Are you ready for the change? Self-employed – Basis period reform

As part of HMRC's Making Tax Digital initiative, the existing method of calculating profits on an accounting year basis is to be abolished for the self-employed and partnerships. From April 2024, all such businesses will be taxed on profits for the tax year. To facilitate this move, the current 2023/24 tax year is deemed a transitional year such that some adjustments may be needed when declaring the assessable profit figure on the 2023/24 tax return.

Who will be affected?

Only specific unincorporated businesses will be affected, being those who do not have a 31 March or 5 April year end. If the accounting date is between 31 March and 5 April this change as such businesses are already on the tax year basis.

Impact on the transitional year

Those business owners affected will declare profits arising in the period from their last accounting date to 5 April 2024. For example, a business with a year end of 30 April will need to include profits realised between 1 May 2022 to 5 April 2024 (23 months) all pushed into the tax return for 2023/24.. This could affect cash flow and working capital and any extra profit will affect the amount of tax payable for 2023/24, including payments on account on 31 January 2024 and 31 July 2024.

This change will inevitably result in higher tax bills for many. The way by which this potentially increased profit (and potentially increased tax bill) can be reduced is via use of any overlap relief available.

Overlap relief

When self-assessment came into being in 1996/97, those unincorporated businesses without a 5 April year end were taxed twice in one tax year. That amount of 'double payment' was carried forward as overlap relief supposedly to be used either when a business changed its accounting date where the basis period for the tax year was longer than 12 months or (if not thereby exhausted) when the business ceased (or deemed to cease). Overlap relief can also currently be available on the commencement of a self-employed business where the usual 31 March or 5 April year end is not used.

Transitional profits and losses

The good news is that this transition year 2023/2024 presents an opportunity for all unincorporated businesses currently trading, regardless of accounting date, to use any remaining overlap relief. The problem is that many traders will need to have kept a record of the overlap profits which may not be readily available particularly where  such profits were created when the changeover to self-assessment occurred. Any overlap profits must be offset against the 2023/24 'transitional' year profits first. However, by default, any additional profit can be spread over the five years from 2023/24 to 2027/28 (although the taxpayer can opt out of this automatic spreading and accelerate the amount of transition profits assessed to tax). If the calculations result in an overall loss, that loss is treated as a terminal loss as if the trade ceases on 5 April 2024. 

HMRC intends to help by introducing a new service providing the overlap relief figures to be used in the tax calculations (assuming these figures have been recorded on HMRC's systems). Where the overlap profit has not been recorded, HMRC will provide data allowing the taxpayer to calculate overlap relief (e.g., the self-employment data from the relevant tax returns where available) on completion of an online form.

Practical point

There is now no facility to allow the business owner to defer the use of overlap relief and save it up to use at a later date (e.g., on cessation). Therefore, consideration should be made by even those taxpayers who have a 5 April year end to change to 31 March to ensure that overlap relief is not lost.