Everything you need to know about basis period reform

Guest writer, Ben Brookes a Partner at Wellers, discusses how basis period reform will impact those in Limited Liability Partnership law firms.

The UK tax system is one of the most complicated in the world and it can be confusing to get your head around filing tax returns. Saying that, one thing that is ingrained in our brains is that the UK tax year runs from 6^th April to 5^th April, and we must report income during this time.

Many who are self-employed or a member of a partnership, like those in Limited Liability Partnership law firms, have their own accounting year, known as the basis period, which doesn’t align with the tax year. When this is the case, tax can be charged twice in the first years of trade as profit calculations can’t be made for the full tax year, leaving individuals potentially out of pocket.

To counteract this overcharge, those impacted can apply for something called overlap relief. Whilst this system does work, the process for applying for overlap relief is long, tedious, and can only be applied for when your business stops trading or if you change your accounting year end. Thankfully HMRC has recognised that the current system isn’t very efficient and has reformed the basis period process with the new system coming into effect from 5^th April 2024.

What is basis period reform?

Put simply, basis period reform means you will have to report on profits gained during the UK tax year alone, regardless of your accounting year. Doing so will stop people in Partnerships being taxed twice and alleviate the need for overlap relief. Basis period reform will have no impact at all on those whose accounting year already falls in line with the tax year but everyone else will need to make some changes to meet this new legislation.

To understand how the change will impact you, you first need to know when your accounting year starts and ends. If your accounting year finishes between 31^st March and 5^th April, you don’t need to do anything as you will already meet HMRC’s new criteria. However, if your accounting period ends at any other point in the year, basis period reform will impact how you report profits to HMRC next year.

What do I need to do?

If you will be impacted by basis period reform, there are two things you can do:

1. Calculate profits from overlapping accounting years, known as the transition period, to provide a profit figure for the standard tax year
2. Move your accounting year so the year-end aligns with the tax year

Each option comes with its own set of complications, so you should consult with a trusted tax advisor who will be able to make a recommendation based on your personal circumstances.

Transition period profits

As already mentioned, to calculate profit from the tax year, profit figures are needed from the overlapping accounting years (two years' worth of accounts). This proves a challenge if your second accounting period doesn’t end in time for the tax return deadline on 31^st January. When this issue occurs, HMRC will accept estimated figures instead, but only on the condition that the true figures are reported within 12 months.

Not everyone enjoys financial calculations (unless you’re an accountant of course). So, to calculate profits in the transition period you can use the following equation:

Standard part profits + (transition part profits – overlap relief)

Standard part profits refers to any profits earned during your standard accounting year which ended in the 2023 tax year. The second part of the calculation, ‘transition part profits’, considers any profit made between the end of your accounting year and the end of the tax year. The final step is to subtract any overlap relief applied for before the basis period reform change, which will reduce the amount of your earnings which will be taxed. Although this looks daunting at first glance, it’s much simpler than it seems. To demonstrate I’ve included a worked example below.

Let’s say your accounting year ends on 31^st December and the taxable profit you’ve made during the 2023/24 tax year (along with prior tax years) stands at exactly £365,000. First, you’ll need to calculate, or in this case predict, your transition part profits.

This can be done by calculating how many days there are between the end of your accounting year, and the end of the tax year being 5^th April, in this case it’s 96 days. Then we divide the profits for the accounting year of £365,000 by the number of days in the year, 365. This provides a taxable profit figure per day of £1,000.

The taxable profit figure per day is then multiplied by the 96 days in the transition period to give a projected transition part profit of £96,000. Taxable profits in the transition period are then calculated as £365,000 + £96,000 = £461,000.

The additional rate of Income Tax and National Insurance are then applied to these earnings. Of note, this example assumes that:

• No overlap profits are available, and hence no overlap relief
• That there is no change of year end taking place
• There is no option to spread the taxation on transitional profits over 5 years
• No other income or losses apply

You can see how things get very complicated quickly, hence I recommend you obtain tax advice on such matters.

Moving your accounting period

The other option is to move your accounting year in line with the tax year. Although this doesn’t involve any extra calculations, it does have its own complexities.

Firstly, an accounting year cannot be longer than 18 months so you may need to have a short accounting period to align to the tax year, which will need to be considered when deciding the best time to make the move. You will also need to consider the impact of any overlap profits held in the year change.

Secondly, you must notify HMRC of the change when you submit your tax return. Although many complete this process themselves, it is best completed by a tax advisor to avoid any unwanted issues with HMRC later down the line.

What are the next steps?

Basis period reform is one of the more complicated HMRC regulation changes, but the good news is it’s a one-time change which will make all your future tax returns that little bit easier. To make sure you are following the correct procedures there are three things you need to do:

1. Make sure you know the dates of your accounting year
2. Consider which route you want to take, either calculate transition profits or move your accounting year
3. Contact a tax advisor to help you make the basis period reform process as smooth, and as simple, as possible

ABOUT BEN BROOKES

Ben Brookes brings his in depth knowledge of running the finance function and delivering tax advice, to each task while ensuring services are tailored to individuals and businesses’ needs. Ben particularly enjoys working alongside SME business owners, helping their enterprises thrive by providing a combination of compliance and advisory services.

Find out more about basis period reform from Wellers.