Article:

How Much Could 'Basis Period' Reform Cost You?

07 September 2021

HMRC has announced a reform of ‘basis periods’ for the taxable profits of sole traders, partnerships and other unincorporated entities with trading income. A consultation proposes changes from 2022/23, and the transitional catch-up to the new rules will create cashflow concerns for many GP partnerships that do not use 31 March or 5 April as their accounting date. 

Core Reforms

At present, sole traders’ and partnerships’ profits are taxed on a ‘current year’ basis – eg the profits of annual accounts to 30 April 2021 are treated as the taxable profit for the 2021/22 tax year. The proposals involve moving to a ‘tax year’ basis, meaning 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. However, the reforms would remove the current complex opening and closing rules that lead to individuals being taxed twice on some profits and creating ‘overlap relief’ given in the closing year of trade.

The aim of the reforms is to align the treatment of trading income with that of non-trading income and make the move to Making Tax Digital reporting for income tax easier from April 2023 onwards. Although forcing all businesses to use a 31 March or 5 April accounting date was considered, adopting the ‘tax year basis’ is the government’s clear preference and the consultation is more about how, not if, it is implemented.

Expensive Transition in 2022/23

The transition from the current to new rules will take place in 2022/23. Continuing businesses will be taxable on their profits on the current year basis (ie 12 months to their accounting date in 2022/23), plus a catch up period up to the end of the tax year (ie 31 March 2023). Depending on the accounting date of a Practice, this could bring almost two years’ profits into charge for 2022/23, although any overlap relief brought forward will reduce the taxable profit. 

Nevertheless, this could lead to a significantly increased tax bill, so the proposals provide for the excess transitional profit to be spread over five tax years to mitigate the cashflow impacts. Individuals will also have the option to be taxed on the full amount in the transitional year – for example, if future income tax rises are a concern. 

Although the proposals are far from finalised, they will undermine most GP partnerships’ financing plans for the next few years – changing your profit periods will change pensionable income, affect your cashflow (by advancing tax liabilities) and affect reporting for other NHS purposes. Even if your practice changes its accounting date to 31 March to reduce the administrative burden of the new rules, this is not straightforward and will itself have a financial impact. 

If your Practice uses an accounting date that is not 31 March or 5 April, please get in touch with our team to discuss the impact on your finances.