An individual carrying on a trade, profession or vocation (either alone or in partnership) is subject to income tax (and Class 4 National Insurance contributions) on their profits but can prepare accounts to any date they choose, not necessarily to coincide with the tax year ending on 5 April.
Until 2022/23, the general rule for determining the profit or loss for the tax year was by reference to the accounts for the year ending in the tax year. Special rules applied for the opening and closing tax years. However, the rules have been reformed from 2024/25 and the basis period for an unincorporated business is now the relevant profits and losses arising within the tax year itself (6 April to 5 April). If the business’s accounting year differs from the tax year (or from the year to 31 March), the results must be apportioned.
The Rules in Practice
The contrast between the ‘old’ and ‘new’ basis period rules may best be illustrated with an example.
Example: The ‘Old’ Rules
Mr Smith started his business on 1 July 2020. He prepares his accounts to 30 June each year and profits are as follows:
Year ended 30 June 2021 £12,000
Year ended 30 June 2022 £14,000
Year ended 30 June 2023 £16,000
Year ended 30 June 2024 £24,000
Year ended 30 June 2025 £30,000
The taxable profit for 2020/21 (the year ended 5 April 2021) is £9,000 (£12,000 x 9/12 months). For 2021/22, the taxable profit would be £12,000 (for the year ended 30 June 2021, the accounting year ending in the tax year). We can see that £9,000 of the first accounting year’s profit has been taxed twice, and this amount could be deducted from taxable profits as ‘overlap relief’ when the business ceased or perhaps when the accounting date changed. The tax liability for 2022/23 would be £16,000 (the profit for the year ended 30 June 2022).
The ‘New’ Basis and the Transition
In the Example, the first full year of the new basis of assessment, 2024/25, will be calculated by reference to the tax year itself. This would be £28,000 (i.e., y/e 30 June 2024, £24,000 x 3/12 months plus y/e 30 June 2025, £30,000 x 9/12 months). Strictly, the apportionment should be made on a daily basis, but an alternative method (say monthly, as here) can be used, if this is done consistently.
The new rules will apply to any business that starts from 6 April 2023. For those trading before that date, transitional rules apply for 2023/24. For that tax year, Mr Smith’s profit will be calculated by reference to the accounting period that started from the day after the accounting year end in 2022/23 up to 5 April 2024. This would be £34,000, being the profit for the year ended 30 June 2023 (£16,000) plus the ‘transition profit’ for the period 1 July 2023 to 5 April 2024 of £18,000 (being £24,000 for the year ended 30 June 2024 x 9/12 months).
This represents 21 months’ worth of profit, but the profit for the transition period can be reduced by the overlap relief of £9,000 which was the profit for the nine-month period that was taxed twice when the business started. So, nominally, the net taxable profit of £25,000 does represent 12 months’ worth of profits, although this is still more than the amount (£16,000) that would have been taxed under the old rules. The £9,000 difference is the amount by which the transition profit of £18,000 exceeds the overlap relief of £9,000. To mitigate the immediate effect of a larger-than-normal liability, one-fifth of the excess (£1,800) can be taxed in each of the 2023/24 tax years and the following four years.
This is a very brief summary of the rules relating to the changing basis of assessment for business profits, and detailed advice may be required in individual circumstances, particularly if losses are involved.
Practical Tip
Businesses may wish to consider changing their accounting years to 31 March or 5 April in the future to facilitate the early calculation of forthcoming income tax liabilities.
