filing deadline. Using provisional figures instead would require amending their tax returns when the actual figures become available, creating an even larger administrative burden.

Even if the trader chose to wait until submitting the next year’s tax return to update the previous return’s profit and loss figures, which HMRC will allow, this would create uncertainty around tax liabilities and their National Insurance and State Pension contributions.

What do the transitional rules mean for your business?

If you run a limited company, or your accounting year ends between 31st March to 5th April, then the basis period change shouldn’t affect you. As the change is supposed to simplify the system, HMRC doesn’t intend to make businesses apportion a few days of profit or loss.

That said, if your accounting period doesn’t align with the tax year even with the allowance of those dates, then the move will potentially increase your tax liabilities from 2023. In addition, everyone else will be affected by the ‘transitional’ component mentioned earlier.

HMRC will automatically allow self-employed taxpayers to spread the ‘transitional’ profits from the 23-month tax period over 5 years to ease the financial burden, though some or all of those profits can be brought forward to pay off tax liabilities sooner if you prefer.

For example, if your accounting year ends on 30th April, your taxable profits for 2022–2024 would be the regularly calculated profits for your accounting year from 1st May 2022 to 30th April 2023, plus one-fifth of the ‘catch-up’ element for your profits from 1st May 2023
to 5th April 2024 (around 541/366ths of the profits from your May 2023–April 2024 accounting year).

If you experienced double taxation in your first year of trading due to your accounting year overlapping tax years, you can carry the amount over and deduct it from another year’s tax liability as ‘overlap relief’ – so if you have remaining overlap relief, you must apply it during this transitional year, as HMRC will not allow it to be generated or carried forward after that.

If you cease trading during the transition period, the total balance that would have been spread over the next few years will become payable in your final tax year of trading.

Get help with Making Tax Digital tax returns

The easiest way forward for most sole traders will be to make the switch from a different accounting period to the tax year basis during the transitional year (April 2023–April 2024).

While you’ll have to account for additional tax on liable profits from the overlapping period, administration will be much simpler from then on, without having to apportion profits and deal with the resulting cashflow issues every year.

Of course, this is easier said than done, as there isn’t a general strategy that would work for every situation. You should speak with an accountant to discuss your unique circumstances and the best way to implement these changes with the least disruption to your business.

If all this is giving you a headache, you’re not alone – but don’t let this complicated situation put you off from taking action to organise your accounts and tax management. It’s better to get to grips with the newer tax system and digital accounting before it becomes mandatory to use the Making Tax Digital online filing system.

For guidance on anything from MTD software to changing your accounting end date to match the tax year, get in touch with us at GBAC by phone or email. Our Barnsley accountants can help traders throughout Yorkshire and across the country get to grips with recent and upcoming tax changes to minimise your administrative burden.