Changes to the basis of assessment

The method of taxing the profits of unincorporated businesses changed significantly in 2023/24 and will also change from 2024/25 onwards. This was originally intended to align with the introduction of Making Tax Digital for Income Tax Self Assessment (MTDITSA), which will now start to be phased in from 2026/27.

Under the old basis of taxing profits, a sole trader or member of a partnership was taxed on their share of profits of the business’s accounting period ending in the tax year. For example, in the 2022/23 tax year, a sole trader with a year end of 31 December would be taxed on their profits for the 12 months ending 31 December 2022.

For the 2024/25 tax year, the profits assessed would be the profits arising between 6 April 2024 and 5 April 2025 regardless of when a trader’s year end is. As a result of this, many businesses have decided to change their accounting year end to 31 March or 5 April so that it corresponds with the tax year. Please note that HMRC allow dates between 31 March and 5 April to be treated the same for these purposes.

There is additional complication if the trader’s year end has not been changed to match the tax year. I.e. if we follow the example above, with a year end of 31 December, we tax: 9 months of the profits from year ended 31 December 2024 plus 3 months of the profits for year ended 31 December 2025. As the 2024/25 Self Assessment Tax Return needs to be filed by 31 January 2026, it is highly likely that the profits for the later period would need to be estimated and subsequently revised.

The Transitional Year 2023/24

A further complication with the change in the basis of assessment is the calculation of profits from 2023/24, the “transitional year”. We are now beginning to file Tax Returns which cover this period of transition from the old ‘current year’ basis to the new tax year basis.

The rules in 2023/24, where the business has a year end that doesn’t correspond with the tax year, seek to tax the profits from the day after the end of the period taxed in 2022/23 until 5 April 2024. A business preparing accounts to 31 December each year would have a 15 month period from 1 January 2023 to 5 April 2024 potentially taxable in 2023/24. However, the 3 months’ profits in the period 1 January 2024 to 5 April 2024, less any overlap relief, is not all taxed in 2023/24 but instead spread over 5 years, unless the tax payer elects to be taxed on a higher amount.

If, in the above example, the sole trader makes profit of £120,000 in year ended 31 December 2024 then £30,000 less any overlap relief (typically from the early years when some profits were taxed twice) would be spread over 5 years. Assuming no overlap relief, an extra £6,000 profits would be added to the profits assessable for each year from 2023/24 to 2027/28 (unless the individual elects to be assessed on a higher amount). This is not straightforward and we can work with you to calculate the transitional profits and advise you of your tax liabilities going forward.

If you would like further guidance on self assessment, please contact 023 8046 1232, or email Martin Back.