Goodbye basis periods!

Lee Sharpe considers some practical aspects of the forced alignment of basis periods to tax years. 

HMRC requires the homogenisation of taxable profit reporting schedules for all taxpayers subject to income tax so that its IT systems can cope with the new quarterly update cycle under ‘making tax digital’. There is no point pretending that there is any meaningful benefit in this huge upheaval to anybody except HMRC; while the government has tried to pass it off as being ‘fairer’ and ‘easier’ for businesses, that would effectively be to pretend that some businesses had been forced to adopt a basis period that did not actually suit them in the first place (before the introduction of this new regime in FA 2022 s 7, Sch 1, I mean). 

The tax year 2024/25 is the one from which trading profits on all income tax returns must be made to a tax period ending on (or between) 31 March or 5 April. But the real work is in relation to the transition year, 2023/24, although it affects only the mere 500,000 or so self-employed individuals and partners that do not already make up their accounts to 31 March or 5 April, etc. 

A reminder of the basic mechanism 

1. Take the tax-adjusted profits (post-capital allowances) for the standard 12-month period ending in 2023/24, or ‘standard part’ profits, as usual, and consistent with previous years. 

2. Prepare to add on the taxable profits as likewise calculated for the period from the end of that standard first period to 31 March 2024 (or 5 April 2024, etc.), as ‘transition part’ profits. 

(NB. If you insist on maintaining accounts that do not coincide with 31 March 2024 (etc.), a corresponding time-apportionment of the adjusted profits of the period straddling 31 March will make the transition part profits.) 

But first, from the transition part profits in (2) – 

3. Deduct any overlap relief available, being the aggregate of: 

1. Relief derived from treating the business (for the purposes of this calculation) as having ceased; and 

2. Any transitional relief that could (should) have been claimed previously, on a change of accounting date in an earlier tax year, but that was not claimed for any reason (which is a quite decent accommodation). 

4. This overlap relief should be deducted only from the transition part profits, and: 

1. Any residual transition part profits can then be ‘spread’ over the next five tax years starting 2023/24, evenly by default but with the option to accelerate the charge as desired in any one or more of the first four of those five tax years (and more than once, if appropriate); but 

2. If deducting the overlap relief makes (or increases) a loss in the transition part, that transition part loss should be deducted from the standard part profits to the extent that the overlap relief in turn makes an overall loss (or enhances a pre-existing loss in the standard part), that element can (again, quite generously) be treated as a terminal loss, with broader opportunities for relief than would otherwise be available for a continuing business. 

Any overlap relief not properly claimed under (4) above risks being forfeit. 

Complications 

If the plucky taxpayer or partnership decides to retain a non-tax year end for accounts purposes, it will need to time-apportion the tax-adjusted results for the accounts that straddle 31 March 2024 (etc.) to derive its transition part profits and likewise patch together apportioned fractions of the results for every period thereafter, to align 12 months’ results with the tax year.  

It may well be that the results for (say) the year to 30 November 2025 are not ready in time for the 31 January 2026 filing deadline for 2024/25, thus necessitating the adoption of reasonable estimates, potentially every year. While estimates should normally be updated as soon as possible under self-assessment, HMRC will allow the amendment to be made as late as the following 31 January (so, 2027 in this case – potentially alongside the initial estimated return for 2025/26). 

A business can decide to change its accounting date in the transition year and, notably, the standard rule that a business may not have an accounting period longer than 18 months has been removed as part of the excision of legislation governing non-tax year basis periods. Hence, it will be possible to have a very long period from (say) 1 July 2022 to 31 March 2024 – 21 months. 

Choosing whether to extend a period of account or to have two periods in 2023/24 may well affect the overall result differently; assuming profits, etc., do not accrue perfectly evenly, the business will likely have different transition part profits: 

• the discrete shorter separate ‘stub’ period ending 31 March 2024; or 

• a time-apportionment of the long overarching period ending on 31 March 2024; or 

If you really want to break your software (and likely HMRC’s) by changing accounting date but not to 31 March 2024, etc. – 

• An unhappy alliance of both approaches. 

Partnerships  

A partnership may be obliged to report at the partnership level but each partner has their own notional trade for income tax purposes, so the accommodation by non-corporate partners of the new tax year basis period is reckoned for each such partner separately (and each of whom will have their own overlap profits, depending on their respective commencement date). It may of course be much simpler going forwards for the partnership to adopt a tax year end accounting date but some partnerships may have non-tax reasons (or non-UK tax reasons, at least) for sticking with June, December, etc. (NB. corporate partners are unaffected by the basis period regime changes.) 

Where the partnership has an ancillary non-trading business such as rental income, traditionally that will also have been made up to the trade’s accounting date, so there will again be a requirement to adjust and align the basis period with the tax year end in 2023/24.  

However, unlike with the approach to trading profits in 2023/24 as set out above: 

• there is no option to ‘spread’ any net transition part profits; also, where the overlap relief on that notional business is substantial;  

• it seems that once any separate overlap relief on that notional business has been set against the overall notional business profits in 2023/24, any excess notional overlap relief may then be set against the partner’s trading income.  

Tax on transitional part profits 

Recognising that even after spreading, the net transitional part profits cropping up over the next few tax years could have quite punitive indirect consequences, the legislation basically requires the taxpayer to: 

1. first, calculate their income tax liability for a ‘spreading year’ going through the ‘steps’ at ITA 2007, s 23, ignoring any transitional profits income component in that year; and  

2. re-calculate the liability that would arise if the transitional component had been included all along, but only bolt on the resulting increase in liability as a late tax adjustment in ‘Step 5’. 

To put it another way, the post-spreading transition profits are ignored as an income component but feature as an adjustment to the tax liability itself, almost like an addendum. 

Deliberately ‘overlooking’ the transitional profit component in the early steps is helpful in that it will not affect: 

• high-income child benefit clawback calculations (which depend on the amount that accords with ‘net income’ at step 2); 

• pensions annual allowance restriction for higher earners (‘tapering’); and 

• CGT (as the transitional profit component is ignored when deciding how much of the basic-rate band is unused for calculating the rate of CGT to apply). 

But it will still adversely affect: 

• tapering of the personal allowance where adjusted net income exceeds £100,000 (because of the re-calculation part (2) above); 

• student loan payment calculations; and 

• payments on account. 

The detailed calculation mechanism and its interaction with other parts of the tax and benefits codes can be complex; practitioners will likely be leaning heavily on their tax software in the next few years. 

Missing overlap relief details 

Overlap profits could have arisen as far back as the 1990s, so HMRC is offering a specific service to confirm the overlap relief figures it holds (or can ascertain) using a dedicated online ‘g-form’ primarily aimed at individual taxpayers, but which agents can also use – one application per individual taxpayer, partner, etc.  

This should normally secure a response within 15 working days, but may take longer in complex cases or where the agent requests the details by telephone instead.  

Conclusion 

The ‘spreading adjustment’ applies only in 2023/24 (in other words, it is not applicable as a fresh adjustment if the business decides to move its accounting date to align with the tax year after 2023/24). Overlap relief is also available only insofar as it may be included in the 2023/24 transitional calculations. Advisers are going to be extremely busy in the run-up to 31 January 2025 but may, in some cases, need to carefully consider if they should be optimising the benefit of the spreading adjustment (or elections to accelerate the charge) – say, by disclaiming capital allowances, or the choice of accounting dates that have a bearing on 2023/24.