The looming abolition of basis period for sole traders and partnerships

How to prepare your clients now

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Finance Act 2022 abolishes the basis period rules, moving all sole traders and partnerships to the tax year basis for 2024/25 onwards. This means 2023/24 will be a transitional year to align the financial year to tax year end, ie 31 March or 5 April.

How are your clients affected by these changes?

All new trades started after 31 March 2023 will have a defaulted financial year ending in line with tax year ended to 5 April 2024 (unless ceased prior to this date).

For existing trade – where the financial year is not in line with the tax year – the legislation provides for the spreading of the transition period profits over five tax years, starting from 2023/24. In each of the four tax years beginning with the tax year 2023/24, an amount equal to 20% of the amount of the transition profits is treated as arising and chargeable to income tax under Chapter 2 of Part 2 of ITTOIA 2005. In the fifth tax year, the balance of the amount of the transition profits is treated as arising and chargeable to income tax under Chapter 2 of Part 2 of ITTOIA 2005.

The trader may elect to accelerate the charge if they wish for an additional specified amount of transition profits to be treated as arising in that year.

The transition period begins the day after the end of the basis period for the tax year 2023/24 and ends on 5 April 2024. For example, if the normal financial year end is 30 April 2023, then the transitional period is 1 May 2023 to 5 April 2024. It also provides for a deduction to be given for the overlap profit that would be allowed if the trade ceased on 5 April 2024.

Transition period profits is the difference between the profits of the tax year 2023/24 as calculated with reference to paragraph 36, and the profits as calculated disregarding paragraph 36. Where the latter exceeds the former the transition period profits are nil.

Where the basis period for 2023/24 includes a transition part, the calculation of profits is more complex. The legislation provides a step-by-step calculation as follows:

Step 1: Determine the profits for the standard part of the basis period.

Step 2: Determine the profits for the transition part of the basis period.

Step 3: Deduct any overlap profit from the Step 2 amount.

Step 4: Add Step 1 and Step 3 to give the Step 4 amount.

Is this nil or less than nil?

  • Yes: 2023/24 profits are the Step 4 amount.
  • No: Proceed to Steps 5 and 6.

Step 5: Determine the transition profits for 2023/24. This is the lower of the Step 3 and Step 4 amount.

Step 6: Is the amount given at Step 1 nil or less than nil?

  • Yes: profits for 2023/24 are the amount of transition profits treated as arising the year.
  • No: Profits for 2023/24 are the sum of the Step 1 amount and the amount of transition profits arising in the year.

Accountants preparing accounts/tax returns for 2022/23 from April 2023 should consider these provisions for the affected clients and communicate the potential impacts to their clients.

More detailed guidance can be found within this earlier In Practice article.