Income tax: Basis Period Reform and the agriculture sector

We’re now midway through the 2023/24 tax return cycle with submission of online returns due by 31 January 2025. One change, which is affecting large numbers of our farming clients for the 2023/24 tax year, is Basis Period Reform. This changes the way in which partnerships and self-employed individuals are taxed under self-assessment. It will affect those who had an accounting year-end that didn’t align with the tax year of 5 April or 31 March in 2022/23.

What were the rules?

Under the previous rules, partnerships or sole traders could choose whichever date they liked to draw up their annual accounts. That accounting year-end date determined in which tax year those profits were assessed for tax. For example, an accounting year-end of 30 June 2022 would have been taxed in the tax year ended 5 April 2023, since it fell within that tax year. An accounting year-end of 31 March 2023 is aligned with the tax year-end, and so would also have been taxed in the tax year ended 5 April 2023.

When a partner joined a partnership, they were subject to what were known as the ‘opening year rules’ for tax purposes. During these early years the partner would be taxed on profits twice. For example, if a partnership had a 30 September year-end, this is six months after the end of the tax year. As a result, the incoming partner would end up paying tax on six months' worth of profits twice. These twice taxed profits are known as ‘overlap profits.’

However, over the course of their time in the partnership, an individual will only ever pay tax on profits once, since those overlap profits are relieved (deducted from profits) when the partnership's financial year is brought in line with the tax year or when the partner retires.

Each partner’s overlap profits will differ, as they are based on the partner's share of profits during their initial years in the partnership.

What has changed from 2023/24?

From 2023/24 everyone will pay tax on 12 months of profits to the end of the tax year – to 31 March/5 April.

This means that any partners whose accounting year doesn’t end 31 March/5 April will be able to deduct their overlap profits in the transitional tax year, 2023/24.

It doesn’t mean that businesses have to change their accounting year-end date. However, if they continue to keep, for example, a 30 June year-end, then their tax return will take three months of profit from one set of accounts and nine months from the next set of accounts, so that they are assessed on a tax-year basis. 

What does this mean for my tax bill?

Overlap profits were created when an individual joined the practice or when self-assessment was introduced in 1995/96. Overlap profits aren’t uplifted for inflation so they’re unlikely to represent current profit levels, i.e. six months of profits when you joined the partnership may be less than your current six months of profits – especially if you joined a partnership on a first share/profit share arrangement which was lower than your current first share/profit share arrangement.   

This means that, once you've switched to this new tax basis, you'll be paying some tax earlier than you would have under the previous system, which would normally only be due when you left the partnership.

HMRC recognise that you could pay significantly more tax as a result of the adjustments in the 2023/24 transition period, therefore, you’ll be able to spread the excess profit over five years to help cash flow.

The five-year spreading of additional profits is only available in 2023/24.

However, there will certainly be some other problem areas to consider.

1. If you choose not to align your accounting year with the tax year, you may need to complete your accounts earlier so that your tax returns can be filed on time. Or estimated figures may need to be used and subsequently revised.
2. Calculating estimated profits will be challenging. Farming profits are heavily impacted by stock and fixed asset changes. There are going to be a lot of ‘unknowns’ which will make estimating profits hard to get right. It’s likely that revised tax returns will need to be filed.
3. Due to advancement of profits, you might have less time to consider partnership shares which will make tax planning for a typical partnership harder than before.
4. The five-year spreading could affect your tax rate band for the following five years i.e. loss of personal allowance, putting you into a higher tax band. This will have a significant impact on farmers’ averaging calculations as they could become more complex and possibly not as beneficial.
5. If you’re making pension contributions to extend your basic rate band, you may need to reconsider your approach. This is especially important when business profits are being proportioned, to make sure the contributions have the intended tax benefits.
6. Cash flow could be a concern if businesses have to pay extra tax due to the advancement of tax in the transitional year.

Need help?

If you have any concerns regarding the information discussed in this article, or have any other questions, please get in touch with your usual Larking Gowen contact or look for contact details in the Our People section of the our website. Alternatively, call 0330 024 0888 or email enquiry@larking-gowen.co.uk.

Laura Clayton