We now know more about how the transition to the tax year basis will work in practice, and it means making some difficult calculations for the tax year 2023/24.
The basis period for 2023/24 will be defined as starting immediately after the end of the basis period for 2022/23, and ending on 5 April 2024, without exception. However, this long basis period is then divided into two notionally separate basis periods:
A. Standard period: the first 12 months (ie the accounting period currently used)
B. Transitional period: rest of the basis period to 5 April 2024.
These two basis periods: A and B, are then dealt with separately.
To avoid distortions to total net income due to the long period, and potentially loss of allowances, or imposition of HICBC, only the profits from period A are considered for the allowance withdrawal or variable tax charges.
The profits for period B are calculated after deduction of any overlap relief which arose at the start of the business, or on a previous change of accounting period. These period B profits are also ignored for farmers and creative artist averaging, which would otherwise distort the averaging of profits from 2022/23.
If the net result of period B is a loss, this loss is treated as a terminal loss for a period to 5 April 2024, so it can be carried back up to three years.
Any profits calculated from period B are automatically spread equally over five years: 2023/24 to 2028/29, with 20% of the amount treated as arising in each of those years. The taxpayer can opt out of this automatic spreading of profits.
If the trade ceases before 2028/29 all the remaining profits from period B are taxed in the year of cessation.
The total taxable profits for 2023/24 are the sum of those from Period A (as reduced by personal allowances) plus 20% of profits from period B, if the opt-out of spreading has not been activated.
Example
Muriel’s wedding planning business has an accounting period ending on 30 September, as that’s when her season ends. She has overlap profits of £1,000 and makes the following profits:
- Year to 30 September 2023: £50,000
- 1 October 2023 to 5 April 2024: £6,000 (includes Easter 2024)
Her transitional year profits are calculated as:
- Period A: £50,000
- Period B: £5,000 (after deduction of overlap relief)
Muriel is assessed to income tax on £51,000 for 2023/24 (50,000 + 5000/5), with an additional £1,000 added to the profits of each of the years: 2024/25 to 2028/29.
Even with this spreading of the transitional profits from period B over five years, Muriel is pushed into the higher rate tax band for 2023/24 (threshold frozen at £50,270 until 6 April 2026).
From 6 April 2024 Muriel is required to report her income and expenditure on a tax year basis under MTD ITSA. This is effectively a forced change of accounting date.
Written by The Tax Advice Network