Income tax basis changes - what self-employed workers need to know before 2024

From the 2024/25 tax year, all unincorporated businesses will be taxed on profits generated in the 12 months leading up to 5 April (or 31 March).

Such businesses may face a single, higher tax bill from their profits arising at the year-end falling in the 2023/24 tax year to 5 April 2024 as they will be required to pay tax on up to 23 months of profits in that one year!

Reliefs, allowances, and tax band thresholds will remain unchanged and will not be pro-rated, which may result in some taxpayers moving into higher tax bands while reducing their ability to benefit from various annual reliefs and allowances. These problems could be reduced by paying pension contributions in 2023/24.

Here are the key points to consider:

• The Government will change the tax basis period for all unincorporated businesses.
• Sole traders, partnerships, and LLPs without an accounting year end on the specified date will be impacted.
• The changes may result in additional tax liability.
• Extra tax payments will be spread out over five years but can be brought forward and taxed earlier or by using Time to Pay arrangements.
• Accrued overlap relief will be used to offset a larger tax bill.
• These changes will affect accounting periods starting on 6 April 2023, with a transition period during 2023-2024 when all businesses will have their basis period moved to the end of the tax year.

The Government postponed the implementation of these changes from the original timeline of 2023/24 to provide affected businesses with additional time to prepare.

Existing system

At present, unincorporated businesses, including self-employed sole traders, are taxed on profits earned during their accounting period that ends in a given tax year.

The law does not require unincorporated businesses to produce accounts or produce them on a specific date, allowing them to choose any accounting date they prefer.

Consequently, a business’s profit or loss for a tax year typically corresponds to the profit or loss until their accounting date, known as the basis period. In the initial trading years, specific regulations determine the basis period.

If the accounting end date does not fall on 5 April or 31 March (equivalent to 5 April for the first three years of trading), the rules can create overlapping basis periods that impose tax on profits twice, generating “overlap relief” when the business ceases.

The differing rules for trading profits compared to other forms of income, such as dividends and income from property, which are taxed based on the tax year, may cause confusion for some taxpayers.

Upcoming changes

The proposed reforms will alter the basis period for all unincorporated businesses, moving it to the end of the tax year, currently set as 5 April.

This change will require interim arrangements for businesses that do not presently have year-ends between 31 March and 5 April each year.

Businesses with accounting period end dates differing from the end of the tax year will need to apportion profits/losses and may need to use provisional figures in their tax returns if they have not prepared accounts and tax computations for later accounting periods before the tax return filing deadline.

HMRC has extended the statutory rule that deems 31 March to be equivalent to 5 April for the first three years of trade to all years, including the transition period, and potentially also to property businesses.

Businesses whose year-ends do not align with the tax year will have a shorter time between generating profits and when taxes fall due, which may have cash flow implications.

Businesses will use all accrued overlap relief when they began trading during the transition year (2023/24). This implies that such businesses will only have tax liability on 12 months’ profits. However, the overlap relief dates back to the first year of trading, during which the business is likely to have been less profitable.

In the future, when these new regulations come into effect, new businesses will not generate overlap relief, and no specific regulations will be necessary for starting, ceasing, or changing the accounting period end date.

Non-trading income remains unaffected by these changes, as it is assessed on a tax-year basis. For the numerous unincorporated businesses with year-ends synchronised with the tax year, including those between 31 March and 5 April, nothing will change. However, for those with year-ends not aligned with the tax year, careful tax planning may be necessary, considering several factors.

How we can help

Businesses should be prepared for these changes to be implemented in future and have suitable plans in place that reduce the impact of this substantial amendment to the tax rules.

These changes, when implemented, are likely to have a significant impact on unincorporated businesses, leading to substantial tax bills and costs without careful planning.

Worried you may be affected by these reforms? Find out how we can assist you.