Income Tax: Basis Period Reform
Draft legislation on the proposal to reform income tax basis periods was released on 20 July 2021. A consultation on how to implement these reforms was also launched alongside the draft legislation.
The proposed rule change affects the self-employed, partnerships, trusts, and estates with trading income, with an accounting year end of anything other than 31 March or 5 April.
The reform to basis periods is intended to simplify the tax system before the introduction of Making Tax Digital (MTD) for Income Tax and make it easier for small businesses.
Table of Contents
Aligning taxable profits with the year
The proposal changes the basis period rules from a ‘current year basis’ to a ‘tax year basis’. The changes would come into full effect in tax year 2023/24. A business’s profit or loss for a tax year would be the profit or loss that occurs in the actual tax year itself, regardless of its accounting date.
As a result, we may see some businesses changing their accounting period end date to 31 March or 5 April, although this might not be practical in all cases.
2022/23 - Transition year
The transition would take place in tax year 2022/23, with all businesses’ basis periods being aligned to the tax year.
In this year, profits will be taxed in the usual way but in addition, profits arising from the end of the accounting period to the 5 April 2023 will also be taxed. Any previously created overlap profits will be able to be used to reduce the taxable profits, although these are often created in the early years of trading when profits might have been lower and in some cases could be from many years ago.
It is those with current year ends of 30 April, 31 May & 30 June which will see the biggest impact in tax year 2022/23.
A business with a current year end of 30 April (that retains that year end) will be taxed as follows:
(Please note: *Table only visible on laptop/desktop*)
Income Tax Basis Period
|Tax Year||Basis Period||Taxable Period|
|2021/22||year ended 30 April 2021||12 months|
|2022/23 (Transitional Year)||year ended 30 April 2022 + 11/12 x year ended 30 April 2023||23 months|
|2023/24||1/12 x year ended April 2023 + 11/12 x year ended 30 April 2024||12 months|
As above, it may become more practical in some cases to change the accounting period end date to 31 March or 5 April. For example, the above business may decide to have its usual year ending 30 April 2022 but then follow that with an 11 month period to 31 March 2023. Those two periods (23 months in total) would form the basis period for the tax year 2022/23, i.e. to give the same result as retaining the 30 April year end. The next accounting period, the year ending 31 March 2024, would however then fall neatly into the basis period for the tax year 2023/24.
In terms of the impact in the transition year, those currently with year ends of 31 December, 31 January and 28 February will be affected but to a lessor extent.
Spreading the cost
For many businesses this could result in a significant liability with potential cash flow issues. Therefore, the draft legislation proposes to address this by allowing taxpayers to spread the additional profits over a 5 year period.
Timetable and concerns
The ICAEW and other finance and tax professional bodies have written to the Treasury to express concerns over the proposed timetable for reforming basis periods and asks the government to reconsider. They argue that the proposed changes are scheduled to come in alongside other significant changes, in particular Making Tax Digital for income tax self-assessment (‘MTD ITSA’) and risks the integrity of the tax system by putting pressure on taxpayers, agents and HM Revenue & Customs itself.
The consultation period ended on 31 August 2021 and we await the outcome.