Examining the impact of abolishing ‘basis period’ from 2024-25
Part 4 of Finance Act 2022 has set out how the profits of the self-employed sole traders and partners in a partnership will be taxed from 2024/25. This has resulted in a number of changes to the legislation – including abolishing the well-known term ‘basis period’. The changes mean that the profits will be taxed on a tax-year basis – ie to the end of 5 April instead of the profits for the 12 months to the accounting date in the tax year.
From 2024/25, taxable profits will be based on time-apportioned profits of the accounting periods that fall within the tax year.
For example, if a trader prepares their accounts to 31 December every year, their 2024/25 taxable profits would be based on 275 days (out of 366 days) of the 2024 calendar year profits and 95 days (out of 365 days) of the 2025 calendar year profits.
The 2024/25 tax return is due by 31 January 2026. It is unlikely that the trader will be able to finalise the accounts and tax adjustments for the 2025 calendar year accounts in time, hence they may need to file a tax return based on provisional figures and then revise the return later once the correct figures are known. This exercise would be repeated every year thereafter.
To reduce the administrative burdens on businesses – such as two sets of tax computations (from different accounting periods) for each tax year and problems with estimation and possible revisions/ amendments to tax returns following finalisation of accounts – HMRC has suggested the following options to its consultation responses:
There are lots of examples available within HMRC manual from BIM81040 onwards covering various scenario of change of accounting date along with how the overlap relief can be claimed.
Specific provision has been included to ensure that overlap relief is not one of the reliefs restricted under s24A, Income Tax Act 2007 (ITA 2007), which puts a limit on such reliefs of:
(a) £50,000 or
(b) if more, 25% of the taxpayer's adjusted total income for the tax year.
Almost everyone with an accounting date other than 31 March or 5 April will have an entitlement to overlap relief and can ‘cash it in’ either on a change of accounting date or on cessation of the business.
Where a business changes its accounting date, there will generally an overall saving to be made where current profits are at a lower level than the profits arising when the ‘overlap’ first arose.
Where a change of accounting date takes place in year four or later years of trading, three conditions must be met for the basis period for the year of change to end with the new accounting date. The legislative provisions are found in S216-S217 ITTOIA 2005
The three conditions are:
HMRC manual BIM81050 provides more guidance on commercial reasons for changing an accounting date. It is important to remember that obtaining a tax advantage is not a commercial reason (S218(6) ITTOIA 2005)
Once the client decides to change the year end, overlap relief is given as a deduction in calculating the profits of the trade for the tax year in which there is a change of accounting date, if the basis period for that tax year is longer than 12 months. HMRC guidance on basis periods is found at BIM81000 onwards.
The amount of overlap relief given for the tax year in which such a change of accounting date occurs is restricted by reference to the number of days:
Where the accounting date in the year is 31 March or 1-4 April inclusive, the basis period may be treated as ending on 5 April for the purpose of calculating the amount of relief.
The effect of offsetting overlap relief on a change of accounting date is to ensure that tax is paid on 12 months’ worth of profits. If, for example, the basis period is 14 months long then the overlap relief of two months will be deducted. The legislation achieves this result by listing six ‘steps’ used to calculate the deduction, as follows:
The following example shows how these above steps can be applied in practice:
The overlap profit available for relief after 2016-2017 is £54,492 over 340 days.
In 2018/19 the accounting date is changed again from 30 April 2018 to 31 October 2018. The relevant conditions for a change of accounting date are met.
The basis periods are:
2017/18 |
Year 8 |
12 months to 30 April 2017 |
2018/19 |
Year 9 |
18 months to 31 October 2018 |
2019/20 |
Year 10 |
12 months to 31 October 2019 |
The profit for the 18 months to 31 October 2018 is £120,000.
Overlap relief given for 2018/19 is restricted (because at least 12 months’ worth of profit must be brought into the charge to tax for that year).
The basis period for 2018/19 exceeds 12 months by 184 days (549 less 365).
Overlap relief for 2018/19 is restricted to £54,492 x 184/340 = £29,490. Profits taxable for 2018/19 are £120,000 less £29,490 = £90,510.
Overlap profit of £25,002 (over 156 days) remains unused. At cessation any remaining relief will be given in full.
HMRC is yet to issue guidance on how the 2023/24 transition year will work in practice, where some businesses will need to estimate figures and amend as necessary. In the meantime, traders with accounting dates that do not align with the tax year should prepare for any additional tax liability that may arise from these changes.
HMRC manual BIM81080