Basis period reform – the end of overlap profits for the self-employed

The transitional year

The change requires all unincorporated businesses to be compliant with the new rules from 6 April 2024 (the 2024/25 tax year). The preceding tax year (2023/24) is therefore the “transitional year” in which all business will need to have their house in order. 

During the 2024 tax year businesses will be taxed on the following:

• Their profits on the ‘current year’ basis (i.e. for the 12 months to their accounting date which ends in the tax year 2023-24), PLUS
• Profits which arise in the period from the day after the current year basis period to 5 April 2024.

Depending on your financial year end, this could result in almost two years’ worth of accounting periods becoming taxable in one year!

Example: 31 December

Taking an example of 31 December.

2023/24 tax year (the transitional year):

1. 12 months profits to 31 December 2023;
2. Plus: 1 January to 5 April 2024 (generally pro-rata based on taxable profit to 31 December 2024);
3. Less overlap profits brought forward.

2024/25 tax year (tax year basis):

1. 6 April 2024 to 5 April 2025 (again, generally pro-rated from the two accounting periods).

What are the practical implications?

It is important to be aware of the additional tax, compliance and reporting implications of the changes before the start of your next accounting period.

Income tax

For businesses with higher profits in 2023/24 (after the deduction of overlap profits) due to the change in basis, there is an automatic election to spread those additional profits over a period of five years, which you can opt out of. 

This ‘profit spreading’ must commence in 2023/24 and taxpayers can elect to bring in to charge the additional profit allocation at any point during the spreading period. 

The transitional profit will create a ‘stand-alone tax charge’ that will not affect the level of taxpayer’s income that is used to calculate entitlements to relief on pension contributions or Child Benefit.

Compliance and reporting

You will be required to prepare and pay tax on profits for a period in which the accounts may not yet be finalised and estimates will be required. Estimates will almost certainly be inaccurate and so further reports will need to be prepared, effectively doubling the workload for finance teams. 

Updating the figures will entail an amended Tax Return being submitted to HMRC. It is important to note that any late submissions will incur automatic penalties from HMRC. 

If any amendments result in an increase in reportable profits, this in turn will cause an increase in tax payable. It is important to note that any late paid tax will result in late payment interest (and in extreme cases, penalties) being charged by HMRC. 

Late payment interest charges is set to rise to 4.75% from 11 October 2022. 

How to prepare?

• Undertake a review of the transitional rules in line with forecast to see the cashflow impacts for the business and its members.
• Test the resources you have available in preparing two sets of financial data.
• Consider a change in year end. (Please see our article on changing your year end for other points to consider).

The changes may be particularly challenging for large firms with complex financial and tax affairs, and the impacts will need to be carefully considered and prepared for ahead of the transitional year.

Please contact us if you would like assistance in clarifying how these changes will affect your business.