What's Changing?
From 6 April 2024, business profits will no longer be assessed using the current year basis. Instead, income tax will be charged on the full amount of profits or losses arising in the tax year (6th April to 5th April). Note that this only applies to Sole traders and Partnerships, Companies are unaffected by the change.
Where a business draws up accounts to a date that does not coincide with the end of the tax year, profits or losses of a period of account will need to be apportioned to the parts of that period falling in different tax years.
Apportionment will generally be done with reference to the number of days in the period concerned. However, a trader may use a different method of apportionment if it is reasonable to do so and is applied consistently.
For trades that have an accounting date of 31 March, 1, 2, 3 or 4 April, profits and losses for the period starting after the accounting date and ending on 5 April are treated as nil, and the profits of losses for that short period are included in the following tax year.
Trades with accounting periods ending on 31st March, 1, 2, 3, 4 or 5th April will therefore be unaffected by the changes.
All other period ends will be treated differently beginning with a 2023/24 basis period.
2023-24 Basis Period
Trading Starts or Ceases Within Tax Year Ended 05 April 24
Where a business starts to trade in 2023–24 and does not cease in the year, the basis period for 2023–24 will begin with the date the trade began and end on 5 April 2024.
If a business ceases in 2023–24, the transitional rules in FA 2022, Sch. 1, Pt. 5 and 6 do not apply. The profits for the final year of trade will be calculated using the rules for the current year basis.
Continuing Trades
For continuing trades, the basis period for 2023–24 is split into two parts:
- the standard part; and
- the transition part.
The standard part is the 12-month period beginning immediately after the end of the basis period for 2022–23.
The transition part is the period beginning immediately after the standard part and ending on 5 April 2024 (or between 31 March and 4 April)
Example
A trader who has been trading for a few years and prepares accounts to 30 September each year.
Their basis period for 2023/24 would be:
- The Standard Part between 01 October 2022 to 30 September 2023; PLUS
- The Transition Part between 01 October 2023 to 05 April 2024
Businesses that have previously drawn accounts up to 31 March or up to 04 April will not have a transition part of the basis period for 2023–24 and so will not suffer any additional tax liability because of these changes.
For businesses with a different year end, these rules will result in additional profits being charged in 2023–24 as you could have chargeable profits of anywhere between 13 to 23 months worth in 1 tax year.
To alleviate the extra tax charge arising in the addition months over the usual 12 month period, the transitional rules provide for relief for overlap profits (see below section that explains how that is relieved) and the spread of additional profits over five tax years.
Interaction with Overlap Profits
The transitional rules allow for any overlap profits that have arisen from the previous application of the current year basis to be deducted from transition profits. Where this deduction turns a profit into a loss, or increases an existing loss, the loss is treated as if it were a terminal loss.
This means that these losses may be carried back to the previous three tax years but only relived against trade profits in those earlier years. This is not as generous, because relief for current year trade losses that can, subject to a cap, be relieved against total income.
Relief for overlap profits is no longer available after 2023–24. Any overlap profits remaining after 2023–24 will be lost.
Tax on transition profits
If a trader has transition profits for 2023–24, the transitional rules provide for the transition profits to be spread over the following five tax years.
In each of the four tax years beginning with 2023–24, an amount equal to 20% of the transition profits is treated as arising and chargeable to income tax as trade profits, with the balance chargeable in the fifth year.
Example
A trader has part of their basis period for 2023-24 has a transition profit of £100,000.
The amount treated as arising in each tax year is:
- From 2023-24 to 2026-27 = £20,000 (£100,000 x 20%)
- 2027-28 (5th Year) = £20,000 (£100,000 less £80,000)
If the trade ceases before all transition profits have been charged to income tax, the balance is treated as arising and chargeable to income tax for the tax year in which the trade permanently ceases.
Example
Based on the above example, we're now in the 2026-27 tax year and the Trader decides that they are going to cease trading.
The transition profits treated as arising in each tax year would be:
- From 2023-24 to 2025-26 = £60,000 (£20,000 x 3 years)
- 2026-27 = £40,000 (£100,000 less £60,000)
Accelerating the Charge on Transition Profits
Where an amount of transition profits for 2023–24 is subject to income tax for a tax year, an election can be made for an additional specified amount of transition profits to be treated as arising in that year.
The election should be made on or before the first anniversary of the normal self-assessment filing date for the tax year. And, if made, the spreading rules apply to subsequent tax years as if the amount of transition profits were reduced proportionally over the remaining years.
Example
The Trader has transition profits of £35,000 for 2023–24. They make an election in 2024–25 to treat an additional £8,000 of the transition profits as arising in the year.
The transition profits treated as arising in 2023–24 is £7,000 (£35,000 × 20%).
The transition profits treated as arising in 2024–25 is £15,000 (£7,000 + £8,000).
Transition profits are then reduced by £13,333 (£8,000 × 5/3).
The amount of transition profits to be assessed in each of the three subsequent tax years will be £4,333 (£21,667 × 20%).
Potential Problems
Date Issues
One of the biggest issues facing Traders is the potential reduction of time between the period end and the tax filing deadline. For example a year of 30 June year end, when preparing the 2024/25 period end, they would need to wait until post 30 June 2025 before being able to prepare the 2024/25 tax return accurately. This would give the individual 3 months fewer to prepare their tax documents.
Taking that to the extreme, individuals could have a year end date of end of February meaning they would always be late with the information required for the 1 month period needed to complete their tax return.
In those circumstances, estimates would be required, for the short periods as it wouldn't be practical (or even possible) to be able to complete any year ends towards the end of a calendar year.
Alternatively, to work around the issue permanently, the individual may choose to change their accounting period to match the tax year end (so to have an accounting period end date of between 31 March to 05 April).
This seems like the sensible option for a lot of individuals, to align their year ends with the Tax year end, but ultimately the choice is with the individual trader.
Large Profits
Inevitably for individuals this is likely to lead to larger than expected profits, which is likely to affect them for the next 5 tax years if they've decided to spread this out over the maximum period.
This is especially true if the individual decided to cease trading before the end of the 5 years, leaving a large balance taxable within the cessation period.
Tax Saving Opportunities?
There are potentially ways to help reduce the impending tax burden and, in some cases, careful planning will be required to ensure the tax exposure is minimised as far as possible.
An example of this would be for individuals looking to change their accounts period to 31 March 2024. If their account period end was previously 30 September they would have a couple of options;
- Prepare 2 sets of accounts covering the periods:
- 01 October 2022 to 30 September 2023
- 01 October 2023 to 31 March 2024
- Prepare 1 set of accounts covering the whole period of 01 October 2022 to 31 March 2024
Preparing different sets of accounts for the period may allow for larger profits to be spread over the transitional period, taking some pressure off the tax chargeable and possibly even reducing the tax below the various thresholds into a lower tax bracket.
As businesses navigate through these changes, it becomes increasingly important to seek expert guidance and support. With a keen eye on maximising tax efficiency and minimising potential pitfalls, we ready to assist in exploring various avenues and strategies. By proactively engaging with our professionals, businesses can chart a course towards economic resilience and sustainable growth in the ever-evolving tax landscape.
Please get in touch with SBP for support in this area to discuss various options.