We are now a full tax year on from the basis period reform rules, which came into place in the 2023/24 tax year, and firms/partners are feeling the effects of the changes.
We explore the key impacts it is having on firms/partners and how they are reacting to the change in cash flow. We also explore the key considerations that firms/partners should consider moving forward.
Summary of the rules that came into place for the 2024/25 tax year onwards
Partners will be assessed on their taxable profits for the year ending 5 April.
Where a firm has an accounting year end that straddles 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 a 30 April year-end, the assessable periods are:
- 25/366 of their share of the firm's taxable profits to 30 April
- 340/365 of their share of the firm's taxable profits for the following 30 April.
‘Additional net profits’, or ‘transitional profits’, generated in the 2023/24 tax year are automatically spread over five years from the 2023/24 tax year to the 2027/28 tax year.
Partners can elect to accelerate the assessment to tax of their ‘additional net profits’ at any point during the five-year period.
Therefore, if tax rates increase, 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.
Key impacts
Amending provisional tax returns and late payment interest
Impact on partners
If a firm has not changed its year-end, partners may have to file provisional returns, including an estimate of their profit share for the relevant period. Once the returns had been amended for the final figures, partners could find themselves in one of two situations:
- The final figures are lower than the estimates originally provided. A repayment of the tax should therefore be reclaimed with a repayment supplement from HMRC.
- The final amounts are higher than the estimates originally provided. This will result in further tax being due both in respect of the balancing payment for the tax year and the payments on account for the following tax year.
If additional tax is due, late payment interest, which has ranged from 7% to 8.5% in the last 18 months, will be levied and can quickly mount up.
Therefore, for those partners that will need to file tax returns using provisional figures, great care needs to be taken when estimating amounts and hence it is important to consider including a buffer to limit the possibility of interest being levied.
Impact on firms
It is usual for UK firms to hold tax reserves on behalf of partners and to make the relevant tax payments in January and July of each year.
Ensuring there is a sufficient buffer to minimise any potential interest charges is another strain on cash flow for the firm, and with increases in employers' NIC and other factors affecting firms, cash flow management has never been quite so important.
If firms do not have sufficient funds to settle the additional tax liabilities for their partners, they could look to the following:
- acquiring a loan from the firm’s bankers to manage the shortfall and settle partners’ overdue liabilities
- ask partners to settle the shortfall personally
- revisit the capital structure of the firm and reflect on the level of working capital required, and if necessary, increase the level of capital provided by partners.
Interaction with pension contributions and annual allowance
For partners whose annual allowance for pension purposes may be restricted, i.e., whose adjusted income for pension purposes falls between £260,000 and £360,000. When making a pension contribution, the level of adjusted income figures will not be known, as taxable profit shares are not usually known until several months after the accounting year-end date and therefore an estimate will have been used.
Basis period reform adds a further level of complexity when trying to work out the restricted annual allowance for the year.
The annual allowance is restricted from £40,000 down to £10,000, and if too much is paid, then a pension savings charge may result, a clawback of the tax relief on the excess pension contribution.
Therefore, if adjusted income is unknown and likely to be above £260,000, then contributing the restricted amount of £10,000 gross, and utilising unused annual allowance carried forward, should ensure that there is no pension savings charge and that the full annual allowance is utilised over a period of time.
For further information on pensions, check out the briefing Pension planning for partners.
Key considerations
Firms changing year-end to 31 March
Now that the dust has settled on basis period reform, some firms are reviewing the benefits of changing their accounting year-end to 31 March to help simplify everything from a tax reporting perspective.
However, changing year ends will impact a number of internal processes and procedures, and these need to be taken into account.
Partner retirement – which date is best?
Firms should reflect on which partners are likely to retire in the current tax year, 2026/27 and consider the benefits of flexing the retirement date to minimise the tax impact. Modelling the income levels will highlight the tax exposure and the timings of the tax liabilities. Each partner will be different as their personal situation will impact the result. See Retiring Partners briefing.
If you would like to discuss this further, please get in touch with your usual Crowe contact.
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