Cash Basis Accounting for the Self-Employed
As we move closer to the introduction of Making Tax Digital, the Government and HMRC continue to attempt to reduce the burden of record keeping for the self-employed.
From 6 April 2017, the turnover limit below which self-employed businesses (e.g. sole trader or partnership) can use the “cash basis” was increased to £150,000 per annum.
With the cash basis, businesses only record income received in a tax year i.e. they are not taxed on monies owed but not received. Similarly, expenses are only relieved when they are paid, relief is not given for money owed.
The cash basis avoids the need for potentially time-consuming year-end adjustments required under traditional accounting for debtors and creditors. This also applies to the traditional year-end taxation adjustments, such as capital allowances for equipment purchases which are replaced by relief for qualifying capital expenditure as and when it is incurred. However, this treatment does not apply to cars where capital allowance computations continue to be necessary.
Apart from accounting simplicity, the other advantage of the cash basis is a deferral of tax due, as debtors and work in progress will be excluded from the taxable income. This could be particularly attractive for the early years of a growing business.
However, there are several significant disadvantages to the adoption of the cash basis:
- Cash accounting identifies cashflows, but it does not give a true picture of the business profit or loss. Records (and controls) of debtors and creditors are still required to accurately monitor the business performance.
- Third parties may still want to see “traditional” accounts for lending purposes.
- Tax relief for interest and charges is restricted to £500.
- Losses incurred cannot be relieved against other income, instead they are carried forward to set off against future profits of the same trade.
- The deferral of tax on income not received at the year end is only temporary. If tax rates rise this can be detrimental.
- There are various specialist businesses that are excluded from the cash basis, together with all limited companies and limited liability partnerships.
It is possible to withdraw from the cash basis in a subsequent year, and you must leave the scheme if your turnover subsequently increases to over £300,000 per annum.
In the first year in which the business changes from traditional accounting to the cash basis, transitional adjustments are required to ensure that income is not taxed twice, or expenses relieved twice. An entry is required on the self-assessment tax return to show that the cash basis has been adopted.
If you would like to discuss the blog in more detail please email Gary Plumb or call 0115 9721050.