Transitional arrangements for basis period reforms are far from simple

Accountants discuss the issues that transitional arrangements are causing.

Basis period reforms came into effect in April 2023, with the intention of simplifying how business profits are taxed. But the transitional arrangements are actually making things more complicated, causing financial headaches for many businesses including those in partnerships.

This introduction gives an overview of BPR, so for a more detailed explanation AAT members should read our article on Knowledge Hub.

The basis period refers to the time period in which a sole trader or partnership pays tax on actual profits accrued during the tax year.

Under the old rules, for new businesses, the basis period began from the start of the business to the end of that particular tax year (5 April). In the second year, the basis period was based on the date the business’s accounts were prepared and took into account whether the accounting date was less or more than than 12 months since the date the business was first established.

After that, and for established businesses, the basis period covered the twelve months’ accounting period which ended with the tax year.

As these rules were primarily based on a business’s accounting period, they tended to create overlapping basis periods which meant businesses were being taxed twice.

Under the basis period reforms:

• Basis periods are now known as ‘tax year basis’.
• Accounting periods must now align with the tax year.
• The reforms removes the issue of overlapping basis periods.

These reforms will apply in full from 2024/25 but transitional arrangements were put in place from 2023/2024. It’s these transitional arrangements which are causing issues for businesses.

Under the transitional arrangements, businesses whose accounting periods don’t align with the tax year are temporarily required to implement two accounting periods. This often results in shorter timeframes in which to declare taxable profits and a likelihood of returns needing to be amended at a later date.

We spoke to accountants about the impact these transitional arrangements are having for themselves and clients.

The reforms spell an initial cash nightmare and extra work

Vipul Sheth, Chartered accountant and MD, Advancetrack

Basis Period Reform (BPR) aligns sole trader and limited liability partnership (LLP) tax filings with that of the tax year itself. From April 2024, businesses are now required to report taxable profits for the period up to 5 April, regardless of their accounting year-end.

But BPR could be a cash nightmare for small businesses, with some suffering financial catastrophe if arrangements are not made to accommodate them.

That’s because 2023/24 is a transition year and businesses with a year-end that doesn’t match the tax year-end will have to catch up. Those with an end-of-April year-end could be taxed on 23 months of profit.

BPR will result in extra work for accountants who will need to bring clients in line with the changes. Clients won’t necessarily see the work as adding any value and could lead to difficulties when it comes to charging fees.

Many practitioners are already considering changing accounting periods for some clients to assist them in managing upcoming tax bills. Although existing ‘overlap relief’ allows spreading the additional tax burden over five years, the reforms could still significantly impact cash positions.

I also have concerns around BPR awareness and its impact:

The lack of extensive publicity means many tax professionals are aware but haven’t paid it the same level of attention as major government projects like MTD.

Some LLP accountancy practices may have failed to mitigate against potential difficulties that these accelerated tax payments (and/or shifting their accounting period) may have on any partner pay-outs. This will need to be accounted for if cash flow arrangements have been taken out to mitigate against the initial one-off tax bill caused by BPR.

Hospitality and farming businesses in particular usually have specific accounting dates that match up to the end of busy periods. Moving their date away from those periods will skew numbers.

Accountants should provide intricate tax advice to navigate various scenarios to limit undue tax increases. There will also be additional reporting costs, potentially requiring extra accounts, advice and more complex tax calculations as the changes take effect.

Verdict: The reforms could be an initial cash nightmare for businesses while accountants have their work cut out to support clients.

The basis period reforms will result in massively reduced working capital for businesses

Nicky Owen, Head of Professional Practices, Crowe

These reforms will affect partners in partnerships and the self-employed where their accounting year doesn’t align with the tax year.

With the reform, you’re taxed on the profits of a fiscal year. If accounts straddle 5 April, two sets of accounts will be apportioned. For example, with an accounting date of 30th April, you’ll be taxed on ¹⁄₁₂ of one accounting year and ¹¹⁄₁₂ of the following.

For the transitional year 2023/2024, individuals are taxed on their accounts ending in the tax year plus the transitional profits, profits to the end of the tax year less overlap profits.

For example, businesses with 30 April year end, the assessable profits will be for the year ending 30 April 2023 plus ¹¹⁄₁₂ profits to 30 April 2024, less overlap profits. Transitional profits can be spread over five years.

If the individual retires within five years the untaxed transitional profits will crystalise. So what’s the impact? Acceleration of the tax payable on profits, starting with 31 January 2025. The knock-on effect is that working capital is reduced. Individuals and firms will need to plan cash flow for the future.

Some individuals will have to file provisional returns and estimate profits, in particular those with an accounting year end of 31 December.

How do individuals and firms estimate profits? Some firms have said they won’t be providing estimates; they don’t want to have difficult conversations reconciling the estimates to actual.

All this is to make things simpler for MTD!

Small businesses can be nimble enough to change their accounting year to align with the tax year. However, for larger businesses, it’s an upheaval with the impact on processes within HR and accounting functions.

Call to action: Cash flow management, replenish working capital and work out what additional tax is due.

Verdict: The basis period reforms will result in massively reduced working capital for businesses.

Not all businesses can change their accounting year-end date

Kelly Dixon, Tax Manager, DSG Chartered Accountants

From 6 April 2024, taxable profits will be based on the tax year irrespective of the accounting year-end. A trader who does not prepare their annual accounts to 31 March or 5 April will be required to apportion their profits.

The tax year 2023/24 acts as a transitional year for businesses to adapt. During this year, the basis period for a 30 September year-end will be 12 months to 30 September 2023 and six months to 31 March/5 April. A trader will therefore be subject to tax on profits earned over a period greater than 12 months.

Overall, HMRC hopes the new rule will eliminate the burden of calculating overlap profits for new traders and simplify tax reporting.

However, the reforms bring added complications and issues including:

Having to estimate profits if the accounts figures are not available in time for the Tax Return filing deadline. Estimated Tax Return must therefore be provisionally filed and later amended to reflect actual figures.

Cash flow issues, particularly during the transitional year where businesses will be assessed on more than 12 months of profits.

To mitigate additional tax liabilities, HMRC allows use of overlap profits brought forward which can be deducted from the profits in the transitional year. Remaining tax liabilities arising from the reforms will be spread over a five-year period, with 20% of the additional profits taxed in each consecutive year.

Businesses are encouraged to change their accounting year-end date during this transitional year, but this isn’t possible for some businesses. Seasonal businesses, such as farming, will be unable to change their accounting year as 5 April year end coincides with one of their busiest periods (e.g. lambing season).

Other businesses operate a calendar year-end date of December to align their business affairs with an overseas year-end date.

Verdict: Not all businesses can change their accounting year-end date – seasonal businesses and those with a year-end date of December to align with overseas subsidiaries will struggle.

Would you like to contribute to future articles like this one? If so, please get in touch with Annie Makoff-Clark at [email protected].

Annie Makoff is a freelance journalist and editor.