Self-employed must report profits on tax year basis

Big changes are here for the self-employed! From 2024-25, profits must align with the tax year, replacing the old “current year basis.” Overlap relief is ending, and transition profits will be spread over five years. Here’s how the new system affects your tax bill.

The reform to the self-employed tax basis period has introduced significant changes in how trading income is allocated to tax years. Previously, the tax basis period operated on a “current year basis,” but the reform has now shifted to a “tax year basis.” As a result, all sole traders and partnership businesses are required to report their profits based on the tax year, commencing with the self-assessment return that was due by 31 January 2025. This return covered the tax year 2023-24.

Under the previous system, overlapping basis periods could occur, which resulted in certain profits being taxed twice. To counter this, businesses could claim ‘overlap relief,’ typically at the time of business cessation. The introduction of the “tax year basis” eliminates the possibility of overlapping basis periods, thereby preventing the generation of further overlap relief.

It is important to note that businesses which already prepare annual accounts to a date between 31 March and 5 April are not affected by these changes. These businesses continue to file their tax returns as they did under the old system, without any alteration.

The full implementation of the new rules takes effect in the current 2024-25 tax year, which ends on 5 April 2025. The 2023-24 tax year is considered a “transition year.” During this transitional period, the basis periods for all businesses will be aligned with the tax year, and any outstanding overlap relief can be utilised against profits for that period.

In cases where profits exceed the period covered by the overlap relief-specifically profits that span more than 12 months-these are referred to as “transition profit.” This transition profit will, by default, be spread across five tax years, from 2023-24 to 2027-28, to help ensure a smooth adjustment to the new rules.