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Potential changes to basis periods’ rules

The Government has released further details of its plans to change the current rules for basis periods.

Updated 27 September 2021

Intended to simplify the current arrangement, the Government’s proposed changes include taxing unincorporated businesses on the profits made in a tax year and moving the year-end of those businesses to align with the tax year.

The move would affect self-employed individuals, partners, trusts and estates with trading income. It would not affect companies.

What are basis periods and why are they used?

Businesses who currently use basis periods do so to allocate trading profits and losses to specific tax years. There are complex rules for basis periods when a business starts and finishes, but the intention is that over the lifetime of the business all profits are taxed once.

For example, by choosing a year-end accounting date that isn’t 5 April or 31 March, some profits are taxed in the early years of trading as the base periods may overlap.  These doubly taxed profits are carried forward and known as ‘overlap profits’.  When the business ceases trading or when its accounting date is changed, the overlap profits are deducted as ‘overlap relief’.

A large percentage of unincorporated businesses already have a 5 April or 31 March year-end to align with the fiscal year.  For some, however, seasonality of trade or other operational issues mean their year-end is at a different time.

What would be the implications of the change?

By aligning all year-ends of unincorporated businesses to the fiscal year, some will be forced initially to add additional later months into the next year’s profits.  For some, that may be an additional 11 months of profit being included, and this would mean 23 months of profit being taxed in one year.

For example…

A business which draws up accounts to 30 June every year would normally have a tax liability for 2023/24 based on the accounting year ending 30 June 2023. 

As this is the transitional year for these reforms, the actual taxable period would be 1 July 2022 to 31 March 2024, a 21 month period.

HMRC argue that such a business would have 9 months of overlap relief to use from the early periods of trading, and hence only 12 months are really being taxed in that year.  However, in many cases the 9 month overlap profits for the start of a trade will likely be far less than the 9 months profits of an established business.

Liquidity challenges

This obviously has serious implications for the cash flow of these businesses.  In its consultation paper, the Government has recognised the cash flow implications and has indicated that all existing overlap relief which businesses have amassed must be used to help during the transition period, but as above, this may not be enough.

There is also a suggestion any increased tax caused by the change might be able to be spread over up to 5 years, but any details regarding that are unavailable – for example, would interest run on any outstanding amount.

Timeline for the proposed changes

A key reason for the proposed changes is to help simplify the current system and pave the way for the introduction of Making Tax Digital for Income Tax.

The Government’s consultation closed on 31 August 2021. In a statement by Lucy Frazer, The Financial Secretary to The Treasury, on 23 September, it was announced the changes to basis periods will now not come into effect before April 2024, with a transition year no earlier than 2023. In its initial consultation, the Government proposal had suggested the changes would come into force in April 2022. The Government plans to release more information regarding the next steps in due course.

How to minimise the impact

Affected businesses should still start assessing now how the proposed changes would impact their cash flow and operations.  The basis period changes may also mean some will want to adjust their VAT filing timetable.  Cash flow projections and assessing what increased tax payments you can expect and when, will be key to making the transition a smooth one. 

Can we help?

If your unincorporated business would be affected given its current accounting period, do get in touch with one of our specialist team shown on this page. We can help you understand the implications of the changes for your specific circumstances and help you prepare.

Specific advice should be obtained before taking action, or refraining from taking action, in relation to this summary. If you would like advice or further information, please speak to your usual Shipleys contact.

Copyright © Shipleys LLP 2021

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