Basis Period Reform Change for many sole traders and members of partnerships

Posted: 1st Dec

All changes take effect from April 2023

HMRC is seeking to modernise the tax system and to bring in tax revenues earlier. A key part of this is the introduction of MTD (officially “Making Tax Digital”), currently scheduled for April 2024.

The cornerstone of HMRC’s MTD system is the requirement for sole traders, members of partnerships and landlords to submit quarterly tax returns to HMRC through compliant software. These will be in
addition to the annual tax return currently submitted.

MTD will be the subject of a later article as much of the detail is still under development. However in preparation for its introduction, the rules for taxing trading profits made by sole traders and members of
partnerships and LLPs will change significantly from April 2023.

What is changing?

At the moment, sole traders and members of partnerships and LLPs pay tax on their business profits based on the accounting year-end falling during that tax year. By way of example, if your business
draws its accounts up to 30 June each year, you would pay tax on the profits made in the period 1 July 2020 to 30 June 2021 on your 2021/22 tax return.

From April 2024, all sole traders and members of partnerships and LLPs will pay tax on the profits made in the business in the tax year itself. This means that many will pay taxes on more than 12 months of
profits in the year of transition which is 2023/24.

Taking again, a business which currently has a 30 June year-end, the table below shows the profits which will be taxed each year:

Tax YearProfits TaxedMonths taxed
2021/221 Jun 20 – 30 Jun 2112
2022/231 Jul 21 – 30 Jun 2212
2023/24 (transition period)1 Jul 22 – 5 Apr 2421
2024/256 Apr 24 – 5 Apr 2512

Who is not affected?

Sole traders and partnerships which already draw up their accounts to 31 March or 5 April each year are not affected as they already pay tax on the profits arising in the tax year. There is no impact on business
trading through a limited company.

Practical implications

For many affected businesses, there will be higher taxable profits in 2023/24 than in other years simply because more than 12 months of profits will be taxed. There are however some reliefs available:

  • Deduction of overlap relief
  • Spreading the additional profit over up to five years

Most affected businesses will have overlap relief available based on profits made by the business either in its opening years, or on a previous change of rules in the 1990s. From a practical perspective, the overlap relief figure is not always immediately available and it may be necessary to contact HMRC to obtain it. If this is the case we are recommending that affected businesses contact HMRC sooner rather than later, which we are in the process of undertaking for our clients.

Spreading is designed to mitigate the impact of the change on affected businesses. The rules should generally have their desired effect, but many will still see higher tax bills for a period of time as a consequence of the changes. Tax bills will increase from January 2025.

Although it will not be a requirement for sole trader businesses and partnerships to have a 31 March or 5 April year-end, generally it will be simpler for businesses to change their year-end from 2024.

If a business needs a different year-end for commercial reasons, a common example would be farmers, this is possible but the business will still be taxed on profits arising during the tax year. At a minimum taking part of the profits of two accounting years on each tax return will create increased complexity. It may also mean accounts need to be completed very quickly after the business’s year-end to enable tax returns to be prepared in time for the 31 January filing deadline.

The impact on each business will be different, but change is coming.

We would be pleased to talk with businesses that will be affected.

About Chris Bentley
Before joining Harts in 2014, Chris gained several years of experience within the tax department of PwC in Manchester. As a Director, Chris now heads up the specialist Tax and Forensic departments at Harts.

E: CBentley@harts-ltd.com