April 2013 saw the introduction of an optional cash accounting regime for small, unincorporated businesses. The introduction of the new regime is part of the UK Government's ongoing initiatives to support small businesses, with the stated aim of the policy being to simplify the self-assessment of business income, by reducing the concerns, uncertainty and administrative burden for such taxpayers. While the accruals basis still applies to companies and the majority of unincorporated businesses, the measures allow eligible businesses to elect to use the cash basis if they feel that this method of profit calculation will be beneficial to them.

Historical Position

Prior to 6 April 2013, all unincorporated businesses were required to calculate profits on an accruals basis in accordance with generally accepted accounting practice. Under ITTOIA 2005 s25, any profits so calculated are then subject to adjustment as required by tax legislation, for example adjustments in respect of capital expenditure, which may include the separate calculation of capital allowances.

The New Rules

Under the new rules, eligible small businesses which do not need or want to prepare their business accounts under the traditional accruals basis, may instead elect to calculate their taxable income by taking business receipts in the relevant basis period and deducting allowable business expenses paid in the period. The cash basis is therefore essentially a ‘money-in, money-out’ approach and the usual accounting adjustments for stock, accrued or deferred income, debtors and creditors will not apply.

Eligibility

Businesses can elect for the cash basis if their receipts for the year do not exceed the amount of the VAT registration threshold (currently €79,000) or twice that for recipients of Universal Credit. Where the basis period for a tax year is less than 12 months, the VAT threshold is proportionately reduced. It should also be noted that any cash basis election applies to all the businesses carried on by a person in the year for which an election is made, therefore combined business receipts need to be considered when applying the eligibility criteria.

A business must leave the cash basis after their receipts exceed twice the amount of the VAT registration threshold (currently €158,000). The use of the cash basis is optional and a business can choose to leave the scheme if it has a change in commercial circumstances which means the cash basis is no longer appropriate for it.

Specific persons are excluded from using the cash basis, including LLPs, Lloyd's underwriters and those businesses with a current herd or profit averaging election. A full list of excluded persons may be found at Section 31C ITTOIA 2005.

Losses

Under the cash basis, losses may only be carried forward to the next year. ‘Sideways’ loss relief against other income, including the carry back of losses to earlier tax years, or capital gains tax relief is not allowed under the cash basis, so if a business is likely to be loss making it will probably not adopt cash accounting. For example a start-up trader, perhaps made redundant from a previous employment will not want to forgo the possibility of claiming sideways loss relief against tax paid in their previous employment.

Receipts

HMRC issued a Technical Note on 28 March 2013 to provide an overview of the new legislation. The Technical Note confirms that receipts include all amounts received in the basis period in connection with the business, to include tips, commission, receipts in kind (for example goods, services or assets received as payment), refunds of deductible expenses (including VAT refunds), sale proceeds from the disposal of non-durable assets ( eg plant and machinery), receipts in respect of damages or insurance claims, grants and Business Support Allowances. Additionally, on cessation of a trade within the cash basis, the value of trading stock and work in progress are counted as receipts of the business.

Notable exceptions are receipts from the sale of property, bank loans and any other assets for which costs would not be deductible as expenses (eg investment assets).

Expenses – General Rules

In general, allowable expenses under both the cash and accruals methods, must be amounts paid wholly and exclusively for the purposes of the trade. However many of the provisions relating to allowable expenditure under the accruals basis do not apply under the cash basis and alternative rules apply.

As noted above, cash accounting is essentially ‘money – in, money-out’ so only actual amounts paid out during the basis period are allowable as deductions. So for example an electricity bill covering the period January to March 2014, that's not actually paid until April 2014 will be included in the accounts for the year ended 31 March 2015. Stock purchases do not have to be matched with corresponding sales receipts and a full deduction for the cost of any goods purchased will therefore be allowable in the basis period of payment.

In line with the accruals basis, if payment is made for something that the taxpayer also uses privately (a telephone bill for example), only the amount relating to business use may be deducted. All payments for business entertaining, purchase of cars or motorcycles, property or similar assets which hold most of their investment value must also be excluded.

Motoring expenses for cars may be calculated either by using existing Capital Allowances rules and actual expenditure (apportioned for private use) or by using the simplified expenses mileage rates detailed below.

There is generally no need to make adjustments for capital allowances for plant and machinery as capital expenditure (apart from cars) is simply relieved as and when it is incurred, just like any other revenue expense. It should be noted however that unlike capital allowances, deductions for capital expenditure under the cash basis cannot be restricted in a year where profits are low, for example in order to utilise the personal allowance in full.

Any interest element of a payment of a deductible expense ( for example trade credit for stock, hire purchase costs) may be deducted if paid during the period, as may interest on cash borrowings of up to €500.

Simplified Expenses

Finance Act 2013 introduced the option for unincorporated businesses ( not just those businesses who have elected to use the cash basis) to choose to make fixed rate deductions for vehicle expenditure, expenses relating to the business use of a home, or private use of business premises. The option is not available to partnerships where at least one partner is not an individual.

Vehicle Expenditure

A fixed rate deduction is allowed for expenditure on the acquisition and ownership of a car, motor cycle or goods vehicle where a deduction would be allowed under normal trading rules. A deduction is only allowed if no other deduction is made for that expenditure, if no capital allowances have been claimed on the vehicle and in the case of a van or motor cycle, no deduction on acquisition has been claimed by a business which calculates profits on a cash basis. Once the flat rate has been claimed in relation to a particular vehicle, this method must be used for as long as the vehicle remains in the business. The number of qualifying business miles is multiplied by the rate for the vehicle and is the same as the HMRC approved mileage rates:

• Cars or good vehicle – 45p for the first 10,000 miles and 25p per mile thereafter;
• Motor cycles – 24p per mile

It is important to note that the 10,000 mile band is shared between all of the business vehicles and will therefore be less attractive when multiple vehicles are used as it is unlikely to cover the fixed costs of more than one vehicle.

Use of Home for Business

Rather than calculate a deduction based on actual running costs, apportioned between business and private use, an optional fixed rate deduction has been introduced by HMRC. The deduction is the sum of the ‘applicable amounts’ for each month, or part of a month, falling within the relevant basis period. The ‘applicable amount’ is based on the number of hours spent wholly and exclusively working in the trader's own home, as set out below:

So, if for example a trader worked 60 hours per month from home, a flat rate deduction of €216 could be claimed in relation to a 12 month accounting period.

Mixed Use of Premises

Where premises are used mainly for the purposes of carrying on a business but also used as a home by the business owner(s), for example a bed and breakfast business, a fixed rate deduction may be made in calculating profits. The amount of the deduction is the total of expenses actually incurred in the period, less an amount representing non-business use. The disallowable amount for each month, or part of a month is based on the number of ‘relevant occupants’. A ‘relevant occupant’ means an individual who at any time in the period, either occupies the premises as a home or stays at the premises otherwise than in the course of the trade. The amounts are as follows:

The flat rate includes all household goods and services, food and non-alcoholic drinks and utilities. It does not include mortgage interest, rent of the premises, council tax or rates and a reasonable apportionment of these expenses should be made based on the private occupation of the premises in accordance with HMRC Brief 14/2013.

Issues for Clients and Advisers

Taxpayers electing for cash accounting will generally do so either because it is ‘easier’ than GAAP accounting and/or there may be cash flow advantages as tax payable under cash accounting may be lower than under GAAP. It is important to note however that the cash basis is essentially only a timing difference and over the lifetime of the business the overall taxable profits of the business will remain the same under GAAP and cash accounting.

An important consideration for clients is whether they need more information to run their business effectively and whether they need to prepare GAAP accounts, either for internal management purposes or for obtaining loan finance. If GAAP accounts are required for either purpose it will obviously not be cost effective to provide accounting information in one form and tax information in another. Alternatively where sales and purchases are for cash as opposed to credit and no stock is involved, the cash basis may be attractive to such clients.

The cash basis will not suit every small business and practitioners will need to provide appropriate information and advice, relevant to their clients’ individual circumstances.

Helen Allen is a Tax Director in BDO Northern Ireland with over 20 years experience in the Accountancy profession.

Tele: Direct +44 (0) 28 90677326

Tele: Mobile +44 (0) 7891 240135

Email: Helen.Allen@bdo.co.uk