Tax Reform for all Unincorporated Businesses

An HMRC tax reform that will change the basis period for all unincorporated businesses to 5th April is delayed but still due. The changes will mean that businesses will be taxed on the profit or loss for the year ended 5th April regardless of the accounting period.

The basis period reform – which will align the tax basis period with the tax year end – was due to be introduced in 2022/2023 but has been delayed after accountancy and tax bodies, including the Institute of Chartered Accountants in England and Wales and the Chartered Institute of Taxation, urged ministers to drop the reform or, at the very least, delay it to give businesses more time to prepare.

The new basis period rules will apply from 2024/25, with a transition year in 2023/24.  Unincorporated businesses, particularly those with rising profits, will be impacted significantly by this.

Reform objectives

The government’s policy paper uses a hypothetical example of two businesses that are identical except for their accounting date.  Under the current year basis system, the two may have very different taxable profits for a tax year. The tax year basis is intended to remove this difference and create fairer outcomes between businesses.

It is hoped that using the tax year basis will remove complexity and lead to a clearer and more transparent relationship between the profits arising in a tax year and the tax liability related to them.

What is changing

Currently, a business’s profit or loss for a tax year is usually the profit or loss for the year up to their accounting date in the tax year, called the ‘basis period’. According to Specific rules determine the basis period in certain cases, including during the early years of trading. These rules can create overlapping basis periods, which charge tax on profits twice and generate corresponding ‘overlap relief’ which is usually given on cessation of the business. Overall, this basis of taxation is called the ‘current year basis’.

This measure changes this to a ‘tax year basis’ with effect from the tax year 2024/25, so that a business’s profit or loss for a tax year is the profit or loss arising in the tax year itself, regardless of its accounting date. This removes the basis period rules and prevents the creation of further overlap relief. On transition to the tax year basis in the tax year 2023/24, all businesses’ basis periods will be aligned to the tax year and all outstanding overlap relief given.

Businesses affected 

The reform will affect unincorporated business that have an accounting year which is not 31 March or 5 April. In the past many businesses have chosen a different year end to delay tax liabilities and it is these businesses who will experience tax payable on a period of profits spanning more than 12 months.

The change is expected to affect 528,000 unincorporated businesses – the self-employed, sole traders, partnerships, trusts and estates.  Many seasonal businesses and large partnerships will fall into this category.

Those affected are expected to pay a total of more than £1.7bn in tax and if these businesses are seeing rising profits over the next couple of years, then this tax bill will be greater and could seriously affect the cash flow for some of them.

Transition tax year

The consequence of this change will be to accelerate tax payments due. The crunch will therefore come in the transition tax year ending 5 April 2024, when affected businesses will calculate their tax on three elements:

  1. The tax due on the normal profits up to their normal accounting year end
  2. The tax due on the profits from the end of their accounting year end up to the 5 April 2024
  3. A reduction for historic overlap profits (these are profits which have been taxed twice in the first year of the business or when the business changed its accounting year end)

For most unincorporated businesses this will result in additional tax. HMRC has said that the additional tax can be spread over a period of five years to manage the impact on cash flow.

In order to prepare for this future change or to receive help with budgeting for these one-off tax charges, please feel free to contact Briars.