In the ever-evolving landscape of taxation and financial regulations, staying informed about changes is crucial for individuals and businesses. One such significant change in the UK’s tax system is the Basis Period Reform. This reform has far-reaching implications, and understanding its importance is essential for anyone involved in taxation and accounting. In this blog, we will delve into what the Basis Period Reform is and why it’s important for your journey to MTD.
What is the Basis Period Reform?
The Basis Period Reform is a fundamental change in the way self-employed individuals and partnerships calculate their taxable profits. Prior to this reform, the basis period was determined by reference to the accounting period of the business, which often led to complexities and mismatches in tax liability. The reform was implemented to simplify the tax system and bring about more fairness and consistency.
Therefore, trading income will be charged in the tax year that it arises. That said, there will be no mandating of the 31st March/5th April year-end; taxable profits will have to be calculated as if they were mandated. These changes will be effective 2024/25 but the transitional year is 2023/24.
What are the changes?
The tax year 2023/24 will be the transitional year aligning taxable profits to the 31st of March 2024. This means you will be taxed on the normal 12 months, plus any additional months to take you to the 31st of March 2024; this creates 2 accounting periods in the year 23/24. The second accounting period is the transitional period which can be spread over 5 years; beginning 23/24 – with a minimum of 20% per year.
Who will it affect – and when?
The Basis Period Reform will affect self-employed trading businesses that do not have a 31st of March/5th April year-end and will impact in the 23/24 tax year, unless it is correct for the client to do it earlier.
What are your options to plan ahead?
- Do you align in the 22/23 year?
- Do you align in the 23/24 year?
- Do you never align?
The correct answer is: It depends on the client.
The classic solutions are:
- If the client is expected to have significant profit, you can spread forward the transitional profit up to 5 years.
- If the client has low profit, you can release the transitional profits earlier.
- If there are losses in the basis period and transitional period, the basis period is treated normally, and the transitional period is treated as terminal losses.
Why Does It Matter?
Simplification and Clarity
One of the primary goals of the Basis Period Reform is to simplify the tax calculations for self-employed individuals and partnerships. Previously, the basis period could be determined by different rules, leading to confusion and unnecessary complexity. With this reform, the calculation of taxable profits is more straightforward, making it easier for taxpayers to understand and comply with their tax obligations.
Reduced Tax Liability Mismatches
Under the old system, the misalignment between accounting periods and tax periods often resulted in tax liability mismatches. This could lead to situations where individuals and businesses paid tax on income they hadn’t yet received or, conversely, delayed paying tax on income received. The Basis Period Reform aims to align tax liability with actual income earned, reducing these mismatches and providing a fairer system.
Enhanced Planning and Predictability
With the new rules, taxpayers can have greater control and predictability over their tax planning. By allowing for more flexibility in choosing the basis period, individuals and businesses can better manage their tax liability based on their financial circumstances. This increased flexibility is particularly beneficial for those with fluctuating incomes.
Alignment with Digitalization
The Basis Period Reform is designed to align with the ongoing digitalization of the tax system in the UK – Making Tax Digital (MTD). As more tax-related processes move online, having a simplified and consistent basis period calculation is essential for efficient reporting and compliance. It helps streamline the transition to MTD and makes it easier for taxpayers to interact with HM Revenue & Customs (HMRC).
Fairness and Consistency
Perhaps the most significant impact of the Basis Period Reform is its contribution to fairness and consistency in taxation. It ensures that individuals and businesses are taxed on the income they have actually earned within the chosen basis period, eliminating potential distortions and discrepancies.
Can there be issues with Non-Alignment?
If a business chooses not to align to the tax year, then it is very likely that those businesses will need to refile a Self-Assessment if estimates are being used.
In a constantly changing tax landscape, staying informed about reforms like the Basis Period Reform is crucial. This reform simplifies tax calculations, reduces mismatches in tax liability, and provides individuals and businesses with greater control over their tax planning. Moreover, it aligns with the ongoing MTD, making compliance more efficient and convenient. Understanding the importance of the Basis Period Reform empowers taxpayers to navigate the tax system more effectively and make informed financial decisions.
Want to learn more? Join our webinar on Wednesday 4th October at 12PM where our guest speaker, Martyn Verity, Partner at Moorhurst Partners LLP, will be taking an in-depth look at what the Basis Period Reform really means for Accountants today.