Basis period reform - Tax year basis
Previously you could choose any accounting date for your partnership. You were taxed on whatever accounting date ended in the relevant tax year e.g. the year end 30th June 2022 ended in the 2022/23 tax year and the year end 31st March 2023 which ends in the 2022/23 tax year.
However this basis of assessment ceased with effect from the 2024/25 tax year. From 2024/25 you will be taxed on all profits/losses arising in the tax year ended 5th April regardless of your accounting date this is known as the tax year basis. These changes are designed to assist HMRC with the implementation of Making Tax Digital.
There are a number of considerations you need to think about where your accounting period does not end between 31 March and 5 April and we’ve highlighted these below:
Transitional year - 2023/24
If your partnerships accounting period does not end between the 31 March and 5 April you will be transitioned across to the new tax year basis during the 2023/24 tax year.
For the 2023-24 tax year, for those who do need to transition, your taxable profits will be based on your accounting period end date plus the remaining profits arising in the year, from the day after the accounting period end to 5 April 2024
So for example, if you have an accounting year end date of 30 September, then the profits for the year ended 30 September 2023 plus those for the period 1 October 2023 to 5 April 2024 will be assessed in the 2023/24 tax year.
Those overlap profits brought forward will be available to offset in full in the 2023/24 tax year. No overlap profits will be available to carry forward into 2024-25. You can some examples in HMRC's guidance here as to how this will work in practice.
Overlap profits
Under the old rules the taxman aimed to tax your profits in full once and once only over the lifetime of your business.
However unless your accounting date fell between 31 March and 5 April (inclusive) there would always be some element of double counting or ‘overlap profits’ (see below), in the first full tax year your profits were taxed on the current year basis.
This is because a business was taxed slightly differently in the first year of its trade than it normally is in subsequent years.
The easiest way to demonstrate this is, is to show you an example:
Let’s assume your first business accounts were drawn up for the year ended 30 April 2020 and the profits were £30,000. You would be taxed as follows:-
2019/20 (‘Actual’ profits in the tax year)
Profits for the period 1 May 2019 to 5 April 2020 fall within the 2019/20 tax year.
Therefore 309/365 x £30,000 = £25,397 taxable profits.
2020/21 (Profits for the twelve month period ending in the 2020/21 tax year)
Profits for the period 1 May 2019 to 30 April 2020
Therefore £30,000
As you can see the profits of £25,397 for the period 1 May 2019 to 5 April 2020 were actually taxed twice in the 2019/20 and 2020/21 tax years - hence the reason why they were known as ‘overlap profits’.
These ‘overlap profits’ could be deducted from your profits either when you ceased your business (see below) or when you changed your accounting date at a later stage.
However now these 'overlap profits' will be deducted from your taxable profits during the 2023/24 tax year as part of the change to the tax year basis of assessment.
Higher profits in the 2023/24 transitional year
Depending on your partnerships' accounting year end date you could end up paying tax on more than 12 months’ worth of profits during the 2023/24 tax year as part of the transitional arrangements.
This is because you are taxed in your final year on the profits to the start of the accounting date ending in the 2023/24 tax year – this could be in a previous tax year.
Where the above calculation gives rise to transition profits, this increased profit will be automatically spread over five years and taxed in those years to ease the financial burden.
- In each of the four years beginning with the transitional year of 2023-24, 20% of the additional profits will be taxable.
- In the fifth year, the balance of the additional profits will be taxable.
- If, before all of the additional profits have become chargeable to tax, the business ceases to trade, the remaining balance will be taxable in the year of cessation.
An election can be made to tax any or all of the excess in any given year within those five years.
- The election must specify the amount to be taxed.
- The time limit for the election is the first anniversary of the filing date of the original Self Assessment return for the tax year in which the business wishes to bring in additional transitional profits.
- Where the election is made, any remaining additional profits will be spread across the number of years out of the five that still remain.
HMRC have detailed in their published guidance how this will work in practice.
Losses in the 2023/24 transitional year
There are special rules where due to the deduction of overlap relief either a trading loss is created for 2023-24 where there would have been profit, or an existing loss for 2023-24 is increased due to the overlap relief.
The Terminal loss relief provisions applies to that part of the loss created by the overlap relief, essentially as if the trader had ceased to trade on 5 April 2024.
Put very simply this means the resulting trading loss can potentially be offset against profits for 2021/22, 2022/23 and 2023/24.
The 2023/24 transitional year - other points
Other points to mention as part of the change in how business profits are taxed are as follows:
- Transition profits will be included in amounts that qualify for relief from Enterprise Investment Scheme (EIS), and Seed Enterprise Investment Scheme (SEIS) reliefs.
- HMRC have confirmed that transition profits will count towards Relevant earnings for pension contribution purposes.
- When calculating student loan repayments, ‘normal’ profits (i.e. for the current year basis) plus transition profits, after overlap relief, are used. This may result in higher student loan repayments in 2023-24 to 2027-28.
- HMRC have also confirmed that Capital Gains Tax (CGT) rates will not be impacted by transition profits.
As a rule of thumb, the tax for a tax year is based on the profits of a twelve month accounting period ending in a tax year.