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How to Work Out Your Transitional Profit if You’re Self-Employed

With the new tax year basis reforms coming into effect for the 2023 to 2024 tax year, the self-employed must understand these changes to ensure they get their transitional profits right. This blog is here to help. We’ll walk you through figuring out your transition profit, splitting your profits, deducting Overlap Relief, and understanding how much of your transitional profit will be taxed in the 2023 to 2024 tax year.

Understanding Transitional Profit

Transition profit comes from the Basis Period Reform, which changes how self-employed people report their income. Before, you might have reported your profits based on an accounting period that didn’t align with the tax year. 

This reform aims to make the whole process more straightforward. So, getting the transition period right is key for accurate tax reporting and making sure you comply with the new regulations. It might seem a bit daunting at first, but understanding these changes will make managing your taxes much simpler in the long run.

Standard Part vs. Transitional Part

Let’s break down the standard part and transitional part of your basis period so you can better understand how to handle them:

  • Standard Part: This is the 12-month period right after the end of your basis period for the 2022 to 2023 tax year. It usually lines up with your accounting period from 2022 to 2023.
  • Transitional Part: This begins right after the standard part and goes until the 5th of April 2024, or your accounting date in 2023 to 2024 if it’s between the 31st of March and the 4th of April 2024. For example, if your accounting year ends on the 31st of December your transition period would run from the 1st of January to the 5th of April 2024.

Deducting Overlap Relief

Overlap Relief is important for reducing your taxable transition profit. If you’ve previously reported profits for overlapping periods, you can deduct these amounts from your transition profit to lower your tax bill. This figure may have been reported on the first tax return you declared your self-employment/partnership profits, which may have been long in the past, so the best way to check the amount to provide to your accountant is to use the HMRC service

Spreading Your Transitional Profit

After deducting Overlap Relief, your transitional profit will be spread over five years, starting from the 2023 to 2024 tax year. This means in the first year (2023-24), you’ll need to include at least 20% of those transitional profits in your taxable income. You have the choice to include more if it suits your financial strategy. The rest will be spread evenly over the following four years. This gives you flexibility in managing how these profits affect your taxes over time.

It’s important to carefully consider the impact on your tax obligations for the 2023/2024 tax year. By spreading out the taxable amount over five years, you can potentially reduce the immediate tax burden while making sure you stay compliant with HMRC guidelines. 

If you opt to accelerate the recognition of transitional profits into an earlier tax year, you must make this election by the first anniversary of your normal Self Assessment filing date for that tax year. This strategic approach allows you to align your tax liabilities with your business’s financial circumstances more effectively.

Reporting on Your Tax Return

When filling out your Self Assessment tax return, you’ll need to include:

  • Your transitional profit
  • Your Overlap Relief
  • The amount of your transition profit after Overlap Relief that should be taxed in 2023 to 2024

If you decide to tax more than 20% in the first year, mention this amount and explain it in the ‘Any other information’ section.

Special Considerations

  • If your business ends before the 5th of April, 2027, any remaining transitional profits yet to be declared, after Overlap Relief, must be taxed in the year your business ceases.
  • Farmers and creative artists should remember that transition profit doesn’t count when calculating averaging adjustments.

Need Help?

Calculating your transition profit can be tricky, especially with needing to split profits accurately and deduct Overlap Relief. If you’re self-employed, use the HMRC transitional profit calculator for detailed help.

It’s a good idea to prepare your annual accounts to the 31st of March or the 5th of April to simplify future tax returns. Aligning your accounting period with the tax year removes the need for complex apportionment and makes tax reporting smoother. It will also reduce the complexity of your tax returns meaning you’ll be more likely to actually understand the figures you’re sending to HMRC.

By following these guidelines and using the available resources, you should be able to confidently handle the Basis Period Reform and ensure your tax return is accurate for the 2023 to 2024 tax year. Should you need any further guidance with the above, you can always get in touch with one of our in-house Tax advisors who are specialists on this subject.