Basis Period reform – Ceasing trade during the transition period

As many will now know, sole traders and partnerships, including Limited Liability Partnerships (LLPs) are going to be affected by tax changes that are going to be taking place by way of a reform to the existing basis period method of taxation. At the time of writing, it is expected that the reforms will be fully effective from the 24/25 tax year, with 23/24 being a transition year.

These changes will affect all sole traders, unincorporated partnerships and LLPs who currently do not prepare their annual accounts to a reference date ending between 31 March and 5 April.

But what will happen if you cease to trade during the transition period?

The 2023/24 transition year

2023/24 will be the key tax year when it comes to the new rules, as this will be the year of transition.

Individuals will be taxed on a long period of account ending 5 April 2024. This period will pick up all untaxed accounting profits generated up to this date.

Relief will be given for any overlap profits generated under the current basis period rules.

Transitional profit spreading

There are rules that allow the payment of the tax liability generated from transitional period profits to be spread over five tax years, beginning with the year of transition.

This should ease cash flow, by ensuring the extra tax due on these profits is not paid entirely in the 2023/24 tax year.

Example

Under the current rules, the taxable profits for the 2023/24 tax year would be £100,000 but the changes see taxable profits of £130,000 for 2023/24.

This is a significant impact on cash flow.

The excess profits of £30,000 can therefore be spread across five tax years, with an additional £6,000 taxable over the five years from 2023/24 to 2027/28.

What happens if you cease trading during the spreading period

If a business ceases to trade, or a partner retires during this period any transitional profits not already taxed will be included in full in the tax year of cessation.

Next steps

You should consider whether changing your business’ accounting year-end to 31 March or 6 April is beneficial.

Unless there is a significant commercial driver to maintain a different year-end, it’s likely that most businesses will choose to align their year-end with the tax year.

Maintaining a different year-end will see an increase in accountancy fees, as financial accounts will need to be prepared alongside estimated figures up to 31 March or 5 April.

You should review your future tax liabilities, and when and how these will become payable.

While this means that excess profits cannot be spread over five years, if profits exceed £125,000, an additional £25,000 will fall to be taxed at 45% – as opposed to 40% in the 2023/24 tax year – due to the reduction in the additional rate band.

The cash flow impacts on your business clearly need to be factored in.

You now have the opportunity to plan any change to your accounting year-end that may reduce the administrative burden that these new rules may create.