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July 30, 2021

HMRC Set to Scrap Basis Periods for Businesses

HMRC has opened a consultation on reforming Basis Periods for unincorporated businesses, such as sole traders and partnerships. The current rules are  straightforward for those that draw up their annual accounts to 5 April, however complexities arise for those with alternative accounting periods, particularly in the first few years of trading.

Current Rules

Under the current rules, businesses are taxed on the Current Year Basis.

If a business draws it's accounts to 5 April, then the profits in that accounting period is allocated to the same tax year (i.e. 6 April - 5 April).

Where a business selects an accounting period end date other than 5 April the situation becomes more complex. The Basis Period for a tax year for the businesses is the period of 12 months ending with the accounting date in that year. In other words, business profits are allocated to the tax year in which the last day of the accounting period falls. So, if a business's accounts run from 1 January 2020 - 31 December 2020, these profits will be allocated to the 2020/21 tax year as 31 December 2020 falls in the period 6 April 2020 - 5 April 2021.

Additional complexities arise on the commencement and cessation of businesses with an accounting period end date other than 5 April, with special rules in the first 3 years of trading meaning that the same profits are taxed twice (generating "overlap profits"). These overlap profits are carried forward and then relieved against profits arising in the final year when the business ends ("overlap relief").  Unsurprisingly, some businesses lose track of their overlap profits which may date from many years ago, meaning business owners lose out on relief they are entitled to.

How might the rules change?

The consultation document proposes a simplified alternative to the Current Year Basis: the Tax Year Basis. This would mean that businesses would be taxed on profits arising in the tax year. Businesses with a period of account that does not match the tax year would have to make an apportionment to identify the profit or loss arising in a specific year.

It is thought that this change will clarify and reconcile the tax rules surrounding Basis Periods, particularly with overlap profits being removed from the system altogether. It is also noted that this change will remove the tax deferral advantages that can be achieved by choosing an accounting date early in the tax year, so accounting periods are chosen for their commerciality only.

It is proposed that transitional rules are put into place to ease the one-off cash flow impact of the change, with existing overlap profits being relieved during this transition period.

As part of the simplification reform, it is also proposed that a statutory rule is introduced that deems the equivalence of 31 March to 5 April for all years of the trading - potentially also for property businesses.

Want your say?

HMRC's full Consultation document can be accessed here, along with instructions on how to respond.

If you run a business and want to discuss Basis Periods in more detail, or if you have another query related to UK tax, please contact a member of our team.

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