As part of the move to Making Tax Digital for Income Tax Self-Assessment (MTD for ITSA), the basis period rules are being reformed. Despite the delay to the MTD for ITSA start date – which will now take effect from April 2026 rather than April 2024 – the reform of the basis period rules is to go ahead as planned.

Nature of the reform

Under the reform, sole traders and unincorporated businesses will, from 2024/25 onwards, be taxed on the profits of the tax year (the tax year basis) rather than, as now, on the profits for the accounting period ending in the tax year (the current year basis). If profits are prepared to a date other than 5 April or 31 March (which is deemed to be equivalent to 5 April), the profits from two accounting periods will need to be apportioned to correspond to the tax year. Accounting dates falling between 1 and 4 April are also treated as being equivalent to the tax year.

To enable traders to move from the current year basis to the tax year basis, 2023/24 is a transitional year.

Making the transition

Where an unincorporated business does not prepare accounts to 31 March or 5 April (or a date in between), the profits assessed in 2023/24 will cover more than a single accounting period.

The basis period for a continuing trade (i.e. one which commenced before 2023/24 and did not cease in 2023/24) starts on the day after the end of the basis period for 2022/23 and ends on 5 April 2024.

The basis period comprises up to three elements:

• the standard part;
• the transition part; and
• days following a late accounting date.

Not all parts will be applicable in all cases.

In addition, relief will be given in 2023/24 for any overlap profits arising on commencement or a change in accounting date which have not yet been relieved.

The standard part is the first 12 months of the basis period. This period starts the day after the end of the basis period for 2022/23. This will usually be the 12 months to the accounting date ending in 2023/24.

If the standard part ends before 31 March 2024 (as will be the case if the accounting date does not fall in the period from 31 March to 5 April), the basis period for 2023/24 will include a transition part as well as the standard part. If it ends on or after 31 March 2024 but before 5 April 2024, the trader is taxed on profits to the accounting date (referred to as a late accounting date); there is no need to calculate the transition element. However, an election can be made to disapply this rule and for the profits for the period from the late accounting date to 5 April 2024 to be taxed in 2023/24.

The transition part is the period that begins immediately after the standard part and ends on either:

• 5 April 2024; or
• the late accounting date.

If the trader has overlap profits which were taxed twice either on commencement or on a previous change of accounting date, these are relieved in calculating the profits assessed in 2023/24.

Example

A trader prepares accounts to 30 June. The basis period for 2022/23 on the current year basis is the year to 30 June 2022. In the 2023/24 transitional year, the standard part is the period from 1 July 2022 to 30 June 2023 and the transition part is the period from 1 July 2023 to 5 April 2024.

Spreading

Unless the accounting period matches the tax year, more than 12 months’ worth of profits will be assessed in the 2023/24 transitional year. To prevent the trader suffering an unusually high tax bill for 2023/24, the profits for the transition part, less any overlap relief, are spread over five tax years.

The effect of this is that 20% of this amount is assessed in 2023/24 in addition to the standard part, and 20% is added to the profits assessed on the tax year basis in each of the tax years 2024/25, 2025/26, 2026/27 and 2027/28. The trader will have higher tax bills in each of those years.

Where beneficial, the trader can elect for some or all of the spread profits to be taxed in an earlier year. This may be the case where the trader’s marginal rate is lower in an earlier year.

Change of accounting date

To prevent the need to apportion profits from more than one accounting period to arrive at the profits for the tax year, consideration could be given to changing the accounting date to 31 March or 5 April.

For a brief period it seemed that the days were numbered for the additional rate of tax following the announcement in the ill-fated mini Budget that it was to be scrapped. Like much of the mini Budget, its planned abolition was swiftly reversed. However, this was not the end of the additional rate tax saga; the Autumn Statement delivered a further plot twist with the announcement that the additional rate threshold is to fall to £125,140 from 6 April 2023.

Why £125,140?

The new threshold is the point at which the personal allowance is completely lost. The personal allowance (which is frozen at its current level of £12,570 until April 2028) is reduced by £1 for every £2 by which income exceeds £100,000.

The combination of the abatement of the allowance and the 40% tax rate that applies at this level means the marginal rate of tax in this band (£100,000 to £125,140) is 60%. Lowering the additional rate threshold to below £125,140 would raise the marginal rate of tax in the abatement zone above 60%.

Additional rate tax landscape

Until 5 April 2023, the additional rate threshold remains at £150,000. This creates the slightly anomalous effect that the marginal rate on income between £100,000 and £125,140 is 60%. Once the personal allowance has been lost, the marginal rate drops to 40% on income between £125,140 and £150,000, rising to 45% on income in excess of £150,000.

From 6 April 2023, this second 40% band will be lost – the new additional rate threshold will mean that income is taxed at 45% once the personal allowance has been fully abated.

Where the income in question is dividend income, it is taxed at 33.75% where it falls in the higher rate band and at 39.35% where it falls in the additional rate band. In the personal allowance abatement zone, the marginal rate is 50.6%.

Planning opportunities

The new lower additional rate threshold does not come into effect until 6 April 2023. This may provide the opportunity to advance income so that it is taxed at the higher rate in 2022/23 rather than at the additional rate in 2023/24. However, care must be taken not to move income from the additional rate band to the personal allowance abatement zone where the marginal rate is higher.

Case study

Tim is the director of T limited. He has income of £130,000 a year. He was planning on paying a dividend of £20,000 in May 2023. If he does so, the dividend will be taxed at the additional rate of 39.35%, meaning Tim will pay tax of £7,870 on the dividend.

However, if retained profits permit, he could instead pay the dividend before 6 April 2023 so that it is taxable in 2022/23 rather than 2023/24. This would mean that it would be taxed at the upper dividend rate of 33.75% rather than at the dividend additional rate of 39.35%. Consequently, the tax payable on the dividend would be £6,750. Advancing the dividend would save him tax of £1,120. On the downside, the tax would be payable a year earlier.

If, however, Tim has income of £100,000 in 2022/23 before paying the dividend and expects to have income of £130,000 in 2023/24 before paying a dividend, it is not worthwhile advancing the dividend payment to before 6 April 2023. If he does this, he will increase his income for 2022/23 to £120,000, meaning he will lose £10,000 of his personal allowance. The tax hit of doing so is more than paying tax at the additional rate. Consequently, it is better for him to pay the dividend on or after 6 April 2023.

Directors’ loans can be tricky from a tax perspective. Specific tax charges apply where loans to director shareholders of close companies (broadly those under the control of five or fewer shareholders) are not repaid by the corporation tax due date. This is nine months and one day from the end of the accounting period.

Where this is the case, the company is taxed on the outstanding loan balance at that date. The tax rate is the same as the dividend upper rate, which has been set at 33.75% since 6 April 2022.

Avoiding the charge

The tax charge (section 455 tax) can be avoided if the loan is repaid or written off before the corporation tax due date. This can be achieved in a variety of ways, including introducing funds into the company, declaring a dividend or paying a bonus. Dividends and bonuses can either be paid to the director, who can then use the funds to clear the loan, or they can be credited to the director’s loan account to clear the overdrawn balance.

Clearing the loan to avoid the tax charge will not always be the best option – the higher and additional rates of income tax and the additional dividend tax rate are both more than the section 455 tax rate. Further, as paying dividends or a bonus will trigger a tax liability (and, in the case of a bonus, a National Insurance liability), it may be necessary for the amount of the dividend or bonus to be more than the outstanding loan balance to provide the director with sufficient funds, both to clear the loan and pay the tax on the dividend or bonus.

A repayable tax

Section 455 tax is unusual in that it is a temporary tax – it becomes repayable nine months and one day after the end of the accounting period in which the loan is repaid.

Changing tax rates

The rate at which section 455 tax is paid is the same at the dividend upper rate at the date the loan was made (rather than the date on which the section 455 tax becomes due). Thus, when the dividend upper rate changes, the section 455 tax rate changes too.

The dividend tax rates were increased by 1.25% from 6 April 2022 pending the introduction of the now-cancelled Health and Social Care Levy. Although the levy is not going ahead, the dividend tax rates remain at their higher level (as does the section 455 tax rate).

Section 455 tax is charged at:

• 33.75% for loans made on or after 6 April 2022;
• 32.5% for loans made between 6 April 2016 and 5 April 2022; and
• 25% for loans made before 6 April 2016

All loans are not equal

The date on which the loan was made determines both the section 455 tax payable on the loan, and also the tax that is repaid if the loan is cleared at a later date. Consequently, from a tax planning perspective, the tax rate needs to be taken into account in deciding which loans to clear first. Loans can be cleared in any order.

To maximise the tax savings and tax repayments, loans should be cleared in the following order:

1. Loans made on or after 6 April 2022 on which section 455 tax has yet to be paid – section 455 is payable at 33.75% on these loans.
2. Loans made on or after 6 April 2022 on which section 455 tax has been paid – section 455 tax was paid at 33.75% on these loans.
3. Loans made on or after 6 April 2016 and on or before 5 April 2022 – section 455 tax was paid at 32.5% on these loans.
4. Loans made before 6 April 2016 – section 455 tax was paid at 25% on these loans.

For example, if a director has two loans outstanding – one made in October 2022 for £10,000 and one made in June 2015 for £10,000, clearing the October 2022 loan first will save section 455 tax of £3,375, whereas clearing the earlier loan will trigger a repayment of only £2,500.

The trading allowance enables an individual to earn up to £1,000 from self-employment, the provision of casual services (such as gardening or babysitting) or from hiring out personal equipment without having to pay tax on that income or tell HMRC about it. You may also make use of it if, for example, you sell items on sites such as eBay and Depop.

The £1,000 limit applies to total income from all self-employments. This means that if you have a main self-employment and a side-line earning less than £1,000 a year, you cannot use the allowance against the sideline – the income is taxable and must be reported to HMRC with that from your main self-employment.

If your income is less than £1,000 but you have made a loss, you may prefer to tell HMRC to calculate your loss in the usual way and tell HMRC about the income so that you can claim relief for the loss. This can be done either against other income of the same year or against future profits of the same business.

If you are starting a new self-employment and you do not expect your income to exceed £1,000 you do not need to register for self-assessment. However, you will need to register if your income reaches £1,000 as you will need to report it to HMRC.

Income exceeds £1,000

If your income exceeds £1,000 you must register for self-assessment and tell HMRC about your income. However, you may still be able to make use of the allowance.

If your income is more than £1,000 you have a choice as to how you calculate your taxable profit, and can choose the way which gives the best result. The first option is to calculate your profit in the usual way, deducting allowable expenses from your income. The second option is to deduct the trading allowance of £1,000 rather than the actual expenses. This will be beneficial where your actual expenses are less than £1,000.

Whichever option you choose, you will need to tell HMRC about your income on your self-assessment return and pay tax on it.

Exclusions

The trading allowance cannot be used for a tax year in which you receive trading income from:

• a company that you own or control or which is owned or controlled by someone close to you (such as a family or personal company);
•  a partnership where you, or someone connected to you, is connected to the partners (for example, from a partnership where one of your children is a partner);
• your employer, or your spouse or civil partner’s employer.

As well as a mechanism for collecting revenue, the tax system is also used to encourage certain behaviours and discourage others. Once example  where this is evident is in the way in which company cars are taxed. To encourage company car drivers and their employers to make environmentally-friendly choices, the taxable amount increases as the car’s CO2 emissions increase. The financial incentive to opt for an electric or ultra-low emission car is significant – a higher rate taxpayer will pay tax of just £240 on an electric company car costing £30,000, while the tax hit on a car with the same list price but emissions of 160g/km or more is £4,440.

Tax advantages of electric cars

The tax system confers a number of tax advantages on electric and ultra-low emission cars.

For 2022/23, 2023/24 and 2024/25, electric cars are taxed on 2% of their list price. The charge for ultra-low emission cars depends on their electric range, with the charge for cars in the 1—50g/km emissions bracket ranging from 2% for those with an electric range of at least 130 miles to 14% for those with an electric range of less than 30 miles. At the other end of the scale, the charge for petrol cars with CO2 emissions of 160g/km and above is 37% of the list price.

Employers can also pay for the electricity for private mileage in an electric company car without the employee suffering a fuel benefit charge as HMRC do not regard electricity as a ‘fuel’ for these purposes. By contrast, if fuel is provided for private mileage in a petrol or diesel company car, a fuel benefit charge arises, found by multiply the appropriate percentage for the car’s CO2 emissions by the multiplier for the year. As this is set at £25,300 for 2022/23, rising to £27,800 for 2023/24, the potential savings of going electric are again significant.

Employees using their own electric car for work can also benefit, as if their employer has workplace charging facilities, they can charge their car at work without any tax consequences.

Employers too benefit from choosing electric cars for their car fleet as they are able to claim a 100% first-year capital allowance if they purchase electric cars. A first-year allowance of 100% is also available for electric charge points until 31 March 2023 (corporation tax/1 April 2023 (income tax). Companies can also benefit from the 130% super-deduction on charging points where the expenditure is incurred before 1 April 2023.

Electric cars are exempt from vehicle excise duty until April 2025.

Looking ahead

In the 2022 Autumn Statement, the Chancellor announced that some of the tax advantages for electric cars are to be reduced. The OBR estimate that by 2025 at least half of new cars will be electric; consequently, there is less need for tax incentives (while the Government will still need to preserve their revenue stream).

From April 2025, the appropriate percentage for electric cars and ultra-low company cars is to be increased, rising by one percentage point for each of the tax years, 2025/26, 2025/27 and 2027/28. This means that electric cars will be taxed on 3% of their list price in 2025/26, on 4% of their list price for 2026/27 and on 5% of their list price for 2027/28. Despite the increases, an electric company car remains a tax efficient benefit – assuming the higher rate remains at 40% in 2027/28, the tax bill for a £30,000 electric car will still only be £600.

Entitlement to the state pension and certain contributory benefits depends on an individual having paid, or been credited with, sufficient National Insurance contributions.

To qualify for the full single-tier state pension, an individual needs 35 qualifying years. A reduced state pension is paid where a person has less than 35 qualifying years, but at least 10.

There are different Classes of National Insurance contribution and the Class paid depends on whether an individual is employed or self-employed. A further Class, Class 3, can be paid voluntarily where an individual wants to top up their contribution record.

Self-employed earners

Although self-employed earners are required to pay both Class 2 and Class 4 National Insurance contributions once their profits reach the relevant thresholds, it is only the payment of Class 2 that counts towards their state pension entitlement.

Class 2 contributions are weekly flat-rate contributions which must be paid by self-employed earners whose earnings exceed the relevant threshold.

For 2022/23 and later tax years, Class 2 National Insurance contributions are payable once profits exceed a new threshold, the lower profits threshold. This is aligned with the lower profits limit for Class 4 contribution and for 2022/23 is £11,908. This means that the starting point for Class 2 and Class 4 contributions is now the same. Where profits are at or above this level, the contributor must pay Class 2 contributions. For 2022/23 these are at rate of £3.15 per week. Class 2 contributions are paid through the self-assessment system with tax and Class 4 contributions. Where the earner has been self-employed throughout 2022/23 Class 2 contributions for the year are payable in a lump sum of £163.80 (52 weeks at £3.15 per week) by 31 January 2024.

Where earnings from self-employment are between the small profits threshold, set at £6,725 for 2022/23, and the new lower profits threshold, for 2022/23 onwards the self-employed earner is treated as having paid Class 2 contributions at a zero rate. The effect of this is that the year counts as a qualifying year for state pension and benefit purposes despite the earner having paid no actual Class 2 contributions. This places a self-employed earner with low earnings in a similar position to an employed earner with low earnings. For 2021/22 and previous tax years, Class 2 contributions were payable at the usual weekly rate once earnings reached the small profits limit.

A self-employed earner with profits below the small profits threshold does not benefit from notional contributions, and unless they pay another Class or receive National Insurance credits, they will need to pay sufficient voluntary contributions for the year to be a qualifying year.

While a self-employed earner whose earnings are below the small profits threshold is not obliged to pay Class 2 National Insurance contributions, they are entitled to. This opens up a low cost route to securing a qualifying year, as paying Class 2 contributions at £3.15 per week for 2022/23 is far cheaper than paying voluntary Class 3 contributions at £15.85 per week – an annual saving of £660.40.

Is it worthwhile?

Whether paying Class 2 contributions is worthwhile will depend on an individual’s circumstances. If they already have 35 qualifying years, or expect to do so without making voluntary contributions by the time that they reach state pension age, there is nothing to be gained from paying Class 2 contributions voluntarily. You can check your state pension entitlement via the HMRC app or online at www.gov.uk/check-state-pension.

Where a person also has a job and will pay Class 1 National Insurance contributions on earnings equal to 52 times the weekly lower earnings limit (£6,396 for 2022/23), they will secure a qualifying year from the payment of Class 1 contributions. Likewise, if an individual receives National Insurance credits, for example, because they are registered for child benefit for a child under the age of 12, it will not be worthwhile paying voluntarily Class 2 National Insurance contributions.

However, where a person has less than 35 qualifying years and is looking to build up their state pension entitlement, serious consideration should be given to paying Class 2 contributions. At 2022/23 rates, each additional qualifying year increases the state pension by £5.29 per week. For a cost of £3.15 a week, this is definitely worthwhile.

The VAT default surcharge is being replaced with a new VAT penalty and interest regime. The new rules apply to VAT accounting periods beginning on or after 1 January 2023.

Late filing penalties

The new penalty regime operates on a points-based system. Each VAT return received late, including nil and repayment returns, will receive one late submission penalty point. A penalty will be charged when the points reach a certain threshold. The penalty trigger depends on the frequency with which returns are submitted.

Submission frequency	Penalty points threshold	Period of compliance
Annually	2	24 months
Quarterly	4	12 months
Monthly	5	6 months

Once the penalty threshold is reached, a penalty of £200 is charged. Further penalties of £200 are charged for each subsequent late submission.

The points total can be reset to zero if all returns are submitted on or before the due date for the period of compliance and all returns due for the previous 24 months have been submitted to HMRC.

Late payment penalties

A penalty may also be charged if VAT owed to HMRC is paid late. The penalty depends on how late the payment is made.

No penalty is charged if payment is made within 15 days of the due date. If payment is made between 16 and 30 days after the due date, a penalty equal to 2% of the VAT owing at day 15 is charged.  Where payment is made 31 days or more after the due date, the penalty charged is equal to 2% of the VAT owing at day 15 plus 2% of the VAT owing at day 31. Where a time to pay agreement is agreed, penalties are calculated by reference to the date on which the arrangement is made.

A further penalty is charged when the balance is cleared or a time to pay arrangement agreed. This is calculated at a daily rate of 4% a year for the duration of the debt.

To allow traders time to become familiar with the new rules, late payment penalties will not be charged during the first year (1 January 2023 to 31 December 2023) where payment is made in full within 30 days of the due date.

Late payment interest

From 1 January 2023, late payment interest will be charged on late paid VAT from the due date until the date payment is made in full. Late payment interest is charged at a rate equal to the Bank of England bank base rate plus 2.5%.

Repayment interest

The repayment supplement is withdrawn from 1 January 2023. Instead, for accounting periods beginning on or after 1 January 2023, HMRC will pay repayment interest on VAT that they owe. The interest period will run from the due date (or date the VAT was submitted if this is later) to the date that payment is made in full by HMRC.

Repayment interest is paid at a rate equal to the Bank of England base rate minus 1%, subject to a minimum rate of 0.5%.

The dividend allowance is available in addition to the personal allowance. It allows all taxpayers regardless of the rate at which they pay tax to receive dividends up to the level of the dividend allowance free of any personal tax. This is in addition to any dividends sheltered by the personal allowance which are also received free of tax.

The dividend allowance has been a useful planning tool for family companies; where family members are shareholders, paying dividends to utilise any available dividend allowance increases the profits that can be extracted tax-free.

However, the dividend allowance, currently set at £2,000, is to be reduced. It will fall to £1,000 for 2023/24 and to £500 for 2024/25. The reduction will affect personal and family companies who extract profits as dividends, and also those who receive dividend income from investments in shares.

Taxation of dividends

Dividends have their own rates of tax, which are lower than the income tax rates. They also benefit from a dedicated allowance – the dividend allowance. Although termed an allowance, it is really a nil rate band, and dividends covered by the allowance are taxed at a zero rate. However, the allowance uses up the part of the tax band in which it falls, with dividends being taxed as the top slice of income.

The dividend tax rates were increased by 1.25% from 2022/23 as part of a package of measures brought in alongside the now cancelled Health and Social Care Levy. Despite the cancellation of the levy and the reversal of the associated temporary National Insurance rises, the dividend tax rates are to remain at their 2022/23 rates whereby dividends are taxed at 8.75% where they fall within the basic rate band, at 33.75% where they fall within the higher rate band and at 39.35% where they fall within the additional rate band.

Impact of reduced dividend allowance

Taxpayers who receive dividend income in excess of £1,000 which is not sheltered by the personal allowance will feel the effect of the reduction in the dividend allowance. Where dividend income is at least £2,000 in 2022/23 and 2023/24, the extra tax paid by a basic rate taxpayer on their dividend income in 2023/24 is £87.50; for a higher rate taxpayer the increase is £337.50 and for an additional rate taxpayer, it is £393.50.

Family companies

Dividends can only be paid from retained profits and must be paid in proportion to shareholdings.

A popular strategy in a family company is to use an alphabet share structure whereby each family member has their own class of share (A shares, B shares, etc.). This allows dividends to be tailored to utilise unused dividend allowances and basic rate bands. The fall in the dividend allowance will reduce the extent to which this strategy can be used to extract profits tax-free. Family and personal companies will need to review their profit extraction strategies as a result.

Where company profits are more than £50,000, the corporation tax increases from April 2023 will reduce the post-tax profits available for distribution as a dividend, and the reduced dividend allowance will increase the tax payable by shareholders  where those profits are extracted as dividends. These changes will reduce the post-tax profits available for use by the shareholders outside the company.

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To help businesses that suffered losses during the Covid-19 pandemic, temporary measures were introduced to increase the period for which certain losses could be carried back. This is helpful as it enables businesses to obtain relief for those losses earlier, generating a useful tax repayment at times when the business may be suffering from cash flow difficulties.

Relief is available to both unincorporated business and companies, although the mechanics of the relief is different. To take advantage of the extended carry back period, the relief must be claimed by the relevant deadline.

Unincorporated businesses

The extended carry-back rules apply to losses for the 2020/21 and 2021/22 tax years. Under the rules, unrelieved losses can be carried back and set against profits from the same trade for the three years before the tax year of the loss. The extended rules apply where a claim has been made to relieve the loss against the general income of the year of the loss and/or the previous tax year, and the loss has not been fully relieved by that claim. Losses carried back under the extended rules are set against the trading profits of a later tax year before that of an earlier tax year. Losses carried back under the extended rules are capped at £2 million for each loss-making tax year within the scope of the relief.

If a business wishes to use the extended carry-back rules in respect of a 2020/21 loss, it must claim by 31 January 2023. The deadline to claim relief for a 2021/22 loss under the extended carry back rules is 31 January 2024. Claims are normally made in a tax return, but a stand-alone claim can be made where the claim affects more than one tax year.

Example

A sole trader makes a loss in 2020/21. He has no other income in that year. He makes a claim for sideways relief to carry back the loss against his general income for 2019/20. If he wishes to take advantage of the extended carry-back rules to carry back any unrelieved loss against trading profits of 2018/19 and, where loss is not fully relieved, against trading profits of 2017/18, he must claim by 31 January 2023.

It should be noted that the claim cannot be tailored to prevent personal allowances from being wasted. Where this will occur, consideration should be given to whether it would be preferable to carry the loss forward instead and set it against future trading profits.

Companies

Under normal rules, a company can carry back a loss for an accounting period back one year against the profits of the previous accounting period. Under the extended carry-back rules, losses for accounting periods ending between 1 April 2020 and 31 March 2022 can be carried back up to three years. Losses must be set against the profits of a more recent accounting period before those of an earlier accounting period. A cap of £2 million applies to losses for accounting periods ending between 1 April 202 and 31 March 2022 which can benefit from the extended carry-back. A separate £2 million cap applies to losses for the accounting period ending between 1 April 2021 and 31 March 2022.

Claims must be made within two years of the end of the accounting period in which the loss arose.

Example

A company prepares accounts to 31 March each year. It made a loss in the year to 31 March 2021. Under normal rules, the loss can be carried back against profits for the year to 31 March 2020. If the loss is unrelieved, a claim can be made under the extended carry back rules to set the loss first against the profits of the year to 3 March 2019 and, if still not fully relieved, against the profits of the year to 31 March 2018.

The claim must be made by 31 March 2023.