Changes to the Basis of Assessment 

The way that profits of unincorporated businesses are taxed changed significantly in 2023/24 and will also change from 2024/25 onwards. This was originally intended to dovetail with the introduction of Making Tax Digital for Income Tax Self-Assessment (MTDITSA), which will now start to be phased in from 2026/27.

In this post we’ll look at what’s changed, and how it might impact your accounts as a sole trader.

Under the old basis of taxing profits, a sole trader or member of a partnership was taxed on their share of profits of the business’s accounting period ending in the tax year. For 2022/23, the last tax year when that basis applied, profits of year ended 31st December 2022 would have been taxed that tax year. Unless that business changes its accounting date, the profits assessed in 2024/25 would be the profits arising between 6th April 2024 and 5th April 2025 i.e. 9 months of the profits from year ended 31st December 2024 plus 3 months of the profits for year ended 31st December 2025. 

As the 2024/25 self-assessment tax return needs to be filed by 31st January 2026, it’s highly likely that the profits for the later period would need to be estimated and subsequently revised. As a result of this complication, many businesses decided to change their accounting year end to 31st March or 5th April so that it corresponds with the tax year.

The Transitional Year 2023/24

A further complication with the change in the basis of assessment is the calculation of profits in 2023/24, the ‘transitional year’, which seeks to transition from the old ‘current year’ basis to the new tax year basis. 

The rules in 2023/24, where the business has a year-end that doesn’t correspond with the tax year, seek to tax the profits from the day after the end of the period taxed in 2022/23 until 5th April 2024. 

A business preparing accounts to 31st December each year would have a 15 month period from 1st January 2023 to 5th April 2024 potentially taxable in 2023/24. However, the 3 months’ profits in the period 1st January 2024 to 5th April 2024, less any overlap relief, is not all taxed in 2023/24 but spread over 5 years, unless the taxpayer elects to be taxed on a higher amount.

If, in the above example, the sole trader makes profits of £120,000 in year ended 31st December 2024 then £30,000 less any overlap relief (typically from the early years when some profits were taxed twice) would be spread over 5 years. Assuming no overlap relief, an extra £6,000 profits would be added to the profits assessable from 2023/24 to 2027/28 unless the individual elects to be assessed on a higher amount, in which case the balance of the £30,000 would then be spread over the remaining years to 2027/28. 

This is not at all straightforward, so if you’re a sole trader, it’s definitely something to discuss in detail with your Accountant. We’ve been through this with all of our sole trade clients and, if you’re not a client, are happy to talk to you and explain how you can calculate the transitional profits and advise you of the best way to move forward. Get in touch if you’d like to chat to us.