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simple numbers | accountingweb | Basis period reform: how to allocate transitional profits
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How to advise clients on basis period reform

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Basis period reform should simplify taxable profits, particularly in the initial and final years of trading. Amy Chin looks at considerations for allocating additional profits.

28th Nov 2023
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In the tax year 2023/24, the “transitional year” for basis period reform, many businesses will have additional taxable profits to report. The taxable profits for 2023/24 are split into two parts:

  • the standard part: taxable profit for the accounting period (AP) ending in 2023/24, and
  • the transitional part: taxable profit between the end of the AP in 2023/24 and 5 April 2024.

So for a business with a 31 December AP end that means:

  • standard part: 1 January 2023 to 31 December 2023
  • transitional part: 1 January 2024 to 5 April 2024.

Any unused overlap relief will be included on the 2024 tax return and automatically deducted from the transitional part. The net transitional profit is then spread over the five tax years 2023/24 to 2027/28.

Although the default will be to allocate the transitional part evenly over those five years, this is not compulsory. The allocation can be accelerated by bringing in more than the minimum additional profit in any of the five years, as best suits the taxpayer’s situation. There are various circumstances where an uneven allocation will be beneficial to the taxpayer and tax advisers need to consider the implications for each of their clients.

It is of course vitally important to get the calculations right, as Rebecca Cave explained. This article will focus on the instances where an uneven allocation of transitional profits should be considered and why.

Thresholds

The most obvious point surrounds income tax thresholds. As the transitional profits will count towards the thresholds, some taxpayers face the prospect of being pushed into a higher or even additional rate bracket in some or all of the five years. If profits are predicted to increase each year, simple tax planning could reduce the additional tax burden by bringing more of the transitional profits into the earlier years, leaving less to be added in later years when profits are forecast to be higher.

Transitional profits are also included in the £100k threshold above which the personal allowance begins to taper, so an individual anticipating taxable profits creeping towards the £100k mark in 2027/28 would be better off taking more of their transitional profits into the years 2023/24 to 2026/27, reducing the amount added in 2027/28.

Cashflow

Although the above can result in absolute reductions in tax payable, the way the transitional profits are allocated can also be key to the taxpayer’s cashflow.

For the current tax year, payments on account are based on tax year 2022/23, so not affected. But over the five following years, the amounts payable at 31 July and 31 January will fluctuate depending on how the transitional profit is spread and some taxpayers will want to be aware of their options.

Good news for some

Taxpayers with adjusted net income (ANI) above £50,000 are liable to pay the high-income child benefit charge. Happily, transitional profits will not be included in the ANI calculation for this purpose for any of the five tax years concerned.

The news is similarly pleasing for those fortunate enough to be making chunky donations into their pension pots. Transitional profits will not count towards the income limits above which the annual allowance taper kicks in (£200,000 threshold income and £260,000 adjusted income at the time of writing).

Cessation and incorporation

If any clients are considering cessation, or incorporation, whether that happens before or after 5 April 2024 could be consequential.

When a business ceases on or before 5 April 2024, “old rules” apply. Any overlap relief brought forward will be deducted from the final year’s profits and there will be no spreading of the transitional part.

For example, a sole trader or partner with profits for 12 months to 30 June 2022 of £110,000; profits for 12 months to 30 June 2023 of £120,000; profits for the nine months and five days to 5 April 2024 of £130,000; and overlap profits brought forward of £11,000 choosing to cease (or incorporate) on 5 April 2024 will be taxed as follows (*figures taken from Absolute’s Basis Period Reform App).

Tax year 2022/23

Taxed on 12 months to 30 June 2022 taxable profits £110,000.

Income tax and class 4 national insurance contributions (NIC) on £110,000 = £38,795*.

Tax year 2023/24

Taxed on 12 months to 30 June 23 taxable profits £120,000 “standard part” and nine months to 5 April 2024 taxable profits £130,000 “transitional part” less overlap relief £11,000.

Income tax and class 4 NIC on £239,000 (£120,000 + (£130,000 - £11,000)) = £100,921*.

But wait until 6 April 2024 to cease trade or incorporate, and we enter the brave new era of basis period reform. One-fifth of the transitional profits are included in 2023/24 but the other four-fifths will be taxed in the year of cessation 2024/25 and benefit from an extra year of personal allowance and thresholds.

Tax year 2022/23

Taxed on 12 months to 30 June 2022 taxable profits £110,000.

Income tax and class 4 NIC on £110,000 = £38,795*.

Tax year 2023/24

Taxed on 12 months to 30 June 23 taxable profits £120,000 “standard part” and one-fifth of the transitional part (nine months to 5 April 2024 taxable profits £130,000 “transitional part” less overlap relief £11,000). OK, I’ve not bothered to apportion one day into 2024/25, but Absolute’s app has.

Income tax and class 4 NIC on £143,800 (£120,000 + ((£130,000 - £11,000)/5)) = £56,133*.

Tax year 2024/25

Taxed on remaining transitional part £95,200 ((£130,000 - £11,000) x 4/5) = £29,842* 

Not only does the delay to 6 April delay tax liability from 2023/24 to 2024/25 it also reduces the total tax and class 4 by a staggering £14,946.

Change of accounting date

Although HMRC has publicly expressed a desire for traders to change accounting dates to 31 March or 5 April 2024 (a change in the tax year 2023/34) there are circumstances where, if still possible, a trader could benefit from making such a change in 2022/23.

Any change of accounting date notified to HMRC before submission of the 2022/23 SA tax return (for which it may already be too late if the taxpayer has managed to beat the rush of SA season), the change will be subject to the old opening year rules including overlap taxation. Depending on the dates and figures concerned changing, say, from 31 December 2023 to 31 March 2023 could be advantageous.

However, if you wait until post 5 April 2024 then the process will be much simpler.

Simplicity on the horizon

Basis period reform should, in theory, remove much of the headache and complexity around taxable profits, particularly in the initial and final years of trading. Standing between us and that sweet simplicity is a veritable jungle of taxation tangles but with the right advice it might just be worth it in the end.

Replies (20)

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By Open all hours
28th Nov 2023 17:41

The only reason for basis period reform is to accommodate MTD. It is part of the huge and grossly expensive face saving exercise.
30 April year ends were best for tax planning and many clients have good reason to have specific year ends depending on their trade.
To hell with the customers though, HMRC know best and you will be forced to comply or forever submit estimated figures.
Mr Harra, shame on you for treating your customers in such an appalling way.

Thanks (11)
Replying to Open all hours:
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By exceljockey
29th Nov 2023 09:37

The least HMRC could do is put on their big pants and change the tax year end to match a period end - 31 March or even better 31 Dec. They changed it successfully in Dublin when I was doing my articles.

Thanks (10)
Replying to Open all hours:
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By farrcorfe
29th Nov 2023 11:09

Ah, but you have fallen into the trap of calling taxpayers 'customers' ha,ha. Perhaps HMRC are secretly brainwashing you! But, yes, I agree that HMRC have a total and cynical disregard for the taxpayer and also for their accountant advisers - all part of the inexorable progress to the totalitarian state fuelled in part by the advance of online and digital diktats

Thanks (2)
Replying to farrcorfe:
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By Open all hours
29th Nov 2023 15:54

Apologies. Customers maybe should have had inverted commas. My comment was written in part for the benefit of the HMRC surveillance team who no doubt trawl these pages in order to put markers on some of our files. I was speaking their language for their benefit.

Thanks (0)
Replying to Open all hours:
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By Calculatorboy
29th Nov 2023 20:37

Taxpayers are not Customers

Customers are a voluntary party to a contract for the purchase of goods or services at a mutually agreed price.

Thanks (3)
By Nebs
29th Nov 2023 09:43

When self assessment started there was no indexation for overlap relief on the grounds that you could use it whenever you liked. Now that taxpayers are being forced to use overlap relief they should be given an indexation uplift as the choice has been removed.

Thanks (5)
Replying to Nebs:
Morph
By kevinringer
29th Nov 2023 09:55

Agreed, if you wouldn't mind mentioning it to Jeremy Hunt.

Thanks (1)
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By Stu8
29th Nov 2023 09:47

If a client has their year end as 31st March or 5th April does this mean BPR is irrelevant?

Thanks (0)
Replying to Stu8:
Morph
By kevinringer
29th Nov 2023 09:54

Yes

Thanks (0)
Morph
By kevinringer
29th Nov 2023 09:54

Businesses generally incur losses in the early year of trading, which will generate overlap relief of £nil. Basis Period Reform will result in a massive increase in profits in 2023-24. But the following year HMRC expects businesses to switch to cash basis when stock. Most of my clients stock+debtors are larger than creditors, therefore will have a big reduction in profit in the transition year. I'm currently working on a client with 31 December year end (they're compelled to use that year end for commercial reasons) who when transits to Basis Period Reform will be pushed well into the higher rate of tax but when switches to cash accounting will generate a loss.

Thanks (4)
Replying to kevinringer:
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By exceljockey
29th Nov 2023 11:11

I remember when I returned to the UK in 2010 and the Conservatives had just been elected. They promised a reduction in red tape and compliance for businesses. I now am beginning to think I must have misheard David Cameron in 2010 and Boris in 2016 (when Brexit promised the same thing.)

Thanks (0)
Replying to exceljockey:
Danny Kent
By Viciuno
30th Nov 2023 11:34

No, you didn't.

They just talk out their ar$e.

Thanks (2)
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By Mr J Andrews
29th Nov 2023 10:26

I suspect the ''reform'' will also be a day of reckoning for those long established traders for whom the figure of Overlap Relief was not calculated / recorded back in 1997.
The HMRC helpsheet HS 260 won't be much help here.

Thanks (0)
Replying to Mr J Andrews:
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By Calculatorboy
29th Nov 2023 11:02

You can ask hmrc for it as agent . I had a few clients where previous agent didn't provide any info , hmrc were pretty quick to provide it, for once i was impressed with hmrc , so we are all ready for it now .

Thanks (0)
Replying to Mr J Andrews:
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By bendybod
30th Nov 2023 13:00

Indeed, I have a friend who was told by HMRC that they "didn't have a record that far back" and that he should calculate it himself. So, essentially, pick a figure, any figure!!

Thanks (0)
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By AndrewV12
29th Nov 2023 10:46

'Any unused overlap relief will be included on the 2024 tax return and automatically deducted from the transitional part. The net transitional profit is then spread over the five tax years 2023/24 to 2027/28.'

I had no idea of the above, its quite significant it could keep clients out of 40% tax bands.

Thanks (0)
Replying to AndrewV12:
Morph
By kevinringer
29th Nov 2023 10:56

I wonder if the MTD ITSA software can cope with the spreading.

Thanks (1)
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By Calculatorboy
29th Nov 2023 11:10

I'm all for it and more importantly the long period of account is an opportunity for pro rata higher fees in that transitional year , just then blame it on on hmrc if client moans.ive already forewarned clients affected .

Thanks (0)
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By JohnB
29th Nov 2023 11:41

Will bringing in a new partner in 23/24 be a good idea to reduce the tax charge - assuming that the new partner will not be a higher rate taxpayer already?

Thanks (0)
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By Ardeninian
06th Dec 2023 11:55

"The taxable profits for 2023/24 are split into two parts:

the standard part: taxable profit for the accounting period (AP) ending in 2023/24, and
the transitional part: taxable profit between the end of the AP in 2023/24 and 5 April 2024."

Just to point out that the standard part is actually the first 12 months of the basis period. So the profit of the standard part may be the profit of the AP ending in 2023/24, but where for example someone extends their AP to 31 March or 5 April this will not be the case.

Thanks (0)