Self-employed individuals, including those in a trading partnership, will all pay tax on profits at the same time, under the UK government’s new basis period reform rules, which are set to take effect from the 2025 tax year. The move is an attempt to simplify the self-employed income tax payment process where some traders pay tax later due to the end date of their accounting period. The basis period reform follows a consultation and draft legislation issued in 2022.
At present, individuals operating on a self-employed basis don’t have to pay tax on profits in the tax year if their accounting end date isn’t 5th April or 31st March. By changing the basis period tax date, everyone will pay tax based on the tax year. Other income streams, such as income from property and dividends, are already taxed in this way. HMRC aims to simplify the process and create a simpler, fairer, and more transparent set of rules for the allocation of trading income to tax years.
The changes to self-employed income tax are to be brought in for the year 2025, making the tax year 2023-2024 the transitional period. In this year, there could potentially be tax on 23 months of profit, if your year-end is 30th April. You will receive overlap relief at this point. However, there won’t be any future overlap relief for any self-employed business. It’s worth noting that the basis period reform for self-employed income tax isn’t expected to affect many people working for themselves. HMRC itself reckons that around 93% of sole traders and up to 67% of individuals in partnerships already file tax in line with the new reform.
It’s important to note that clients who already have an accounting period aligned to the tax year will not be affected by these changes. From 6th April 2024, self-employed profits will be taxed in the tax year in which they arise. Currently, clients who are self-employed or are in a partnership will be taxed on profits made in the accounting period ending in the tax year.
Choosing a date that ends early in the tax year is popular as it allows businesses a longer period before the tax bill has to be settled. So, the tax on profits for the business year ending 30th April 2022 does not have to be settled until 31st January 2024. From a pension perspective, it also means that profits are known well in advance of the tax year end and, therefore, easier to gauge the level of contribution.
This means that where the accounting period is not re-aligned to the tax year and the business year end is unchanged, profits will be proportionately applied to the tax year in which they accrued. For example, if Tony’s accounting period runs from 1st June – 31st May each year, his tax bill for the 2024/25 tax year will be based on 2/12ths of the profits from the accounting period ending 31st May 2024, and 10/12ths of the profits from the accounting period ending 31st May 2025. As a consequence, UK relevant earnings for pension purposes may not be known until after the tax year-end, and pension contributions will be based on estimated profits.
In the transitional year 2023/24 self-employed individuals will be taxed on the profits for the accounting period ending in that tax year in the normal way but, in addition to this, they will also pay tax on the balance of profits accruing up to the 5th April 2024.
Transitional profits will boost UK relevant earnings in the year/years they are assessed to tax. This might be good news for those looking to maximise pension funding. An earnings spike might be an opportunity to make a larger pension contribution without too much concern over tapering issues.
In summary, the self-employed basis period reform will have implications for pension funding for some self-employed individuals. The changes will align self-employed profits with the tax year, meaning some clients may experience higher pensionable income during the transitional year 2023/24. This can present an opportunity to maximise pension funding and potentially reduce tax bills through carry forward of unused annual allowance. To ensure you are making the most of the changes, it’s important to speak with a financial adviser who can help guide you through the complex pension rules and regulations. Professional advice can help you make informed decisions on your pension contributions and take advantage of any opportunities presented by these reforms.
