Policy paper

Income Tax: basis period reform

Published 20 July 2021

Who is likely to be affected

The consultation will be of interest to self-employed traders, including individuals with a profession or vocation, partners in trading partnerships, other unincorporated entities with trading income, such as trading trusts and estates and non-resident companies with trading income charged to Income Tax. These groups are collectively referred to as ‘businesses’ in this document.

This proposal will mainly affect businesses which do not draw up annual accounts to 31 March or 5 April, and those that are in the early years of trade.

General description of the measure

This proposal changes the way trading income is allocated to tax years.

Generally, businesses draw up annual accounts to the same date each year, called their ‘accounting date’. Currently, a business’s profit or loss for a tax year is usually the profit or loss for the year up to the accounting date in the tax year, called the ‘basis period’. Specific rules determine the basis period in certain cases, including during the early years of trading. These rules can create overlapping basis periods, which charge tax on profits twice and generate corresponding ‘overlap relief’ which is usually given on cessation of the business. Overall, this basis of taxation is called the ‘current year basis’.

This proposal changes this to a ‘tax year basis’ with effect from 2023 to 2024, so that a business’s profit or loss for a tax year is the profit or loss arising in the tax year itself, regardless of its accounting date. This removes the basis period rules and prevents the creation of further overlap relief. On transition to the proposed tax year basis in the tax year 2022 to 2023, all businesses’ basis periods would be aligned to the tax year and all outstanding overlap relief given.

Policy objective

The overall objective of the proposal is to simplify the taxation of trading profits. This is in line with stakeholder requests to simplify this part of the tax system.

The current year basis requires a set of rules to cover all eventualities. After the transition year in 2022 to 2023, the tax year basis would require much simpler rules to cater for the taxation of businesses.

At present, 2 businesses that are identical except for their accounting date may have very different taxable profits for a tax year. The tax year basis would remove this difference, leading to fairer outcomes between businesses. Businesses with non-tax year basis periods currently experience double taxation in early years of trading, with relief generally given on cessation. Using the tax year basis would remove this distortion and lead to a closer relationship between the profits arising in a tax year and the tax liability related to them.

All other forms of income are taxed on a tax year basis for individuals, including property income, interest and dividends. This policy aligns trading income with these other forms of income. This could also help to align reporting requirements for different forms of income in Making Tax Digital (MTD). Introducing the tax year basis for trading income would bring the payment of tax closer to the time that profits are earned, making it easier for businesses to save for their tax obligations, improve compliance, and reduce tax debt write-off. Bringing the payment of tax closer to the time profits are earned would also make the Income Tax system more responsive, giving effect to changes in rates and rules sooner for self-employed people and allowing support to be better targeted.

Background to the measure

This proposal was put forward as an example of a possible simplification in ‘The tax administration framework: Supporting a 21st century tax system’ call for evidence published on 23 March 2021. This TIIN accompanies a consultation document on basis period reform and draft legislation outlining how a move to the tax year basis would be implemented.

Detailed proposal

Operative date

The proposal would first take effect in the tax year 2022 to 2023. This would be a transitional tax year, during which businesses that do not have a basis period aligned to the tax year would be brought into line with the tax year basis. In 2022 to 2023, all overlap relief brought forward would be used. The tax year basis would start in the tax year 2023 to 2024, after all businesses have transitioned.

Current law

The current law on the taxation of trading income, including basis periods, is in Part 2 Income Tax (Trading and Other Income) Act 2005 (ITTOIA). The law currently provides for tax to be charged on the profits of a trade (including a profession or vocation) of the tax year, and that the profits of the tax year are the profits of the basis period of the tax year.

The current law on basis periods is in Chapter 15 of Part 2. The general rule is that the basis period for a tax year is the period of 12 months ending with the accounting date in the tax year. There are then further rules to deal with early years, final years, changes of accounting date and relief of overlap profits.

Proposed revisions

This proposal would remove the references to basis periods and provide for the profits of a tax year to be the profits arising in that year, in the same way as property income.

The rules which currently require apportionment of profits to basis periods would instead require apportionment of profits to tax years. There would be deeming rules for businesses with accounting dates very close to 5 April to prevent these businesses having to apportion small amounts of profit.

This proposal would also introduce special rules for the transition year in 2022 to 2023. The basis period for the year would be the current year basis period plus a transition element, starting on the following day and ending on 5 April 2023. Any overlap profits either brought forward or generated, or both, would be relieved in full in 2022 to 2023 and not carried forward into the tax year basis.

For businesses with higher profits in 2022 to 2023 due to the change in basis, the government is considering an election to spread the additional profits over a period of up to 5 years. Details will be finalised following consultation.

Summary of impacts

Exchequer impact (£million)

2021 to 2022	2022 to 2023	2023 to 2024	2024 to 2025	2025 to 2026	2026 to 2027
Empty	Empty	Empty	Empty	Empty	Empty

The Exchequer impact will be estimated following consultation, final scope and design of the policy and will be subject to scrutiny by the Office for Budget Responsibility. The impact will be set out at a future fiscal event.

Economic impact

This proposal is not expected to have any significant macroeconomic impacts. 

Impact on individuals, households and families

This proposal is expected to have no impact on individuals as it only affects the self-employed and partners with trading income. There is expected to be no impact on family formation, stability or breakdown. 

Equalities impacts

Businesses that are expected to be affected by the proposal include farming, other seasonal businesses and large partnerships. Data is not available to determine any particular equalities impacts for those in groups sharing protected characteristics, but it is not anticipated that there will be any. Consultation will provide an opportunity to gain more detailed insight and this will allow for the equalities impacts to be subsequently revised.  

Impact on business including civil society organisations

This proposal is expected to have an impact on all self-employed traders and partners with trading income who do not currently draw up their accounts to 5 April or 31 March. It simplifies the method for allocating trading profit to specific tax years, removing the existing complex basis period rules and replacing them with a much simpler method, taxing profits arising during the tax year. This impact will be explored further as the proposals develop during consultation.

One-off costs would include familiarisation with the changes and could also include updating software and guidance to remove the current basis period rules.

Continuing costs could include the administrative burden of the cost of estimating profit figures for a small proportion (approximately 3% of sole traders and 15% of partners), and of submitting amended returns to provide final figures after the filing deadline.

The proposal would also bring forward tax calculations that would otherwise have happened at cessation or on a change of accounting date. For these calculations, associated administrative costs are assumed to be mostly brought forward from future years rather than being additional costs to businesses. 

Continuing savings could include all sole traders and trading partnerships no longer having to familiarise and apply the basis period rules, not having to notify HMRC on a change of accounting date, and not paying tax twice on the same profit without claiming corresponding relief. They would no longer have to inform HMRC of their basis period or calculate and record overlap relief carried forwards in Self-Assessment tax returns. Businesses would no longer risk failing to use their overlap relief if they mislay their records of it, which may date from many years previously.

Customer experience could see an improvement as completing Self-Assessment tax returns would be simpler. The consultation will provide an opportunity to test these assumptions with businesses. 

This proposal is not expected to have an impact on civil society organisations. 

Operational impact (£million) (HMRC or other)

HMRC would need to make changes to its IT systems to support safe and timely delivery of this policy. There is also likely to be impact on HMRC contact centres in supporting taxpayers adjust to this change. Additional policy resource is also expected to be required to support implementation over the scorecard period which would be covered as part of business as usual resourcing. Funding will be required to support safe delivery of this measure. Costs are anticipated to be between £15 million and £20 million to deliver this change.

Other impacts

Other impacts have been considered and none has been identified.   

Monitoring and evaluation

The proposal would be monitored through information collected from tax returns, and kept under review through communication with affected taxpayer groups.

Further advice

If you have any questions about this change, contact T Brown or D Shaw by email: businessprofits.admin@hmrc.gov.uk.