Basis period reform and the impact on farmers and land-based businesses
The ‘basis period’ is the starting point in calculating the taxable profits of a business each year for income tax purposes, and currently generally follows the 12-month accounting year ending in the tax year. For businesses with an accounting year-end between 31 March and 5 April, for simplicity, the accounting period is treated as aligning with the tax year.
For all types of businesses (whose profits are subject to income tax) that do not account to these dates, their accounting periods do not currently align with the tax year. It’s these businesses that the basis period reform will impact. In the future, for income tax purposes, the business profits will need to be matched to the tax year, regardless of the date to which the business prepares accounts. The aim is to simplify tax administration and to align all businesses that are subject to income tax with the tax year-end. This will in turn support the delivery of Making Tax Digital. The new tax year basis rules will start from the 2024-25 tax year, with a transitional year having started from 6 April 2023, meaning there’s still time to prepare and take the required action.
30 September year-end consequences, an example
Many businesses in the rural sector have year-ends that align more closely with the farming harvests (often 30 September). Basis period reform could therefore have a significant impact, as the shift to using a tax year basis will effectively accelerate six months’ worth of profits (although, as outlined below, the spreading rules mean that not all of these profits are automatically taxed in the transitional year).
Consequently, unless the accounting year-end is changed, the taxable profits will be derived by taking six months of profits from each of two sets of accounts for this business. This will require the accounts for the second year to be prepared before the January tax return filing deadline. For example, a 30 September 2025 set of accounts would be required before 31 January 2026. Otherwise, estimates and annual return amendments will be needed, which adds further administration and complexity to the process.
Overlap relief and transitional profit spreading
To assist in minimising the potential impact of transition to the new basis, businesses are able to deduct any existing overlap relief in the transitional year. This relief will have emerged from the double taxation of profits, most commonly in the early years of trading, if a business doesn’t have a year-end aligned with the tax year. See below for more on calculating the available overlap relief. In broad terms, where additional ‘transitional’ profits remain after overlap relief has been deducted, these are, by default, spread over five years, rather than having them all taxed in one year. If they were not spread in this way, tax could be payable at the higher, or even additional rate in that tax year (in cases where taxable profits exceed £150,000), when they would otherwise have been taxed at a lower rate.
"If it's favourable, a business can choose not to spread the profits at all or to accelerate the rate during the five years."
Additional considerations for farmers
It’s important to note that the transitional profits are ignored for the purposes of farmers’ averaging.
This means that the additional profit should be ignored both when considering whether averaging can be used, and in calculating the averaging adjustment. However, whilst this is ignored for the averaging rules, it could impact the rate of tax payable in that tax year.
Given the volatility of profits from farming, farmers may wish to accelerate some or all of the transitional profits to use lower tax rates and allowances in a year of low profits.
The interaction with capital allowances should also be considered (as part of a farmer’s overall tax planning), as the ongoing annual investment allowance (AIA) can help to reduce profits in a year where substantial plant and machinery purchases have been made. In this case, there’s likely to be a desire to accelerate profits, again, to utilise lower rate bands available rather than risking higher tax rates in later years.
Calculating available overlap relief
The calculation of overlap relief can be complex, particularly for those who were farming before the introduction of self-assessment in 1996-97, which created a special form of overlap relief. Whilst HM Revenue & Customs (HMRC) have indicated they hope to assist in providing this information, they may not be able to do so in all cases. We therefore recommend that time is taken now to consider the level of overlap relief that may be available, so that business owners have more clarity around the options available to them.
There’s no requirement for a business to change its accounting period. However, if this is not done, it will lead to complexities in the annual tax calculation. With the knowledge of the overlap relief available, farmers may wish to consider whether they would prefer to align their accounting period end with the 2022-23 tax year-end. This will make the calculation of taxable profits more straightforward and may be beneficial if they know they’ll have a significant new income source (such as that from a diversification project) in the next few years. It will, however, bring forward the charge to tax on additional profits, without the ability to spread those profits.
All business owners who are affected by the changes should consider their next steps whilst there’s still time to plan ahead. Every taxpayer will have differing circumstances, so we recommend you seek individual advice.
We have extensive experience in advising farmers and land-based businesses on the basis period reform.
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