From 6 April 2024 all unincorporated businesses (sole traders and partners in a partnership) are required to report profits or losses in line with the tax year.
Businesses with an accounting period end other than 5 April or 31 March will need to report pro-rated results from two accounting periods for tax purposes, unless the accounting period is changed to align with the tax year.
For the 2023-24 tax year, dubbed the ‘transitional year’ by HMRC, businesses must report their profits from the start of the accounting period ending in 2023-24 to 5 April 2024. For a 31 December year end this is the period from 1.1.23-5.4.24. This 15-month period is made up of the 12 months to 31.12.23 ‘the standard part’ and the three months to 5.4.24 ‘the transitional part’.
As this will result in extra taxable profits for many businesses, HMRC is allowing the profits from the ‘transitional part’ to be spread over five tax years. Any unused overlap profits can be deducted from the transitional part.
By default, transitional profits will be spread evenly over the five years to 2027-28. It is also possible to accelerate the recognition of these, by bringing more of the extra profits into earlier tax years. There are many reasons why it may be beneficial to recognise more than the minimum amount of transitional profits in a particular year.
For example a sole trader whose business is growing might decide to recognise more of their transitional profits in 2023-24 and 2024-25, while ensuring they stay under the higher rate threshold. This would leave less extra profit to be recognised in 2025-26 onwards when the business is expected to make higher profits and potentially taxed at a higher rate.
Where overlap profits exceed transitional profits, resulting in a loss, this is not spread over five years. Instead it is deducted from the profit or loss in the standard part in 2023-24.
Where a business chooses to change its year end to align with the tax year end, it will still be possible to spread any transitional profits over five years.
We have been preparing for basis period reform for several years and can help you manage the transition.
Contact us to discuss whether your business could benefit from this.