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Change of basis period and the new rules for income tax

Change of basis period and the new rules for income tax. Are you effected?





If you are self-employed and running your business on an unincorporated basis, that is you aren't an owner of a limited company, then tax change is coming. 



You may or may not be aware of the mechanics of how your annual taxes are calculated. It has been relatively straightforward - you run your business and prepare your year end accounts then the profits from those accounts go onto your next self assessment tax return. However, that is all changing and for some the change will result in higher tax bills for the next few years. 



So what is changing and why?


The method described above is known as the current year basis but everyone is being moved over to a tax year basis. What this means is that you will now pay tax on the profits made in the tax year regardless of when your business accounts year end is. The impact of this is that if your business year end is not in line with the tax year (31st March or 5th April) then you will have additional profits to pay tax on to 'force' your profits in line with the tax year. You would have paid tax on these profits anyway, but the reporting and therefore the due date of this tax has been brought forward. This means you may have an unexpected hike in your tax bill. 



Let's look at an example:



John Smith trades as JS Builders and has a business year end of 30th September. On his 2022/23 tax return that has just been filed he declared his business profits for the year ended 30/09/22 and paid tax on these. When he comes to complete his 2023/24 tax return, he will declare his business profits for the year ended 30/9/23 as usual. However, he will also have to declare his business profits for the period 1/10/23-5/4/24, an extra 187 days. This means that his 2023/24 tax return will contain 18 months worth of profits instead of the usual 12. It also means that John will need to prepare his 30/9/24 business accounts before he can complete his 2023/24 tax return. Moving forward to the following tax year, he will return to being taxed on 12 months of profits, but these will continue to be taken from two sets of business accounts: 178 days of year ending 30/9/24 and 187 days of year ending 30/9/25. 



What is the impact of these changes on my tax bill and can anything be done?


From a tax point of view, the tax bill for 2023/24 will be higher as it reflects tax on an 18 month period. This is unavoidable. However, there are two things that can help bring that bill down. 



Firstly, if your business year end isn't in line with the tax year (31st March or 5th April) then there is a good chance you will have some historic overlap profits. Overlap profits are profits that would have arisen when you first started trading and your profits were adjusted to fit the old tax rules. Usually, you can only recover these when you cease trading but the change in rules mean overlap profits will be obsolete and so you can use them in the 2023/24 tax year. It is therefore important to check with HMRC if you have any overlap profits you can use to offset this additional taxable profit/taxes. 



Secondly, HMRC realises this will impact on taxpayers and so have introduced transitional spreading rules to help ease the burden. You will still have a higher tax bill but the transitional element (the extra months above the usual 12) can be spread over the next 5 years. A minimum of 20% of the additional profits will be taxable each year, with the balance being due in the fifth year.



A note of caution if you intend to cease trading! If you cease before all of the additional profits have been taxed then it will all fall due in the year of cessation. Therefore, if you do intend to cease in the next 5 years it may be worth declaring more than the 20% to spread the tax burden. 



It should also be borne in mind that the impact of these extra profits may also have additional consequences for your tax bill. As you will now, for the next few years, be taxed on 120% of your profits then your taxable income increase may be enough to push you from a basic rate to higher rate tax payer, further increasing your tax burden. 



As you can see, the new rules will have tax implications for many business owners for the next few years and so it is important to understand this and be prepared for these changes. 

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