Here is an example of how Basis periods work and how they create overlap periods taken from our blog What is Overlap Profit? – Steve J Bicknell Tel 01202 025252
A business commences on 1 October 2010. The first accounts are made up for the 12 months to 30 September 2011 and show a profit of £45,000.
The basis periods for the first three tax years are:
| 2010-2011 | Year 1 | 1 October 2010 to 5 April 2011 |
| 2011-2012 | Year 2 | 12 months to 30 September 2011 |
| 2012-2013 | Year 3 | 12 months to 30 September 2012 |
The period from 1 October 2010 to 5 April 2011 (187 days) is an `overlap period’.
It is a complicated and confusing process and the overlap profit is effectively taxed twice and given back later as tax relief.
There are two ways to gain access to your overlap relief: cease trading or change your accounting date.
The Proposal
The HMRC proposal affects the self-employed, partnerships, trusts, and estates with trading income. The proposal affects unincorporated businesses that do not draw up annual accounts to 31 March or 5 April, and those that are in the early years of trade.
Having carried out a short informal consultation with a range of businesses and tax experts, the government intends to implement the proposed reform ahead of the mandation of Making Tax Digital for Income Tax in April 2023.
The consultation period end on 31st August 2021.
Example
A business draws up accounts to 30 June every year.
Currently, income tax for 2023 to 2024 would be based on the profits in the business’s accounts for the year ended 30 June 2023. Part of the accounts are outside of the tax year, and part of the tax year is not included in profits taxed.
The proposed reform would mean the income tax for 2023 to 2024 would be based on:
3/12 of the income for the year ended 30 June 2023, plus 9/12 of the income for the year ended 30 June 24.
Basis periods are straightforward for the estimated 93% of sole traders and 67% of trading partnerships that draw up their accounts to 5 April or 31 March every year. But if a different accounting date is chosen then the rules are more complex and can be confusing for businesses to understand and apply. The rules can be particularly challenging for new or unrepresented businesses, leading to errors and mistakes in tax returns.
Aligning the basis of assessment for trading income with other forms of income enables wider, simpler reforms to be considered in the future. In particular, transitioning to the tax year basis in the tax year 2022 to 2023 will simplify the introduction and experience of Making Tax Digital for Income Tax. For simplicity, the government proposes a one year transition period, with an option to spread any excess profit arising in that transition period over five years.
The transition tax year would introduce the equivalence rule. This means that businesses can treat the end of the tax year for their tax year basis as any date between 31 March and 5 April.
Alongside this transition, the proposals would mandate that all overlap relief must be claimed in the transition tax year, including any historic transitional overlap relief, or overlap relief generated during the new transition year. No overlap relief would be carried forwards into the new tax year basis, and no new overlap relief would be generated after the transition year.
According to an article in the Law Society Gazzette 13th August
The new rule, proposed by HM Revenue & Customs under the guise of simplification, could generate a badly needed windfall of more than £1bn for the Treasury next year.
Aligning the reporting date with the tax year would mean that profits that arise in each reporting year would be allocated to that tax year. Currently, profits are taxed for the year in which the business’s accounting period ends. Many partnerships thus end their accounting period on 30 April, allowing them 11 months’ grace.
In summary
- The basis period reform will apply from 2023-24.
- There will be a transition period in 2022-23.
- Accounting periods that end between 31 March and 4 April inclusive will be treated as ending on 5 April.
- In the 2022-23 transition year, business profits will be reported from the end of the previous period assessed in 2021-22 up to 5 April 2023.
- Businesses with a 31 March 2023 accounting date will report business profits up to that date. This will be deemed to be 5 April 2023.
- The subsequent accounting period will be deemed to start on 6 April 2023.
