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Tax Questions: The ‘Basis Period Reform’ 2023 Transition

Period Basis

In recent months, the government moved the year the basis period reform would take affect from April 2022 to April 2023. For the self-employed, the approaching basis period reform can increase the profit on which you’re taxed for 2023/24. Within the rules there is room to make this more tax efficient. While this is not imminent, ensuring you have a good accountant to manage your finances when this takes effect, is a good idea.

How the Basis Period Reform works

The method sole traders must use to work out yearly profits is changing in April 2023. Called the basis period reform this new rule will affect anyone with an annual accounting period that doesn’t already end in 31 March-April 5. For 2023/24 and subsequent years, the taxable amount will be derived by ‘apportioning the business accounts’ of 2 years.

Impact on profits in transition year

Say you’re self-employed and up until now you produced accounts for 1 May-30 April yearly until now. Your yearly profit is shown by accounts ending in that year. So 2021/22, taxable profit would be 12 months to 30 April 2021. However, for the first tax year after basis period reform kicks in, 2024/25, profit will be 1/12th of that from your accounts to 30 April 2023 plus 11/12ths from accounts to 30 April 2024. The transition from the current to the new method requires cramming profits between 1 May 2021 to 5 April 2023 (23 months) into 1 tax year (2023/24), known as the transitional year.

Spreading tax relief

However, extra profits in the 11/23rds (in this case) of that for the transitional year can be taxed over 5 years. Say extra profit for the transitional year (23/24) is £50,000. A fifth of this is taxable in 2023/24 and for each of the following 4 years. However, you can elect to accelerate when some or all of the extra profits are taxed. The balance of the extra profits is then evenly spread over the remainder of the 5-year period.

There are various reasons why you might want to accelerate when extra profit is taxed. Say in 2023/24 if profits aren’t sufficient when added to other income to make you a higher rate taxpayer yet a big new contract looming for 2024/25 and later years may make you liable to higher rates. You can elect to bring forward some/or all of the extra profit so it’s taxed in 2023/24 at basic rate instead of in 2024/25 to 2028/29 at the higher rate.

Overlap relief

If your accounting year-end doesn’t coincide with the tax year, you’ll probably have overlap profit. This is profit taken into account for tax purposes twice. Because of this, you’re entitled to claim a deduction for the twice-taxed profits called overlap relief. Under current rules, the relief is allowed when your business ceases or you change your accounting basis period. As such, a change is being forced on you because of the basis period reform – any overlap relief you’re entitled to, must be used for 2023/24 or earlier.

If you don’t know how much overlap relief you’re entitled to and can’t work it out, LHP can help you calculate it. You can engineer overlap relief to apply for 2021/22, 2022/23 or 2023/24. Consider which gives the greatest tax saving. Extra profits can be spread over up to 5 years from April 2023. You can elect to some degree, to allocate them in the most tax-efficient way. If you’re entitled to overlap relief for doubly taxed profits, you can use it in any of the 2021/22, 2022/23 and 2023/24 tax years. Your accountant can consider which will produce the greatest tax reduction.

Let’s Talk

For help calculating the most efficient tax solution for your business under the new period basis reforms in the future, get in touch on Let’s Talk.

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