HMRC clarifies how to work out transition profit

HMRC has issued guidance on how to work out transition profit for the 2023 to 2024 tax year under basis period reform

The change in reporting for the self employed and partnerships comes into effect from April for 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.

Before working out transition profit, 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.

The overlap relief figure can be sourced through HMRC’s online tool with a three-week response time, unless the query is complex.

In addition, 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.

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

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.

For example, you prepare accounts to 31 December each year. The standard part runs from 1 January to 31 December 2023 and transition part runs from 1 January to 5 April 2024.

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

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

For example, if you have an accounting year end date of 31 December, you will report profit from both:

  • 1 January 2022 to 31 December 2023 for the standard part; and
  • 1 January 2024 to 5 April 2024 for the transition part.

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 also stressed that 2024 is a leap year so 29 February needs to be included when calculating the taxable profit.

In addition, ‘if you are a farmer or creative artist, transition profit should not be included when calculating your averaging adjustment’, HMRC said.

The guidance includes a number of examples of how to calculate the transition profit.

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.