The tax landscape is updated often, affecting virtually all businesses at some point in their lifetime.
One of the upcoming reforms that will majorly impact how businesses report their profits is the basis period reform (BPR).
The Government predicts the reforms will affect over 500,000 sole traders, so it’s essential to be aware.
Here’s what you need to know about BPR.
The reforms in a nutshell
Starting from the tax year 2024/25, HMRC is transitioning unincorporated businesses like sole traders and partnerships to pay income tax based on profits earned during the UK tax year, which runs from 6 April to 5 April, rather than their individual accounting periods.
- Sole traders and partnerships whose accounting year doesn’t end between 31 March and 5 April.
- Businesses that start operating after 6 April 2024.
- Accounting period: The time frame chosen by the business for financial reporting.
- Basis period: The period HMRC uses to assess your income tax.
What’s the impact?
- Transitional rules: For the 2023/24 tax year, businesses must adapt to transitional rules, which could involve multiple sets of accounts.
- Self-employed: If your accounting period doesn’t align with the new tax year, you’ll need to estimate profits for part of the year.
- Partnerships: Cashflow could be affected, making it crucial to model various outcomes.
Who will be affected?
The reform primarily targets the self-employed and partnerships that do not align their accounting periods with the tax year, which runs from April 6 to April 5 of the following year.
If your business falls under this category, you’ll be required to change how you report your taxable profits from 6 April 2024.
Understanding the basics
Previously, your accounting period could differ from the tax year, and your profits for tax purposes were aligned with this accounting period.
Post-reform, all self-employed individuals and partnerships must report their business tax on a tax year basis, ie profits will be assessed and taxed in the tax year in which they arise.
The transition period
The tax year 2023/24 will serve as a transition period. If you currently have profits assessed over accounting periods different from the tax year, you may find yourself reporting profits for a duration exceeding 12 months in the 2023/24 tax year.
This could result in additional tax liabilities, spread over five tax years (2023/24 to 2027/28).
The late accounting date rules
If your accounting period ends between 31 March and 4 April, it will be treated as effectively ending on 5 April.
This adjustment spares you from the complexities involved in the transition. You can maintain your existing accounting period for reporting business profits.
Should you change your accounting period?
If your accounting period does not coincide with the tax year, consider aligning them.
Doing so will simplify your reporting process and is particularly beneficial in the context of Making Tax Digital for income tax (MTD), a regime that your business will likely need to adapt to soon.
If changing your accounting period proves impractical, you can still maintain your preferred period, but be prepared for the complexities involved.
Example in navigating BPR
Let’s consider “BuildIt Right,” a partnership construction firm with an accounting year that ends on 30 June.
Before the BPR, BuildIt Right prepared their tax returns based on their profits for the accounting year running from 1 July to 30 June.
Preparing for the transition period
The 2023/24 tax year serves as a transition to the new rules. BuildIt Right will need to prepare two sets of accounts to report their profits for this tax year:
- First set: Profits from 1 July 2023 to 30 June 2024.
- Second set: Profits from 1 July 2024 to 30 June 2025.
Based on these two sets, they will then apportion their profits into the 2024/25 tax year as follows:
- Profits from 6 April 2024, to 30 June 2024 (from the first set of accounts).
- Profits from 1 July 2024, to 5 April 2025 (from the second set of accounts).
Previously, BuildIt Right had until 31 January of each year to file their tax returns, giving them seven months after the end of their accounting period.
However, with the reforms, they will have less time.
Specifically, they’ll have just under three months to finalise the second set of accounts for the period ending on 30 June 2025, to meet the online filing deadline of 31 January 2026.
Aligning accounting and tax year
To simplify proceedings, BuildIt Right might consider changing its accounting period to end on 5 April. This would align with the tax year and make compliance with both tax reporting and MTD more straightforward.
Get advice on your basis period
BPR is not just a compliance issue – it’s an accounting concern and a real headache for some of those affected.
With preparation and advice, your business can turn these reforms into an opportunity to streamline your financial processes. Contact us to find out more.