HMRC Finance Act 2022 – Alignment of Basis Periods

HMRC recently published a consultation on changes that would form part of the Finance Act 2022 relating to the basis periods for unincorporated entities, and which initially proposed to align these periods by the 2023-24 tax year, with a transitional year in 2022-23. Following various representations, a ministerial statement confirmed that the changes would be delayed for a year.

Who will be affected?

These changes that have been published will affect those who are self-employed, those in partnerships, and other unincorporated entities with trading income, such as Trusts, estates and non-resident companies with trading income charged to income tax. These will be collectively referred to as businesses for the purposes of this article.

What are the changes?

Currently, businesses prepare annual accounts to the same date each year, which is known as their ‘accounting date’. A business’s profit or loss for a tax year is usually the profit or loss for the year up to this date falling within the tax year, which is known as the ‘basis period’. Taxing profits of the year to the accounting date that falls within the tax year is known as the ‘current year basis’.

In the first years of trading overlapping basis periods can result in profits being taxed twice, with relief being provided by way of ‘overlap relief’ which is usually only given on the cessation of a business and relieves any of the previously double taxed profits.

The new proposal from HMRC aims to change the current year basis to a ‘tax year basis’, so that a business’s taxable profit or loss for the year matches up with the tax year, which ends on the 5^th April each year.

Removal of basis period rules

This move would see the removal of the basis period rules and the ending of overlap relief. The aim for HMRC is to have this implemented for the 2024-25 tax year, with the 2023-24 tax year being a transitional year, in which all basis periods would be aligned to either the 31^st March to 5^th April, and all outstanding overlap relief would be relieved in this year.

Introduction of equivalence rule

HMRC will introduce the ‘equivalence rule’ where an accounting date falling between 31^st March to 5^th April can be treated as the end of the tax year for businesses, providing that the next period is treated as starting on the following day.

Transitional period

HMRC have proposed a one year transitional period in 2023-24. For those that don’t have a basis period that is aligned with the tax year, the basis period profits would be determined by adding together the profit or loss for their current year ending on the accounting date, and then a transitional element from the end of the basis period to the end of the tax year. Thus the transitional period could include profits for anything from 12 to 23 months.

Bringing forward overlap relief

Businesses should already have overlap relief brought forward covering the same number of months as the length of the transitional extension to the period, meaning that the business will not be taxed on more than 12 months’ worth of profit in the tax year. No new overlap relief will be generated, and all outstanding overlap relief must be claimed.

What about higher profit businesses?

For a business with higher profits in the transitional year, there will be an election available to spread the additional profits over a period of up to 5 years, allowing for businesses to reduce the cash flow issues arising from an increased amount of taxable profit during the year.

Why are HMRC making these changes?

These changes are being made to simplify the taxation of trading profits, as after the transitional year the rules would be significantly simpler than they are at the moment. The current system allows two identical businesses, apart from their accounting date, to return different taxable profits and tax liabilities for the same tax year.

The new rules would remove this difference, and also remove the double taxation that some businesses experience in the early years of trading.

Ease of income reporting

This is also being done to make it easier for businesses to report their income, particularly with 'making tax digital' being introduced for income tax in the future. The aim is to align trading income with other income sources such as property and investment income, which currently operate on a tax year basis.

At Shorts, we can assist with the smooth transition of these accounting dates, calculate profits and work out and claim all available overlap profits, to ensure the disruption to your business is minimal.