Self employment and Partnerships – HMRC has clarified transition profit

Self employment and Partnerships – HMRC has clarified transition profit

HMRC have now issued guidance on how to work out ‘transition profit’ for the 2023 to 2024 tax year under basis period reform – but what does this actually mean?

This change in reporting for the self-employed and partnerships came into effect from April 2024 and only applies to those who do not follow the standard accounting year end between 31 March and 5 April.

Under basis period reform, HMRC is keen for accounts to be prepared to 31 March or 5 April year ends from 2024 onwards.

The first step is to work out the overlap relief if the accounting end date does not align with the tax year (accounting dates between 31 March and 5 April align with the tax year) or if it has been changed to align to the tax year, but the relief was not due.

The new rules also affect reporting if the accounting end date was changed during the 2023/24 tax year to align with the tax year.

To find out the ‘overlap relief figure’ you can use HMRC’s online tool, which has an estimated three-week response time!

From April 2024, HMRC will produce a calculator to work out the transition profit and any other figures required for the 2023-24 tax year.  Users will need to have their overlap relief amount to hand to use the tool.

These businesses will then be taxed in 2023 to 2024 on the profits of the ‘standard part’ and the ‘transition part’ of the basis period.

So how is this made up?

• The standard part is the 12-month period beginning immediately after the end of your basis period for tax year 2022 to 2023. This will normally have been your accounting period in 2022 to 2023.
• The transition part begins immediately after the end of the standard part. It ends on 5 April 2024, or on your accounting date in 2023 to 2024 if it is on or between 31 March and 4 April 2024.

As is often the case, this is made to sound more complicated than it is – as an example, if you usually prepare accounts to 31 December each year, then the standard part runs from 1 January to 31 December 2023 and then the transition part runs from 1 January to 5 April 2024.

Therefore, profits earned in each part of the basis period need to be reported. If the accounts match the part exactly, then the profit can be reported as normal.

If this is not the case, then the parts of the profit from multiple sets of accounts will have to be reported.

The normal method of apportioning profits is by looking at the number of days in each of the accounting periods in the parts of the basis period.

HMRC have therefore also noted that as 2024 is a leap year, 29 February needs to be included when calculating the taxable profit.

However, there are some anomalies, such as farmers and creative artists for which the rules apply differently.

The guidance issued by HMRC includes a number of examples of how to calculate the transition profit, and also advises the following;

• Transition profit after overlap relief will be spread over five years, starting with the tax year 2023/24 and ending with the tax year 2027/28.
• At least 20% of transition profit after overlap relief must be taxed in 2023/24.
• If a business ceases on or before 5 April 2027, any transition profit after overlap relief that has not yet been taxed must be taxed in the year the business stopped operating.

If you find yourself affected by this change and need assistance to complete your self-assessment or partnership returns, please get in touch with us here at Kennedys Accounting – we will be pleased to assist you.