Basis period reform: A summary
Background
Basis period reform will affect partners in firms that have an accounting period that is not aligned to the tax year. The way profits are reported for tax purposes will change from 2023/24 onwards.
The current rules
Partners are generally assessed to tax on their profits for the 12-month accounting period ending in the tax year.
For example, if a firm had a 30 April year end, the partners would be taxable on their profit share for the year ended 30 April 2022 in the 2022/23 tax year.
The new rules
Partners will be assessed on their taxable profits for the year ending 5 April 2025.
Where a firm has an accounting year end other than the 31 March (or 1-5 April 2025), partners will be assessed to tax on the relevant profits from two accounting periods.
For a firm with 30 April year end, this will be:
- 25/366 of their share of the firm's taxable profits to 30 April 2024, plus
- 340/365 of their share of the firm's taxable profits to 30 April 2025.
Transitional year 2023/24
Partners will be assessed on their share of taxable profits for the accounting year ending in the tax year plus the 'additional net profits'. This will be their share of taxable profits from the start of the next accounting period to 5 April 2024, less their overlap profits brought forward.
- For a firm with 30 April year end, a partner will be assessed on the following:
- their share of the firm’s taxable profits of the year ended 30 April 2023, plus
- 341/366 of their share of the firm’s taxable profits of the year to 30 April 2024, minus
- their overlap relief brought forward.
Tax treatment of ‘additional net profits’
The 'additional net profits' will be a separate income item on the tax return for each partner and will be automatically spread in equal instalments over five years commencing with 2023/24 and ending with 2027/28.
They will be ignored when assessing means tested benefits and entitlements to certain tax allowances.
Partners can elect to accelerate the assessment to tax of their 'additional net profits' at any point during the five-year spreading period.
Therefore, if tax rates change, then partners and firms may want to revisit and accelerate the timing of when the ‘additional net profits’ are taxed.
If a partner retires from the firm in the spreading period any of their 'additional net profits' not already assessed will automatically be assessed in the tax year of retirement.
Changing year end to 31 March 2024
If a firm changes its accounting date to 31 March 2024, it will still benefit from spreading as the additional profits for the period to 31 March 2024 will be regarded as ‘transition part’ profits.
Impact of filing provisional returns
If a firm does not change its year end the partners may be required to file provisional returns including an estimate of their profit share for the relevant period.
Where provisional tax returns are submitted, they will need to be amended before the 31 January following the deadline of the original return.
For firms where it is not logistically possible to file anything other than provisional tax returns, the new reform will generate additional work for partners, firms and their advisors and complexity with regards to:
- the provisional numbers to be used
- the reconciliation of the final figures
- the tax payment position
- managing interest charges, when insufficient taxes have been paid
- managing tax reserves effectively
- managing partners expectations of taxable profit shares.
Firms with a 30 April through to 30 June year end may well be in a position not to need to use provisional figures but it is key that their timetables for the preparation of taxable profit shares will continue to be slick and timely.
Those with 31 July through to 28 February year ends will undoubtedly struggle to provide the relevant figures to use in provisional tax returns. Working out estimated figures and trying to minimise the interest charges arising from underestimation of tax payments will prove challenging for a number of businesses.y
Outlook
As a result of these proposals, tax payments will be accelerated, and the first instalment will be due in January 2025.
With the current climate, January 2025 will be a challenging time for firms from a cashflow perspective and hence requirements need to be considered and planned.
Five next steps for partners and firms
To reflect on what the ‘additional net profits’ look like.
- To understand what the corresponding tax liabilities are and when they are due.
- To reflect on which partners are likely to retire before 5 April 2027 and the corresponding impact of accelerating when the ‘additional net profits’ will be assessed.
- To think about how the additional cash outflow is going to be financed – will partners need to contribute additional capital to maintain working capital?
- Does the firm need to agree/mandate that all partners will spread their additional profits and if so, does the LLP/partnership agreement need updating to reflect this?
For more information on basis period reform, get in touch with your usual Crowe contact.
