Understanding the HMRC basis period reform

Understanding the HMRC basis period reform

HMRC is changing the time period sole trader and partnership businesses use to work out their taxable profits.

Currently, businesses calculate their taxable profits based on their accounting period which can end at various points during the tax year. But, from tax year 2024/25, unincorporated businesses will pay income tax based on the profits earned during that tax year.

This change - known as basis period reform - will impact:

• sole traders and partnerships with an accounting period end date that falls outside 31 March and 5 April
• new businesses that begin operating from 6 April 2024.

In this guide, we provide a top level summary of basis period reform legislation and answer the most common questions your clients may have to help you communicate the key facts.

What is the ‘basis period’?

The ‘basis period’ refers to the period of time used to calculate profits and income tax for a business.

Under the current rules, income tax is calculated on the profits earned during a business’ accounting period. Generally, businesses work out their annual accounts using the same year end date - their ‘accounting date’ - each year. For example, if a business has an accounting year end date of 31 October, their taxable profits will be calculated from 1 November 2021 to the year-end date of 31 October 2022 for the 2022/23 tax year.

From the 2024/25 tax year, HMRC's basis period reform means all unincorporated businesses will use the UK tax year of 6 April to 5 April as their basis period for income tax assessment.

What is the difference between ‘accounting period’ and ‘basis period’?

The accounting period is chosen by the business and used to produce financial reports. For example, preparing financial statements for investors or auditors to a year end of 31 October.

A business’ basis period is the window of time HMRC uses to calculate their income tax liability as well as for wider tax purposes.

Accounting periods and basis periods are often the same for businesses, but some differ. For example, if a business was set up in the middle of a tax year, the accounting period could run from 1 June to 31 May.

What is the basis period reform?

The basis period reform will change the window of time when income tax is calculated. In short, you’ll use the tax year instead of a business’ accounting year as the basis period.

Currently, unincorporated businesses are assessed for income tax based on the profits made during their accounting year. Going forward, these businesses will be assessed for income tax based on the UK tax year (6 April to 5 April). This change comes into place for the 2024/25 tax year, with transitional rules applying in tax year 2023/24.

From the 2024/2025 tax year, a business’ income tax liability will be calculated based on their profit or loss during the UK tax year, instead of another accounting period.

Businesses can still use different accounting dates that don't align with the tax year but will need to make apportionment calculations each year when calculating their taxable profits.

Which businesses are impacted by the basis period reforms?

The change will affect unincorporated businesses which are:

• Self-employed traders, including individuals with a profession or job
• Partners in trading partnerships including limited liability partnerships (LLPs)
• Other unincorporated entities with trading income, like trading trusts and estates and non-resident companies with trading income charged to Income Tax.

It may impact other businesses who are benefiting from government tax schemes like research and development (R&D) tax credits.

What does basis period reform mean for self-employed individuals?

Self-employed people who have an accounting period that aligns with the tax year will continue as normal. But if a self-employed individual has a different accounting period, the basis period reform could mean they need to submit estimated profits for at least part of their accounting period.

To do this, they’ll need to use HMRC’s guidance for calculating their profits. As their accountant or bookkeeper, it’s vital that you’re ready to help your self-employed clients with this change.

For partnerships, the basis period reform could impact cash flow depending on whether partners decide to spread transitional period profits. As their accountant or bookkeeper, now is a great time to do some cash flow modelling so you can explore various outcomes and decide on the best approach for your client.

This article has provided a top level view of basis period reform legislation to help you communicate the changes to your clients. If you'd like an in-depth exploration of the basis period reform legislation, take a look at our extensive guide.