Basis Period Changes for Sole Traders

1 month, 2 weeks ago by Oliver Atkinson

As part of the ongoing work by the government to simplify the tax reporting system for the self-employed, a major change is coming for the 2024/25 tax year regarding the basis period for sole traders, partnerships, and LLPs.

Whilst April 2025 might seem a bit far away at the moment, 2023/24’s tax year will factor in to this adjustment, so it’s a good time to discuss if and how this will affect your business and what the next steps might be.

Note: For simplicity, we are going to focus on sole traders in this article, but the change will also affect any partnerships or LLPs with unaligned year-ends. Please get in touch if you have specific questions about the change for these business structures.

What’s a basis period and will the change affect me?

A basis period is the time frame for which you record your income and expenses. For the majority of sole traders, their basis or accounting period is often either the 6th of April to 5th of April, or the 1st of April to 31st of March, lining with the tax year end of 5th of April. However, some sole traders choose to make their books up to a different date and it will be these sole traders who are affected by the changes.

Example: John starts his sole trade on the 1st of October 2005. He decides to make his accounting year end the 30th of September so his accounts will cover a full year. This means that his first-year end will be 30th of September 2006 and his basis period will cross both the 2005/06 and 2006/07 tax years. Under the current rules, sole traders report their profits for their basis period in the tax year in which their year-end falls. In John’s case, the 30th of September 2006 falls into the tax year ending 5th April 2007, so this will be the first tax year he reports his sole trade profits up to 30th September to HMRC even though he actually started trading in 2005.

Going forward John’s basis period will always cross two tax years as long as he maintains the 30th of September year-end and he will continue reporting his profits in the tax year that his basis period year-end falls into.

What’s changing?

The government announced in the Autumn 2021 budget that it wished for the basis period legislation to be reformed so that profits are recorded and reported for the tax year in which they arise, rather than a separate basis period that does not align with the tax year. The legislation will apply from the 2024/25 tax year.

How will this affect me?

If you are a sole trader with an accounting year different to the tax year, then this will require some readjustment in the way your tax is calculated. There are two options;

a) Continue using the accounting period you currently use and calculating the profit and tax to cover the tax year basis period across two sets of accounts.
b) Realign your year-end with the tax year and treat this as your new basis period.

For option a), continuing with your current accounting year requires no change to you the way you record your income and expenses up front, but will mean that you have less time to calculate your tax going forward. If you are required to prepare two sets of accounts with a year end of 30th September, then you will only have from that date until the 31st of January to prepare and file your return, including making the pro rata calculation to cover the basis period. This could mean for some with basis periods that fall late into the submission period, they have very little time to make their calculations.

For option b), you can use the 2023/24 transition year explained below to realign your year end with the tax year. This will require you to start recording your income and expenses on a different basis period and thus will necessitate you start recording your income and expenses to and from a different date.

Transition

Regardless of which option is chosen, the current tax year of 2023/24 will act as a transitional year, and sole traders who are affected by the change will have two different accounting periods to report on their 2023/24 Tax Return:

• Their original basis period up to the current year-end they were using.
• A transition period between their current year-end and the end of the tax year, so between the 31st of March and the 5th of April 2024.

This means in effect you will be reporting the profits for more than a year in one tax year. Of course, this also means that you will be taxed on more than a year’s profits.

Example: John is still trading in 2023/24. He reported his profits for his year ending 30th September 2022 on this 2022/23 tax return and this was the final tax year for which he could do this.

For his 2023/24 tax return he now must include all of the profits from his original 1st of October 2022 to 30th September 2023 basis period, plus an additional period covering 1st October 2023 to 5th April 2024 so he is reporting up until the end of the new tax basis period.

His profits and tax are higher than is usual in a single tax year, as for 2023/24 he has had to include an additional 6 months of profit.

HMRC have considered the possible detrimental effect that paying more tax on more than a year’s profit may have, and there is some possible relief available to this end.

Overlap Relief

Any unused overlap relief from previous year end changes must be used in the 2023/24 tax year. This will allow some deductions from the transition period if overlap relief is available, reducing the overall profit and tax bill.

It’s worth noting here that if are currently using the tax year as a basis period, but you have previously realigned your year end and not yet used up your overlap relief, you still must use it in 2023/24 or it will be considered ‘lost’.

Spreading of transition period profits

If you record a profit in the transition period covering the time-period between your original basis period and the end of the tax year, then you may be able to ‘spread’ the profit over the next five tax years.

After deducting any available overlap relief from your transition period, then you can elect to treat the remainder of the profit as being earned over the next five years, utilising future tax rates and allowances and thus lowering your immediate tax bill for 2023/24.

Contact our team here if you have any questions.