What’s happening with the basis period reform?

Oct 19, 2021

In a recent announcement, the Government said Making Tax Digital for income tax self-assessment (MTD for ITSA) will be pushed back a year and begin from April 2024. 

The scheme is set to change the way accounting data is reported to HMRC and eventually spell the end of self-assessment tax returns for sole traders and partnerships – and just because  it has been pushed back a year, doesn’t mean you can forget about it. 

MTD for ITSA could mean a great expense for some businesses that need to implement new accounting software and a different way of reporting their accounting data.

But what does the deferral mean for the controversial plan to abolish basis periods, which could have happened as early as 2022?

We’ll do our best here to explain everything that led to the Government pushing back its reform to basis periods and what the future holds, avoiding all the jargon.

What are basis periods?

A basis period is the period of time a business pays tax on each year. It’s the period you record income and expenses for on your tax return, and for many businesses, it’s the 12-month period ending on 5 April or 31 March – in either case, close to or aligned with the tax year.

In certain situations, however, such as when businesses are during the early years of trading, basis periods can run differently to this, which sometimes means businesses are charged twice on their profits. 

Relief is available and is usually given on cessation of the business, which is its whole different process and one that some businesses don’t even know about.

Potential impact of the end of the basis period on businesses

HMRC believes the basis period system is overly complicated, and can lead to mistakes and lost profits for businesses that don’t fully grasp the implications of setting their accounting period differently to the tax year. 

That’s why it wanted to switch all unincorporated businesses to a tax year basis before the introduction of MTD for ITSA in 2023, which made 2022/23 the difficult transitional year.

Switching to the tax year basis means all businesses would be taxed on their trading profits arising within the tax year, which ends on 5 April. HMRC added it would consider 31 March to 4 April as the tax year-end. 

Had basis periods been abolished, not many businesses would have seen much practical difference in the way they handled their accounts, given the fact the majority of businesses already align their accounting period with the tax year.

For the 7% of sole traders and 33% of unincorporated business partnerships that don’t align their accounting period with the tax year, however, that wouldn’t have been the case.

Added to that was a further complication – for businesses with an accounting period ending on 31 March, a switch to a tax year basis would have suddenly brought forward the start of MTD for ITSA from 1 April 2024 to 6 April 2023.

Now that MTD for ITSA will not start until 2024, HMRC has also confirmed that if plans to revamp basis periods do go ahead, they will not happen until 2024/25 – making 2023/24 the transitional year.

Making Tax Digital timeline

Again, everything we’ve discussed about basis periods is subject to the Government’s consultation on the issue. 

The rest of the MTD roadmap is relatively straightforward:

  • April 2022 – all VAT-registered businesses will have to keep digital records and submit digital VAT returns via HMRC-approved software, regardless of their turnover.
  • April 2024 – all sole traders and landlords with profits of £10,000 a year or more will have to comply with MTD for ITSA rules.
  • April 2025 – general partnerships will be included in the MTD for ITSA scheme.
  • April 2024 – a voluntary pilot of MTD for corporation tax opens, which will be a precursor to the scheme that could start in 2026 at the earliest.

We went into each stage in great detail in a previous blog, but what you should be doing now is investing in compatible software.

HMRC said this will cost just £20 a year, but only 8% of businesses saw their MTD for VAT expenses stay at or below HMRC’s estimated cost of £43 a year, so plan ahead for greater costs.

Contacting an accountant to see how they are planning for MTD for ITSA is also highly recommended.

Get in touch with us to discuss how MTD for ITSA may affect your business.