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Basis period reform and Making Tax Digital: How accountants can help their clients

Money Matters

Basis period reform and Making Tax Digital: How accountants can help their clients

HMRC has announced basis period reforms.

These are mandatory for unincorporated businesses, such as sole traders—even if they are not affected by Making Tax Digital.

Let’s take a look at the details and how you can roll this out among your clients.

Here’s what we cover:

The reform is straightforward in principle.

As of the 2024/25 tax year, all affected businesses have to use the tax year as their basis period. They will only be liable for profits arising in that and subsequent tax years. Overlap profits or adjustments will no longer exist.

Most sole traders already use the tax year as both their accounting and basis period, of course, so these changes will not affect them. But those that have different accounting periods—such as 1 January to 31 December—will use 2023/24 as a transition period.

In other words, and only for those businesses with accounting periods that don’t match the tax year, this particular basis period will be longer than 12 months.

Because this is likely to create larger tax bills, HMRC will be offering transitional relief.

You can spread payments for the tax bill on this final period (e.g. six months for a business with an accounting date of 30 September) proportionally across the following five years (or paid more quickly, if desired).

Although inspired by the introduction of Making Tax Digital for Income Tax, and beginning on the same date, basis period reform is a separate endeavour.

It will affect all unincorporated businesses—even those unaffected by MTD for Income Tax.

This is how it looks running up to 2024/25, which is the first year for which the reforms are mandatory:

  • 2022/23: Last year of the existing basis period rules.
  • 2023/24: Transitional year. This is when businesses will have to move to the new fiscal year basis and, if not using the tax year as the basis period, will generate transitional taxable profits after their accounting period ends. For most businesses, this will could mean drawing up two sets of accounts: one up to the end of the existing basis period, and transitional accounts drawn up to 31 March 2024. Or accounts could be drawn up for the full 12+ month period.
  • 2024/25: The first year of the new basis. From this point on, businesses will only be taxed for profits earned in the tax year.

HMRC has said an equivalence provision applies in the transition, which is to say, 31 March 2024, 1 April 2024, 2 April 2024, 3 April 2024 and 4 April 2024 are all treated as if they’re 5 April.

In other words, any extra days after 31 March are treated as if they’re in the current tax year.

John Smith runs a plumbing business as a sole trader.

It was established in September 2015, and John decided he would run his accounting period from that date, meaning he generated six months of overlap profits at that point.

When it comes to basis period reform, John has two options:

  • Carry on using his existing accounting period
  • Use the opportunity to switch his accounting period to the tax year so his basis and accounting period match.

For simplicity moving forward, John opts to change his accounting period to align with the tax year.

Profits for his accounting year ending 30 September 2023 will extend by six months to take him to 31 March 2024. This will mean he has an additional six months of profit in the basis period for that year.

However, John also has overlap profits from when he established his business, which must be deducted.

What’s left is referred to as the transitional amount.

John then has the option of proportionally paying the transitional amount over the following five years. Alternatively, he can pay the whole amount immediately, or over fewer years.

There’s no requirement to adjust accounting periods for the basis period reforms.

Indeed, for many clients, such as farmers or seasonal businesses such as tourism, it might be unviable to do so.

And if it were not for the introduction of MTD for Income Tax, this would not be problematic.

But for those that will find themselves adopting Making Tax Digital as of April 2024, having asynchronous accounting and basis periods could present issues.

The issue relates to the requirements for the end of period statement (EOPS) and tax payments.

There’s a requirement to submit the EOPS by 31 January following the end of the tax year. The requirement to pay the tax bill and National Insurance contributions don’t change, so might also be due on account by this date.

However, if the accounting period has not been completed at that point, the accounts won’t have been drawn up.

Therefore, it will be impossible to provide accurate information on the EOPS, and only an estimate can be provided.

Any subsequent tax payment will also therefore also be an estimate. All of this will probably create a requirement to file corrections.

It makes sense to use the transition year to switch to the tax year for the basis period—although don’t forget that businesses will need to know their original overlap profits.

For older businesses, it might be difficult to discover this figure.

While some clients might be waking up to the reality of Making Tax Digital for Income Tax, very few are likely to have heard of basis period reforms.

Don’t forget, too, that many who are outside the scope of MTD for Income Tax will still be affected by the basis period changes if their accounting periods don’t match the tax year.

And the work involved in adjusting could be just as involved as that of embracing MTD for Income Tax.

As is often the case with changes to tax law, HMRC is relying upon accountants to not just get the message out but also to explain the details.

Accountants are not just in a position to help their clients but might be the only sources who are able to explain the on-the-ground reality of what the reforms mean for a client’s unique situation.

Yet the task moving forward isn’t just to educate your clients about issues such as the requirement to switch to a new basis period, and the relief measures available from HMRC.

It’s also to walk them through making key choices about whether to adjust their accounting period.

For clients in business for some time, records of overlap profits might not be available, in which case it might be necessary to contact HMRC well ahead of time and request them.

Considering the large number of businesses that will be requesting such information, you should ensure that preparations get underway as soon as possible.

Editor’s note: This article was first published in January 2022 and has been updated for relevance.

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