Tax planning for the basis period reform

Basis period reform

The method that sole traders must use to work out their profits for each tax year is changing in April 2023. This is called the basis period reform and will affect anyone whose annual accounting period ends on a date other than one between 31 March and 5 April. For 2023/24 and subsequent years the taxable amount will be derived by apportioning the business accounts of two years.

Example. Andrea is self-employed. On advice from her accountant she produced her accounts for the period 1 May to 30 April each year. Therefore, her profit for each tax year is that shown by her accounts ending in that year, e.g for 2021/22 the taxable profit was that for her accounts for the twelve months to 30 April 2021. However, for the first tax year after the basis period reform, 2024/25, her profit will instead be 1/12th of that from her accounts to 30 April 2023 plus 11/12ths from her accounts to 30 April 2024.

For Andrea, the transition from the current to the new method requires cramming the profits between 1 May 2021 to 5 April 2023 (23 months) into just one tax year - 2023/24 - known as the “transitional year”.

Spreading relief

The extra profits (in our example, 11/23rds of that for the transitional year) can be taxed over five years.

Example. Andrea’s extra profit for the transitional year (2023/24) is £50,000. A fifth of this is taxable in 2023/24 and for each of the following four years. However, Andrea can elect to accelerate when some or all of the extra profits are taxed. The balance of the extra profits are then evenly spread over the remainder of the five-year period.

There are various reasons why a trader might want to accelerate when the extra profit is taxed. For example, in 2023/24 the profits aren’t sufficient when added to other income to make them a higher rate taxpayer. However, a big new contract means that for 2024/25 and later years they expect to be liable to higher rates. They can elect to bring forward some or all of the extra profit so that it’s taxed in 2023/24 at the basic rate instead of in 2024/25 to 2028/29 at the higher rate.

Overlap relief

If the accounting year end doesn’t coincide with the tax year the trader will probably have “overlap profit”. This is profit that’s been taken into account for tax purposes twice in the early years of trade, or following a change of accounting date. Because of this traders are entitled to claim a deduction for the twice-taxed profits. This is known as “overlap relief”. Under current rules the relief is allowed when the business ceases or there is a change to the accounting basis period. As such a change is being forced on traders because of the basis period reform any overlap relief they're entitled to must be used for 2023/24 or earlier.