basis period reform

HMRC’s Basis Period Reform: understanding and calculating transition profits

admin

Transition profits (also called “transition part profits”) arise from the UK government’s Basis Period Reform, which changed how self-employed individuals and partners in partnerships calculate their taxable profits for Income Tax. Before the reform, businesses could base their taxable profits on accounting periods that didn’t align with the UK tax year (6 April to 5 April). The reform mandates that, from the 2024-25 tax year onward, all unincorporated businesses (sole traders and partnerships) must use a “tax year basis” for taxing profits—meaning profits are taxed based on what arises in the tax year itself, regardless of the accounting date.

The 2023-24 tax year was the “transitional year” where businesses with non-aligned accounting dates had an extended basis period (potentially longer than 12 months). This extension created “transition profits”: the extra profits in the extended period that wouldn’t have been taxed under the old rules. These profits are taxed separately over multiple years to spread the burden.

Eligibility

  • Applies to self-employed sole traders and partners in partnerships (including LLPs) who:
    • Started their business or joined the partnership before 6 April 2023.
    • Had an accounting year-end date not falling on or between 31 March and 5 April (i.e., not aligned with the tax year).
  • Does not apply if:
    • Your accounting date was already aligned.
    • You started business after 5 April 2023.
    • It’s non-trading income (e.g., property or investment income in partnerships).
  • For partnerships: Only trading or professional profits are affected. Each partner’s share is calculated individually based on the Partnership Statement from the partnership’s tax return (SA850). If you joined before 6 April 2022, you’re likely affected.

If you’re unsure, check HMRC Helpsheet HS222 (“How to calculate your taxable profits”) or use HMRC’s online transition profit calculator (not available for complex cases like multiple accounting periods or partnerships with non-trading income).

Step-by-Step Calculation of Transition Profits

Transition profits are calculated once in the 2023-24 tax year (the transitional year). You don’t recalculate them annually; you just spread the remaining amount. Use Working Sheet 3 from HS222 or the HMRC guidance for this.

  1. Identify the Basis Period for 2023-24:
    • The basis period runs from the day after your 2022-23 basis period ended until 5 April 2024 (or your accounting date in 2023-24 if it’s between 31 March and 4 April 2024).
    • Split into:
      • Standard part: The first 12 months (equivalent to a normal basis period).
      • Transition part: The remaining period after the standard part, up to 5 April 2024 (this creates the “extra” profits).
  2. Apportion Profits from Your Accounts:
    • Use your business accounts that overlap the standard and transition parts.
    • Apportion profits proportionally:
      • By days (recommended for accuracy): Profit in part = Total accounting period profit × (Days in part ÷ Total days in accounting period).
        • Include leap day (29 February 2024) if applicable.
      • By months or weeks: If days are impractical, but must be consistent.
    • Adjust for allowable expenses, capital allowances, and other tax adjustments (e.g., private use) as normal.
    • For partnerships: Use the partnership’s overall profits, then apply your profit-sharing ratio to get your share.
  3. Calculate Gross Transition Profits:
    • Sum the apportioned profits for the transition part.
    • Deduct any losses from the standard part (these offset the transition profits first).
  4. Deduct Overlap Relief:
    • Overlap relief is any previously “doubled-up” profits from earlier years (e.g., when you started business or changed accounting dates).
    • Deduct it fully from the transition profits (it can’t be carried forward beyond 2023-24).
    • If unknown, estimate provisionally and amend your return later.
    • Formula: Transition profits = (Apportioned transition part profits – Standard part losses) – Overlap relief.
    • If this results in a negative (loss), no transition profits arise, and the loss can be carried forward as usual.

Example Calculation (from HMRC Guidance)

  • Your accounting period: 1 October 2022 to 30 September 2023 (profit £45,000); 1 October 2023 to 30 September 2024 (profit £75,000).
  • Standard part: 1 October 2022 to 30 September 2023 = £45,000 (all from first accounts).
  • Transition part: 1 October 2023 to 5 April 2024 (188 days out of 366 in second accounts) = £75,000 × (188 ÷ 366) ≈ £38,525.
  • Assume overlap relief: £10,000.
  • No standard losses.
  • Transition profits = £38,525 – £10,000 = £28,525.
  • For a partnership: If your share is 50%, your transition profits = £14,262.50.

Another example (monthly apportionment):

  • Accounts: 1 January 2023 to 31 December 2023 (£50,000 profit); 1 January 2024 to 31 December 2024 (£15,000 profit).
  • Standard part: Full first accounts = £50,000.
  • Transition part: 1 January 2024 to 5 April 2024 (3/12 months) = £15,000 × (3 ÷ 12) = £3,750.
  • Overlap relief: £1,000.
  • Transition profits = £3,750 – £1,000 = £2,750.

Spreading Transition Profits for Taxation

  • Total transition profits are spread over 5 tax years (2023-24 to 2027-28) to avoid a large one-off tax bill.
  • Minimum in 2023-24: At least 20% of the total transition profits (after losses and overlap relief).
  • Remaining amount: Spread equally over the next 4 years (2024-25 to 2027-28), i.e., one-quarter of the remaining each year.
    • If no acceleration in 2023-24: 20% in 2023-24, then 20% of original each subsequent year (since remaining 80% ÷ 4 = 20%).
    • HMRC phrases it as “25% of the remaining transition profits” for 2024-25 onward, but this means one-quarter of the untaxed remainder at that point (ensuring equal spread).
  • If the business ceases before 2027-28, the full remaining amount is taxed in the cessation year.
  • For partnerships: Report your share in Box 16.3 (SA104F full pages) or equivalent. Do not include in Box 9 (basis period adjustment).
  • Losses: Brought-forward losses from earlier years can offset the spread amount each year (up to the spread for that year—Box 16.4 in SA104F). Current-year losses cannot offset transition profits.
  • Averaging (e.g., for farmers/artists): Transition profits are excluded from averaging claims.

Acceleration Options

  • You can elect to accelerate taxation of more than the minimum in any year (e.g., to use allowances or lower tax rates).
  • How: Enter the higher amount (e.g., standard spread + accelerated) in Box 16.3 (partnerships) or equivalent on your Self Assessment return. Provide full details (including accelerated amount) in the “Any other information” box (page TR 7).
  • This reduces the spread in future years proportionally.
  • No reversal once elected.
  • Mandatory acceleration if business ceases early.

For 2024-25 Specifically

  • This is the second year of spreading.
  • Enter 25% of the remaining untaxed transition profits (after 2023-24 amount) in Box 16.3 (SA104F) or calculate via HS222 Working Sheet.
  • If you accelerated in 2023-24, adjust the remaining downward.
  • Partnerships: Use the latest Partnership Statement; if multiple, adjust in Box 9 but exclude transition profits there.
  • If no transition profits were taxed in 2023-24 (e.g., due to losses), spread the full amount over 4 years at 25% each.

How Transition Profits Affect Your Overall Tax Calculation

From the Tax Calculation Summary (SA110 notes):

  • Transition profits are added to your non-savings income (e.g., Box A43 in the working sheet) as a separate charge.
  • To calculate the tax due on them:
    1. Run the full tax calculation worksheet (Sections 1-12) with the transition amount included in non-savings income (up to Box A240—total tax due).
    2. Run it again without the transition amount (get a second A240 figure).
    3. The difference between the two A240 figures is the tax due on the transition profits.
  • This ensures the tax is calculated at your marginal rate, after allowances and other income.
  • Copy to the relevant boxes on SA110 and add to your total tax liability.

Key Tips and Resources

  • Keep records of your calculation, spread amounts, and elections for future returns (amendable up to 12 months after filing).
  • Provisional figures: Allowed if disputing or estimating (e.g., overlap); mark on return and amend by 31 January 2027 for 2024-25.
  • Penalties: Inaccurate reporting can lead to penalties (30-100% of tax due).
  • Further help: HMRC Helpsheet HS222 (includes Working Sheets); HS227 for losses. Search gov.uk for “basis period reform” or use the online calculator. For partnerships, refer to SA104F/S notes and SA850 guidance.
  • If complex (e.g., multiple periods), consult a tax advisor—HMRC won’t calculate for you if you miss deadlines (paper by 31 Oct 2025; online by 31 Jan 2026 for 2024-25).