Basis period reform

Businesses unable (or perhaps unwilling) to move their accounting period to 31 March or 5 April are in the new regime already. Tax year 2023/24 is the transition year. If you have an immovable year-end, say to 31 August, then the basis period for 2023/24 began on 1 September 2022.

Nothing seismic will be experienced yet, but profits that are earned now by such businesses are going to be governed and taxed according to the new rules.

We are not describing the new tax year basis of assessment here. Let’s take the rules as read. Instead, we will consider the present and near future and look at the issues that many practitioners will be confronted with.

Why not change?

There is an assumption in HMRC’s statements that most businesses who do not currently have a 31 March or 5 April year-end will move to do so now.

However, there are many who cannot (or will not) change for various reasons:

• They operate seasonally. The year-end might reflect the culmination of the year’s trading, which could be six months or more from the end of the tax year. If the accounts span more than one trading season, that could make performance difficult to interpret.
• Large law practices have a lot of strict regulatory requirements to comply with. This means that they would need longer than the 10 months currently available were they to draw up accounts to 31 March, ready to translate into tax returns by the following 31 January.
• A UK business within a large international practice may be prevented from moving to a 31 March year-end if the international accounting date differs (eg, 31 December).
• Larger partnerships may have detailed and complex profit-sharing arrangements that make full compliance to achieve a 31 January filing date difficult with a March year-end.

What are the key problems?

These are twofold:

• The practicalities of filing within statutory deadlines, in terms of assembling numbers, resourcing additional work, paying the right amounts of tax, and communicating to end users (ie, individual and corporate partners).
• Accepting that estimates/provisional figures are needed, how – bluntly – does one get to them to satisfy tax law?

Let’s take a look at 2024/25, within the new tax year basis rules for a UK LLP within a large international firm with a 31 August accounting period end.

• The 2024/25 tax returns must be filed by 31 January 2026.
• The assessable profit will be based on 5/12 of the profit to 31 August 2024 and 7/12 of the profit to 31 August 2025.
• The timetable for completing the work on the computations cannot be compressed materially. Come 31 January 2026, the figures for the year to 31 August 2025 needed in the apportionment are unlikely to be available in final form.
• A good estimate may be available of the taxable profit. Profit-sharing arrangements for the latter year will not have been agreed for all the partners, of which there could potentially be hundreds.

The results? Estimates; provisional figures; lack of certainty; partner tax underpayments and repayments; considerable extra work; administrative burdens; and catch-up payments – all part of the new system.

There is no cure for this – these are the rules. An April 2022 ‘provisional figures’ paper shared with stakeholders offered potential easements. In summary these were:

1. Amending the provisional figures for a tax return at the same time as and by the deadline for filing the following tax return. When submitting the second year’s return you ‘true-up’ the figures from the earlier year and make required adjustments. In the example above you would have until 31 January 2027 to finalise 2024/25.
2. Allowing an extension of the original filing deadline. In theory this then removes the need for provisional figures. The paper leaves open the possibility that the extension might be dependent on the nature of the business or the date of its accounting-period end.
3. Allowing adjustments or a true-up as part of the following year’s tax return, thereby avoiding the need for adjustments to correct provisional figures.
4. Or: keep the current rules. This is the same as point 1 above but businesses must submit amendments as soon as updated figures are available, and not rely on an effective filing extension to the following 31 January.

The paper also covered other potential solutions as an aside, comprising:

1. Corporation tax-style filing, so that filing is based on the accounting date of the business, not fixed at 31 January following the end of the tax year.
2. For partnerships, a suggestion to allow ‘partnership-level’ reporting, so that the partnership effectively becomes the taxpayer and adjustments automatically flow through to the individual partner returns.
3. A ‘safe harbour’ approach, which effectively allows adjustments in the latter year, as relatively small differences would be allowed in the following year or not require adjustment at all if the difference was within some acceptable threshold (5% is mentioned).

The paper is reasonably clear on which alternatives HMRC does not prefer. For example, it warns that option 3 might become a source of tax leakage with businesses planning to delay tax into a later year, or else it points to the complexity of excessively altering primary legislation in options 2 and 3, and in a, b and c, which may take a long time to fully bed in.

At the time of writing, we are still awaiting confirmation of HMRC’s chosen option – in discussions it seemed to lean towards option 1.

Does option 1 help? It gives certainty. We know what we must do to adapt. It is relatively simple to effect the change as it’s only an extension of current practice.

What does it not solve?

Some of these are easily stated:

• Overlap relief must be used in the 2023/24 transition year. Taxpayers may have been planning how best to use this in the run-up to retirement. Now they have no choice – it must be used in 2023/24. It is normal to factor in the crystallisation of overlap relief at the point of retirement. This coincides with a point that they can withdraw capital from a partnership or take pension benefits. Without these, tax will be payable without the incoming cash flow. This could be penal and needs careful (and different) planning.
• There is an assumption that there is perfect information about overlap profit figures. Many self-employed taxpayers will be entitled to overlap relief but may not have been bringing it forward on tax returns (it could go back 25 years). It is important now to check that the information is available. If not, contact HMRC to see if it can assist from records.
• It is essential to look at any tax provisioning models now to get through transition to the new basis to anticipate any funding traps and shortfalls. The transition year and the profit ‘spike’, with or without spreading, is going to skew many results relative to what has been planned. It could ‘artificially’ inflate income both for pension annual allowance and lifetime allowance purposes and is something not to be ignored up to April 2024.
• Such distortions could affect plans even without retirement in mind, with income tipping into the 40/45% rates not hitherto experienced, or with income being pushed into the marginal rate applying after £100,000 when personal allowance is tapered. The taxpayer may need to prepare for higher liabilities caused by this acceleration of the assessable profits (even with overlap). It is important to think about matters now and look ahead to see where these shocks might occur and to consider the funding of the ‘spike’. This is an acceleration of assessment rather than additional tax per se, but it may result in the latter for the reasons above. Within the spreading provision there is the facility to bring in any of the transition profit before the spreading period is up. It is additional work, but could be crucial to a business’s health in volatile economic circumstances.
• Whichever easement option is adopted by HMRC (if any), there is no getting away from the administrative burden of complying with a system that builds in the need to make estimates and provide provisional figures.

Does estimating create new issues?

Yes, and further consultation may be needed in this area. One of the main difficulties for large partnerships is profit-sharing arrangements. None of the options really addresses this.

For example, the large partnership with a 31 August year-end may arrive at an accurate estimate of the overall assessable sum for 2025/26 before 31 January 2027.

However, the division of the profit where there are typically large discretionary elements in deciding the split would not be ascertained until after January 2027 – perhaps as late as April.

While the overall amount to be assessed might be known, there could be widely divergent individual differences for partners between the earlier and later year. Partner X might have a profit share of £200,000 in the earlier year. A reasonable view for the provisional amount/estimate for the following year to meet the January 2027 deadline would be to use that as a base. However, in the profit-sharing discussions, their profit share in the latter year is upped to £1m.

Conversely Partner Y in the same process may see profit share reduced by the same amount.

Although the partnership profit as reported could theoretically be 100% accurate, in practice there will be swings in individual tax liabilities.

This could create rich enquiry pickings for HMRC. It creates interest charges even though overall, in the end the correct amount of tax will have been paid.

The rate of interest paid by HMRC on tax overpaid is base rate minus one percentage point whereas the rate for tax underpaid is base rate plus 2.5 percentage points. So there is always a differential of 3.5 points even when the right amount of income has been assessed overall and all tax has been paid on time.

HMRC has indicated that if the approach is disclosed and it deems it ‘reasonable’, the risk of enquiry will be minimised or even extinguished. HMRC’s Business Income Manual may well be amended to record this. There does not appear to be a solution to the interest issue. This is likely to represent an additional charge to the partnership.

At the end of the exercise…?

We wait to see which easement route is adopted. The assumption at the time of writing is that option 1 is preferred as HMRC views this as the least disruptive. It is of course possible that no easement will be offered so that we just ‘have to get on with it’.

However, it is still a resource challenge – particularly if the partnership is itself an accountancy business dealing with clients who have altered year-ends or need guiding through transition and beyond – creating additional work for possibly no commensurate reward

Editor's note: On Friday 2 December, HMRC confirmed that it will take forward the option that would allow businesses to amend provisional figures within the normal time limits for amendments (ie, option 1). This will effectively allow businesses and agents to amend provisional figures at the same time as the business’s following tax return.

About the author

Simon Girling, Senior Tax Manager, Mazars