Understanding the HMRC’s Basis Period Reform: Implications for Barristers
Introduction
HM Revenue and Customs (HMRC) has introduced a significant reform to the taxation of trading income, which could affect self-employed professionals, including barristers. This change, known as the ‘Basis Period Reform,’ aims to simplify the taxation process, making it more transparent and fairer. It’s a noteworthy departure from the previous ‘current year basis’ of taxation and adopts a new ‘tax year basis’ starting from the tax year 2024-25.
Understanding Basis Periods
A basis period is the time frame for which a self-employed person or partnership pays tax on their profits. Currently, the UK tax system operates on a ‘current year’ basis, meaning businesses are taxed on the profits of the 12 months ending in the tax year. This can lead to complex calculations, particularly for businesses that do not have a 5 April year-end.
Significance of the Basis Period Reform
The Basis Period Reform is a critical shift that affects self-employed traders, including barristers and other unincorporated entities with trading income. Primarily, the measure impacts businesses that draw up annual accounts on dates differing from 31 March or 5 April, which includes many barristers who operate as self-employed professionals.
Under the existing system, the basis period, or the period for which a business’s profit or loss is assessed for tax purposes, is usually the 12 months leading up to the business’s accounting date within the tax year. This system can create overlapping basis periods that might lead to double taxation and the accumulation of ‘overlap relief,’ usually given upon business cessation.
The Basis Period Reform replaces the ‘current year basis’ of taxation with the ‘tax year basis,’ meaning a business’s profit or loss for a tax year is the profit or loss arising in the tax year itself, irrespective of its accounting date. This change eliminates the basis period rules and precludes the creation of further overlap relief. On transition to the tax year basis in the tax year 2023-24, all businesses’ basis periods will align with the tax year, and all outstanding overlap relief will be given.
Implications of the Reform
The reform seeks to provide a simpler, fairer, and more transparent set of rules for allocating trading income to tax years. It removes the complexities associated with double taxation in the early years of trading and the need for maintaining records of overlap profits and relief, which are often lost and not fully utilised by taxpayers.
By using a tax year basis, businesses will experience a more explicit and transparent relationship between the profits arising in a tax year and their tax liability. This alignment of trading income with other forms of income, such as property income, interest, and dividends, will bring the payment of tax closer to the time that profits are earned, improving compliance, reducing tax debt write-off, and enabling more effective targeting of future support measures.
The Reform Process
The HMRC first proposed the Basis Period Reform in a call for evidence published on 23 March 2021. A formal consultation on the measure’s implementation was carried out between 20 July 2021 and 31 August 2021, with draft legislation also published for technical consultation during this period. The reform is confirmed take effect from the 2024-25 tax year, with a transition year in the 2023-24 tax year.
The transition to the tax year basis in the tax year 2023-24 will include special rules. The basis period for the year will be twelve months from the end of the basis period from 2022-23, plus a transition component running from the end of these 12 months to 5 April 2024. Any overlap profits brought forward and/or generated will be relieved in full in 2023-24 and not carried forward into the tax year basis. For barristers with higher profits in 2023-24 due to the change in basis, HMRC will automatically spread the transitional period additional earnings over a period of five years.
Impact on Different Year Ends
The impact of this change will vary depending on a business’s accounting date.
Businesses with a 5 April Year End
The transition will be straightforward for businesses already aligned with a 5 April year-end as their basis period already matches the tax year.
Businesses with a Non-5 April Year End
The transition will be more complex for barristers with a non-5 April year-end. They will need to apportion their profits to two tax years based on the number of days in each. This could result in a temporary increase in tax payments due to the acceleration of tax due.
Overlap Profits
Overlap profits occur when profits are taxed twice as a result of changing accounting dates. Under the current system, these overlap profits can be relieved on cessation of trade or on a further change of accounting date. However, with the proposed changes, these overlap profits will be relieved in the 2023 to 2024 tax year, which could result in a significant one-off tax bill for some businesses.
The extra profit is a consequence of the tax year not necessarily aligning with a business’s accounting year. It arises when a business starts trading, and the profit has been taxed twice because it falls into two basis periods. This typically happens when a business chooses an accounting year end that does not align with the tax year, which in the UK ends on 5th April.
When transitioning to the new tax system, there may be an additional portion of the profit that falls into the tax year due to the change in the basis period. This is the ‘extra profit’ referred to.
To illustrate, let’s take a business with an accounting period that ends on 30th April. Under the current system, the tax calculation for 2024/25 would be based solely on the profits for the year ending 30th April 2024. However, under the new system, the tax calculation for 2024/25 would be based on 1/12 of the profits for the year ending 30th April 2024 and 11/12 of the profits for the year ending 30th April 2025.
The ‘extra profit’ is the 11/12 of the profits for the year ending 30th April 2025, which is now being brought forward into the tax year 2024/25 due to the change in basis period rules. This additional profit is taxed earlier than it would have been under the current system. Hence it’s referred to as ‘extra profit’.
The transitional adjustment allows for this ‘extra profit’ to be spread over five years, reducing the immediate financial impact of the change in tax calculation. Furthermore, any ‘overlap profits’ from the start of the business will be relieved in full in the tax year 2023/24, further helping to mitigate the financial impact of the transition.
Examples
Barrister with a 30 April Year End
Consider a barrister who prepares his accounts up to the 30th of April each year. Under the current tax framework, his income tax calculations for the financial year 2024/25 would be entirely based on the profits he made for the year ending on 30th April 2024.
However, the reforms to the basis period rules will alter this calculation method. With these changes, his income tax calculations for the financial year 2024/25 would instead be derived from 1/12 of the profits for the year ending 30th April 2024 and 11/12 of the profits for the year ending 30th April 2025.
This modification in the tax calculation procedure could result in an acceleration of when the barrister’s professional income is taxed. However, a transitional adjustment provision within the reforms enables the additional profit resulting from this change to be distributed over a five-year period, beginning with the tax year 2023/24.
Furthermore, any profits overlapping from the past (typically from the inception of the barrister’s practice) will be fully relieved in the 2023/24 tax year. This relief could alleviate some of the potential financial impacts of the accelerated tax payments.
Barrister with a 31 December Year End
Consider a barrister who traditionally prepares her accounts up until the 31st of December each year. As it currently stands, her income tax calculations for the tax year 2024/25 would be fully derived from the profits of the year ending on 31st December 2024.
However, the incoming reform to the basis period rules will change this. Under the new system, her income tax calculations for the tax year 2024/25 will be based on a combination of profits from two different years. Specifically, she’ll be taxed on 9/12 of the profits for the year ending 31st December 2024 and 3/12 of the profits for the year ending 31st December 2025.
This shift in the tax calculation method could lead to a situation where her professional income is taxed sooner than it would be under the current system. However, a transitional adjustment included in the reforms will allow the extra profit created by this change to be spread over five years, starting with the 2023/24 tax year.
Furthermore, any ‘overlap profits’ that have been carried forward (usually from when she first started her practice) will be fully relieved in the tax year 2023/24. This provision could help mitigate the financial impact of the accelerated tax payments.
Transitioning to the New Tax Basis
The change in basis could result in higher profits for some businesses in 2023-24. To alleviate this burden, the government is legislating to automatically spread additional earnings over five years in this transitional period. Alternatively, barristers can elect out of this spreading and accelerate the charge, treating additional amounts as arising in the tax year.
The rules have been revised to reduce the impact of transition profits on allowances and benefits, alongside other changes. The intention is to make the transition as smooth as possible for affected businesses, including self-employed barristers.
Impact on Your Tax Payable
The basis period reform brings forward the time when tax on profits is due for payment, impacting your tax payable and cash flow. Barristers with a 30 April year-end will face a significant impact, as they will be subject to tax on both the usual full year’s profits and an additional one-fifth of 340 days of the following accounting year-end, less overlap profit. The remaining four-fifths of the profit will be payable over the next four years.
Considerations for Incorporation
One option to mitigate the impact of the basis period reform is to consider incorporating your barrister practice. Incorporation allows you to operate through a limited company, which is not subject to the basis period reform. You can continue using your current accounting year-end and benefit from other advantages associated with trading through a limited company.
Implications for Barristers
As self-employed professionals, barristers come under the purview of this reform. It simplifies the process of allocating barrister trading profits to specific tax years, replacing the complex basis period rules with a less complex method of taxing profits arising during the tax year.
While there may be one-off costs associated with familiarising themselves with the changes and potentially updating software and guidance, the long-term benefits for barristers include the simplification of the tax system and the removal of complexities associated with the previous basis period rules. However, barristers must plan for the transition year and the potential for higher taxable profits during that period. Those with accounting dates not aligned with the tax year may also need to consider moving their accounting dates to 31 March or 5 April to align with the new tax year basis.
Conclusion
The Basis Period Reform represents a significant change in the UK’s taxation system. Its implications for self-employed barristers and other professionals are substantial and will require careful planning and preparation. However, the reform aims to simplify the tax system, making it more transparent and fairer for all.
The transition year will be critical, and barristers are encouraged to seek advice and make necessary arrangements well in advance to ensure a smooth transition to the new tax basis.
Seeking Professional Advice
It is crucial to understand the full implications of the basis period reform and its impact on your specific circumstances. If your income fluctuates each month, it is advisable to consult with your accountant to determine the best course of action. They can help you evaluate whether changing your year-end or using the apportionment method would be advantageous. At Jack Ross Chartered Accountants, we offer a fixed consultancy review using your personal projections to determine the most beneficial outcome tailored to your needs. This comprehensive assessment is available for £500 + VAT.
Don’t Get Caught Unprepared
Don’t let this new reform catch you off guard. By reaching out to the expert accountants at Jack Ross Chartered Accountants, you’re taking the first step towards fully understanding and effectively managing the changes brought by the Basis Period Reform.
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There’s no better time than now to prepare for the changes. Ignorance can lead to penalties, higher tax bills, or missed opportunities. We’re here to guide you through every step of the process, providing you with detailed advice tailored to your unique circumstances.
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