Basis period reform has started – are you ready?
Basis period reform has started – are you ready?
Core reforms
Until now, sole traders’ and partnerships’ profits were taxed on a ‘current year’ basis – eg the profits of annual accounts to 30 April 2022 become the taxable profit for the 2022/23 tax year. This changes to a ‘tax year’ basis, means that business profits will be calculated for 6 April to 5 April by apportioning accounting year profits as required. In practice, 31 March will be treated as the end of the tax year: therefore a Practice with a 30 April year end would need to count 1/12th of one accounting period and 11/12ths of the next to calculate its ‘tax year basis’ profit.
One problem is that if the accounts (say to 30 April) following the tax year are not finalised by the time the tax return is due, profits/losses apportioned from them will have to be estimated for the return, and the return subsequently amended once the accounts are finalised.
Transition in 2023/24
The new rules take full effect from 2024/25 with a transition year in 2023/24.
Continuing businesses will be taxable on their profits on the current year basis (ie 12 months to their accounting date in 2023/24), plus a catch-up period up to the end of the tax year (ie 31 March 2024). Depending on the accounting date of a Practice, this could bring almost two years’ profits into charge for 2023/24, although any overlap relief brought forward may be available.
This catch-up could lead to a significantly increased tax bill for 2023/24, so the legislation provides for the excess transitional profit to be spread over five tax years (with no interest charge) to mitigate the cashflow impacts. Alternatively, individuals can opt to accelerate the spread of profits to be taxed in any of the spreading years providing it is at least 20% in each year.
Spread or not?
Whether you go with spreading or elect out could depend on many things: for example, whether practice profits have declined post-COVID; the size of overlap profits taken into account; whether the practice pays the tax for partners and fully reserves to meet future tax liabilities but uses those reserves for working capital in the interim. Although rent for letting space to third parties (i.e. Pharmacy rent or room rentals) is included in practice profits this part of the income cannot be spread because it is not trading income. Notional rent is trading income so this income will be available for spreading.
There is also the pension issue to consider: pensionable profits for the NHS scheme are based upon taxable income, if taxable profits are spread, the pensionable profits will also be spread (reducing Scheme contributions in the short term). Conversely, electing out of spreading means higher profits, higher contributions and more tax relief on them. Happily, for pension annual allowance charge purposes, ‘threshold income’ excludes transitional profits, but the pension growth part of the equation will be based upon pensionable profit including transitional profit, so there may still be a risk of a reduced annual allowance.
Fortunately, you can elect not to spread each year up to 2027/28, so these calculations need not be rushed. For help and advice on how the reforms will affect your tax liabilities please get in touch with our team.