Accountants and bookkeepers in the UK need to know the latest HMRC basis period reform for sole trader and partnership businesses to work out their taxable profits.
Almost every business today calculates its taxable profits depending on the individual company’s accounting period, which may end at different points during a tax year.
However, according to the basis period reform, all unincorporated businesses will pay income tax on their profits during a fixed tax year.
This rule will be effective in the UK from the 2024/2025 tax year.
This guide will cover everything about basis period reform legislation and communicate the key factors.
Table of contents
- What is the ‘basis period’?
- Difference between ‘accounting period’ and ‘basis period’
- What is a basis period reform?
- Which businesses are impacted by the basis period reforms?
- What does basis period reform mean for self-employed individuals?
The basis period of a company is the time frame during which they calculate business profits and income tax.
Currently, most unincorporated businesses, like sole traders and partnerships, calculate income tax on annual profits during the business accounting period. However, this period varies from company to company. For example, a partnership’s accounting year-end date is 31 October each year, and they can calculate taxable profits from 1 November of this year to 31 October of next year.
However, from 2024/25, the basis period reform will legally mandate all unincorporated businesses to use the UK tax year of 6 April to 5 April as the basis year for calculating their income tax.
One can choose an accounting period for their business and use that date to close their books or produce financial reports. For example, if 31 October is the account closing day, their accounting year starts on 1 November and ends on 31 October every year.
However, the basis period of the business that HMRC utilises to calculate their income tax liability and work on other tax concerns.
Until now, accounting and basis periods were the same. But, from 2024-25, all unincorporated businesses will have a fixed basis period for tax purposes, while the accounting period may vary.
The basis period reform changes businesses’ income tax calculation period. Previously, the business’s accounting period was the basis period for tax calculation; now, it’s the fixed UK tax period, which is from 6 April to 5 April.
Let us take a basis period reform example to understand the process.
- A business’s accounting period for 2020/21 was from 1 November 2020 to 31 October 2021. This was treated as their tax year as well.
- From 2024/25, even though their accounting period remains the same, the tax period is from 6 April 2024 to 5 April 2025. This is their new basis period for income tax calculation.
No matter what accounting year a business maintains for its multiple other businesses, all their tax basis period remains constant.
These changes are made to simplify the MTD (Making Tax Digital) reporting requirements for income tax in the UK. Presently, all incorporated businesses must understand the connection between basis period reform and making tax digital for smooth tax filing.
2023/24 is the basis period reform transitional year for businesses whose accounting year doesn’t match the UK’s tax year. This one-off basis period for such businesses will be longer than 12 months.
For example, if the accounting period is 15 February to 14 February. For the transitional year, they have to calculate taxes for a basis period of 15 February 2023 to 5 April 2024 as a period of 14.5 months. Though they will land with a larger than average tax bill for the basis period, businesses will get back the overlap profits by offering their detailed report to HMRC.
The basis period reforms in the UK will broadly impact unincorporated businesses. It includes
- Self-employed traders (along with individuals with a profession or job)
- Partnership businesses (including limited liability partnerships)
- Other unincorporated businesses with trading income (e.g., trading trusts and estates)
However, if the businesses use the tax year similar to their business period, none of these changes will affect them.
For self-employed people who have a separate accounting period and tax year, they need to submit their estimated profits for a part of their accounting period. As their accountant or bookkeeper, it is best to follow basis period reform HMRC guidance to calculate their profits.
For trading partnerships, this basis period reform can disrupt their cash flow depending on how the partners decide to spread their transitional period profits. You need to do some cash flow modelling for such businesses to explore different outcomes and determine the best approach for your client.
However, you must read the Business Income Manual and the basis period reform of HMRC thoroughly to help your clients survive the new struggle. People can request their overlap profit information from HMRC after the online form.
This article has offered a comprehensive view of basis period reform legislation to help you communicate the tax calculation changes to your clients.