Changes to basis period reforms: Have you considered the financial impact?

What are the changes?

On 20 July 2021, HMRC announced a consultation on income tax basis period reforms. The consultation, together with new legislation, sets out the way in which self-employed partners’ taxable profits are subject to income tax and Class 4 National Insurance Contributions, with effect from the tax year commencing 6 April 2023.

It is essential that you are aware of the implications, particularly if you are responsible for making tax payments to HMRC in settlement of your tax liabilities each year. Currently, basis period rules identify the taxable profits to be reported on your tax return. For established partners, the taxable profits are currently those covering the 12 months of the accounting period ending in the tax year.

Who is affected?

Self-employed partners in partnerships with non-31 March/ 5 April accounting year-ends will be subject to new rules from the 2023/24 tax year. New self-employed partners are defined as those who started self-employment in the 2021/22 or 2022/23 tax years, and are outside the scope of the changes.

How it will work

2023/24 tax year – transition year

You will be taxed on the following profits:

• profits for the 12 months beginning immediately after the end of the basis period for the 2022/23 tax year. In most cases, this will be the profits for the 12 months ending in the 2023/24 tax year; PLUS
• profits for the period starting immediately after the end of the period in (a) above to 5 April 2024; LESS
• any existing overlap profits.

‘Overlap profits’ are profits that were taxed twice due to the current opening year rules, which were applied when you first became a partner. As a result of business growth and inflation, the value of overlap profits are diminished over time. We expect that in many cases the overlap profits will be less than the additional profits that will be brought into charge.

2024/25 tax year and beyond

You will be taxed on the profits arising in the tax year, using an apportionment of relevant taxable profits from accounting periods which cover the tax year. Apportionments are usually done on a monthly or daily basis, but in some cases other methods may be appropriate.

Example for self-employed partners where the partnership year end is 31 December

By way of a simple example, the calculation of taxable profits for partners in a partnership with a 31 December year-end will be:

a. 9 / 12 months x the taxable profits for the year ended 31 December 2024;

PLUS

b. 3 / 12 months x the taxable profits for the year ended 31 December 2025

Example for self-employed partners where the partnership year end is 30 April

The calculation of taxable profits for partners in a partnership with a 30 April year-end will be:

a. 1 / 12 months x the taxable profits for the year ended 30 April 2024;

PLUS

b. 11 / 12 months x the taxable profits for the year ended 30 April 2025

NOTE: The tax return filing date for the 2024/25 tax year is 31 January 2026. In the above examples, it is possible that final taxable profit figures for the later period will not be available, particularly for partnerships with a 31 December year-end, as the accounting date is only one month before the filing deadline for the tax return. An estimate of the taxable profits for this period is therefore likely to be required on this tax return.

Practical issues to consider

• Spreading profits: Where the taxable profits for the 2023/24 tax year under the new rules are higher than those which would have arisen under existing basis period rules, HMRC will automatically spread the additional profits so that they are subject to tax and Class 4 NICs in five equal yearly amounts commencing with the 2023/24 tax year.
  An election, can, however, be made to increase the additional ‘spread’ profits of a particular year, thereby accelerating the tax charge. By making an election, the amount of profits spread in future tax years is proportionately reduced. Making an election and paying tax earlier on higher profits may be beneficial in certain circumstances, for example, if you consider that income tax and NIC rates will increase during the next five years.
  
• Accurate estimates: Your tax returns may need to be filed to HMRC based on estimated partnership figures as accounts and tax adjust profit figures are not yet available. Therefore, ensuring there are robust systems in place to produce accurate estimates is essential, as otherwise you may be exposed to:
  
  a. Interest on underpaid tax;
  
  b. Over/under contributing to pension schemes;
  
  c. Costs of filing amended tax return, and
  
  d. The extension of HMRC’s enquiry window. We are, however, waiting for HMRC to provide further clarity on interest on underpaid tax, enquiry window extensions, and possible ways of easing the burden of having to submit amended tax returns if estimated figures are used.
  
• Possible additional tax liabilities: Tax payments are likely to be accelerated as a result of the new basis period rules. Therefore:
  
  a. your personal cashflow may be impacted as a result of the possible additional tax liabilities for the five years ending 5 April 2028. You will need to plan ahead and ensure that you retain sufficient funds to pay these liabilities on time; and
  
  b. If your partnership makes tax provisions on your behalf, you should be discussing the changes with those responsible for making tax payments to HMRC to ensure they have sufficient tax reserves in place to pay the tax liabilities due.

If you would like to discuss any aspect of the incoming changes, please get in touch with Mark Waddilove.