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Basis period reform: change to transition profit rules

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Published: 01 Feb 2022 Update History

Proposed amendments to Schedule 1 of Finance Bill 2021/22 at report stage address concerns raised by ICAEW’s Tax Faculty and other parties.

The basis of taxation for sole traders and partnerships will change from 2024/25. Rather than taxing the profits of accounting periods ending in the tax year concerned, the profits arising in the tax year will be taxed (regardless of the accounting date).

In order to move from the basis period to the tax year basis, two income components will arise in the 2023/24 tax year:

  • The ‘standard part’ – the profit on the 12 months’ worth of trading beginning with the start of the basis period ending in the transitional year.
  • The ‘transition part’ – the profits in respect of the period beginning immediately after the end of the basis period and ending on 5 April 2024.

Specific rules are included in Finance Bill 2021/22 setting out how to determine the taxation of the transition part. Broadly speaking, the transition profits were to be treated as a separate one-off item of taxable income to be excluded from net income at Step 2 of the income tax calculation at s23, Income Tax Act 2007 (ITA 2007). The equivalent tax on that income would be brought into charge at Step 7.

That approach avoided the transition part being treated as part of net income, for the purposes of determining entitlement to personal allowances and the imposition of other tax charges, such as the high income child benefit charge.

However, the problem with that approach was that the tax on that income was not capable of being reduced by the items listed at s26, ITA 2007, such as double tax relief, enterprise investment scheme relief and other income tax reliefs. This issue was raised by ICAEW and other parties.

The proposed amendments will treat the tax on the transition part as an amount of tax calculated at Step 4 of the income tax calculation in s23. This then allows the reliefs referred to above to be deducted at Step 6. However, the transition part is still excluded at Step 2, so is not part of net income in 2023/24. The faculty welcomes the change.

Find out more about basis period reform in a webinar from the Tax Faculty that is available to all ICAEW members on 17 February. Book here.

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