Tax legislation now allows some small businesses to compute taxable profits for the purposes of     income tax on a cash basis rather than the usual accruals basis.

The cash basis can first apply for the 2013/14 tax year. This means that we can make a decision about whether you want to use the cash basis for the tax return that is submitted to HMRC this year. Your accounts and tax return can continue to be on the same basis as in previous years. There is only a need to change if the change would be advantageous to you and your business.

The key aspects of the cash basis are that:

  • Small businesses would be taxed on their cash receipts less cash payments of allowable expenses.
  • It is only available to unincorporated businesses.
  • It is an optional scheme and requires an election by the owner(s) of a business.
  • Businesses can enter the cash basis if their receipts for the year are less than amounts based on the VAT registration threshold (currently £81,000) or twice that (£162,000) for recipients of Universal Credit. Universal Credit is slowly being introduced by the Government and is the replacement to the Tax Credits system.
  • Businesses will not have an option of leaving the cash basis in future tax years unless there is a ‘change of circumstances’.
  • Businesses must leave the cash basis the year after their receipts exceed twice the amount of the VAT registration threshold unless their receipts fall back to below the VAT registration threshold.

This sounds simple so should you elect for it if you can?

The cash basis sounds simple but there may be significant complications depending on the nature of your business.

Points to consider from a tax perspective include:

  • Cash receipts include all amounts received in connection with the business including those from the disposal of plant and machinery. The good news is that if a customer has not paid what is owed to you by the year end, the amount due to you is not taxable until next year.
  • Allowable payments include paid expenses but will still need to meet the existing tax rule of being wholly and exclusively incurred for the purposes of the trade.
  • Payments will include purchases of plant and machinery, when paid, rather than claiming capital allowances. The bad news is that if you have not paid a supplier by the year end, the amount is not relievable until next year.

In addition there are special rules in the legislation:

  • Interest payments will only be allowed up to a limit of £500.
  • Business losses may be carried forward to set against the profits of future years but not carried back or set off ‘sideways’ against other sources of income.
  • Rules on entering or leaving the cash basis are intended to ensure that income is taxed ‘once and once only’ and expenses are relieved ‘once and once only’. These rules will require special calculations to be performed.

Are there any non-tax considerations?

Yes, there may well be.

You may still need to have a set of accounts prepared which include a profit and loss account and balance sheet. The health of a business needs to be considered by you not just in relation to a positive bank balance but also the inherent profitability of the business. This is provided by a profit and loss account. Production of a balance sheet provides a snapshot of the assets and liabilities of the business.

If you need finance from the bank for your business, the bank is likely to require profit and loss accounts and balance sheets in addition to cash flow forecasts. The bank would want to see the profitability of the business and the assets tied up in your business.

As we have stated earlier, there is only a need to change if the change would be advantageous to you and your business. We should also point out that if you stay on your existing basis for 2013/14 tax year, a decision can always be made in a later tax year to opt for the cash basis.

Please contact us if you require any further information or advice.