A review by the Office of Tax Simplification (OTS) into the taxation of small businesses found that many of the smallest business, often on-man bands, used cash accounting, and in the majority of cases they did not have specialist tax or accounting help. In addition, the review found that the processes involved in claiming business expenses could be disproportionately burdensome for the smallest business. The OFT review concentrated on businesses with turnover of £30,000 or less which are not generally registered for VAT, which have little or no significant capital investment and often have no employees.
In a report published on 28 February 2012, the OTS recommended that businesses with a turnover of up to £30,000 should calculate their profits using receipts and payments, but should have the option to continue to compute profits in accordance with generally accepted accounting principles (GAAP) if they prefer. The OTS further recommended that simplified arrangements should be introduced for deductions of certain business expenses to make claims easier to calculate.
George Osborne picked up the small business tax simplification baton in his Budget on 21 March 2012 and announced that following the OTS review the Government will consult on introducing a voluntary cash accounting basis for unincorporated businesses with turnover below the VAT registration threshold and also on a simplified expenses system for business use of cars, motorcycles and business use of home. The Government will also look at the possibility of introducing a disincorporation relief.
A report was published at the time of the March 2012 Budget setting out the ways in which Government intends to deliver tax simplifications for small businesses.
At present all businesses must prepare accounts in accordance with UK GAAP. As OTS research shows, this places a disproportionate burden on very small businesses and many find it difficult to work out how much tax they owe and to identify what is a deductible expense.
Following a period of consultation on the details, the Government intends to introduce a new cash basis for calculating the tax of small unincorporated businesses from April 2013.
This means that small businesses will be able to calculate their taxable profit by simply adding up business receipts and subtracting payments made to cover allowable expenses. They will not need to take account of debtors and creditor or accruals or prepayments.
Where a cash basis is used, businesses will not need to pay tax on a sale until the cash is received, they will not need to keep complicated accounting records purely for tax purposes over and above those needed to run their business effectively nor will they need to understand capital allowances. The parallel introduction of simplified rules for the deduction of certain business expenses will means that businesses will not need to keep detailed records for certain key business expenses as they will be able to use standard rates instead.
Who can benefit
The OTS report suggested a cash basis for businesses with turnover of up to £30,000. However, the Government is planning to go further and to introduce an optional cash basis for unincorporated businesses with turnover below the VAT registration threshold (currently £77,000).
An important point to note is that the cash basis will only be available for unincorporated businesses. Business that incorporated to take advantage of favourable corporation tax rates and the ability to extract profits as dividends must continue to calculate profits in the usual way. However, to help companies that feel trapped in the corporate regime and which may wish to move to a cash accounting basis the Government is also to consult on the possibility of introducing a disincorporation relief.
The cash basis is voluntary – wait for the details until deciding whether it is for you. Likewise, small companies should weigh up the advantages of incorporation against the ease of the cash basis.