Wondering how HMRC basis periods work? And the impact of the proposed basis period reform being put forward by HMRC? Then read on. Here, you’ll find out what a basis period is, why they matter for sole trader taxes. Plus, I’ll explain all about the proposed changes being put forward as part of making tax digital.
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Friendly Disclaimer: Whilst I am an accountant, I’m not your accountant. The information in this article is legally correct but it is for guidance and information purposes only. Everyone’s situation is different and unique so you’ll need to use your own best judgement when applying the advice that I give to your situation. If you are unsure or have a question be sure to contact a qualified professional because mistakes can result in penalties.
1. What is a HMRC Basis Period?
HMRC created basis periods to ensure that all self-employed individuals are taxed across the same 12 month period. This stops one sole trader from including numbers on their self-assessment tax return that may be more advantageous in reducing their tax bill more than another sole trader. This is particularly so during the first 3 years of trading.
To keep the tax system fair for everyone who is registered as self-employed, HMRC essentially assesses everyone for tax based on tax year. This means that if a sole trader chooses to draw up their income and expenditure for the accounting period that matches the tax year, then basis periods won’t apply.
For the purposes of self-employment taxes, the 5th April and 31 March both equate to be the end of the tax year.
2. Examples of HMRC Basis Periods
2.1 Choosing Basis Period That Matches the Tax Year
Penny becomes self-employed on 1 June 2019, choosing an accounting end date of 5 April each year. When she fills in her tax return she’ll need to report her income and expenses for the next 3 years for the following time periods:
| Tax Year | Accounting Period |
| 2019/2020 | 1 June 2019 to 5 April 2020 |
| 2020/2021 | 6 April 2020 to 5 April 2021 |
| 2021/2022 | 6 April 2021 to 5 April 2022 |
Since Penny set up her business partway through the 2019/2020 tax year, she’ll need to report her income and expenses for less than 12 months on her first self-assessment tax return. However, subsequent returns will show 12 months figures.
2.2 Choosing Basis Period That Does Not Match the Tax Year
Eddie starts a business on 1 June 2019, choosing an accounting end date of 31 May each year. He’ll need to report his income and expenses for the next 3 years for the following time periods:
| Tax Year | Accounting Period |
| 2019/2020 | 1 June 2019 to 5 April 2020 |
| 2020/2021 | 1 June 2019 to 31 May 2020 |
| 2021/2022 | 1 June 2020 to 31 May 2021 |
After the two years of tax returns, Eddie’s basis period becomes the 12-month period chosen for his accounts – 31 May. But, he has declared and paid tax on profits from 1 June 2019 to 5 April 2020. These are what are known as overlap profits. Although Eddie will get relief for this tax by changing accounting periods or stopping self-employment, he’ll need to pay the tax upfront and wait for a rebate.
3. Basis Period Reform
As part of making tax digital and a desire by HMRC to simplify the tax system, proposals are being discussed that will effectively end basis periods.
93% of sole traders choose to use an accounting period that ends 5th April or 31 March. Therefore, they are unaffected by basis periods. That means only a small remaining percentage of the self-employed are impacted by basis periods but it’s felt that the remaining 7%:
- Confused by the concept of basis periods so don’t use it on their tax returns;
- Forget about claiming overlap relief on when they stop self-employment so lose out on their tax relief.
To simplify things and allow sole trader businesses to pick accounting periods that may work better for them for commercial reasons, HMRC is currently undertaking a consultation to decide whether it is better to abolish basis periods and instead let them pro-rata figures for tax returns. This would be similar to Limited Company tax returns.
Example:
A business draws up accounts to 31 July. Under the proposed reforms, in the tax return for 2023/2024 the sole trader would be able to include 4/12 of the income for the year ended 31 July 2023. Plus, 8/12 of the income for the year ended 31 July 2024.
Under the current income tax rules, self-employment tax payable would be based on business profits for the full year to 31 July 2023.
The proposed changes, if agreed, would come into effect on 6 April 2023.
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