Basis period reform: what practices need to know
In this guide, we explain what you need to know about basis period reform as an accountant or bookkeeper, and how this legislative change is likely to affect your clients.
What is basis period reform?
‘Basis period reform’ is the term used to describe legislation introduced by the UK government to change the way that trading income is allocated to tax years.
Basis period reform will take effect from the 2024/2025 tax year, with a transitional year in the 2023/2024 tax year.
HMRC estimates that around 528,000 sole traders and partners use an accounting year that does not align with the 6th April - 5th April tax year.
Under the old basis period rules, a business includes on its tax return the profit it made for the accounting year that ends within the tax year covered by that tax return. At the start of a business, this method can create overlapping basis periods, which potentially charge tax on profits twice and generate corresponding ‘overlap relief’.
Under the reformed rules, all sole traders and partnerships will be taxed on the profits they made in the tax year (6th April - 5th April), regardless of when their accounting year ends. This removes the complex basis period rules and prevents the creation of further overlap relief.
This measure will affect existing businesses that draw up annual accounts to an end date different to 5th April, although HMRC will allow a year-end that falls between 31st March and 5th April to be treated as if it falls at the end of the tax year.
Timeline for basis period reform
The table below outlines the timeline for basis period reform up to 2024/25, when the reforms become mandatory:
|Final year under the old basis period rules.
|A transitional year. You can find more information on how the transitional year works below.
|The new basis period rules come into effect.
2023/24: a transitional year
HMRC is treating the 2023/24 tax year as a transitional year. During this year, businesses will have to prepare for the new basis period rules and - if not using the tax year as their accounting year end - will generate ‘transitional’ taxable profits after their accounting year ends.
For most businesses, this could mean drawing up two sets of accounts: one up to the end of their existing accounting year (for example, 31st December 2023), and an additional set of transitional accounts drawn up to 5th April 2024.
Alternatively, they may draw up accounts for the full period lasting more than 12 months. For example, a business with a 1st January - 31st December accounting year could prepare accounts for 1st January 2023 - 5th April 2024.
HMRC has said that payments for the tax due on the extra transitional period profits can be spread across the following five years, which may ease cashflow for those affected.
Basis period reform and Making Tax Digital
The introduction of Making Tax Digital for Income Tax Self Assessment (MTD for ITSA) in April 2026 could present issues for affected businesses whose accounting years do not match the tax year.
Under the new MTD rules, HMRC will require businesses to submit a final declaration by 31st January following the end of the tax year. This is similar to how businesses already file Self Assessment tax returns. Many businesses will also have to pay their tax bill and National Insurance contributions by this date.
However, if the accounting year has not been completed at that point (for example, if the accounting year runs from 1st March - 28th February), then accounts may not have been drawn up and it may not be possible to provide accurate information. In this situation, businesses may need to provide an estimate of their tax liability and pay an estimated tax bill based on this.
This may result in an increase in the number of corrections that practices need to file for their clients. To avoid this, it may be worth considering using the transitional year to switch as many clients as possible to use the tax year as their accounting year.
What should practices do about basis period reform?
HMRC is relying on practices to contact their clients and to explain the details of the basis period reform to them. As was the case with MTD, practices will need a robust communication strategy to ensure their clients fully understand the changes. Many of the same principles, such as segmenting your client base and tailoring your messaging to each group, will apply.
Beyond educating clients, practices may need to advise them on whether or not changing their accounting year to match the tax year is the right move for their business. Remember that clients who are outside the scope of MTD for ITSA will still be affected by the basis period reform if their accounting periods don’t line up with the tax year.
Businesses will need to know their original overlap profits in order to calculate their transitional profits correctly. For clients who have been in business for some time, records of overlap profits might not be readily available, in which case it might be necessary for their accountant to contact HMRC well ahead of time and request them.
There’s no avoiding the fact that educating those affected is likely to pose a challenge. But the fact that practices are likely to be their clients’ main source of information about basis period reform means accountants will be uniquely positioned to advise what it means for their businesses.