As part of a package of simplification measures designed to reduce the compliance burden placed on the smallest businesses, sole traders and partnerships with trading receipts not exceeding the VAT threshold (currently £79,0000) can opt to use the cash basis rather than the accruals basis to work out their profits for tax purposes.
Put simply, the cash basis takes account of cash in and cash out. There is no need to take account of bills owing or bills owed, as under the accruals basis.
Income under the cash basis
Where the cash basis is used, income is only taken into account in working out profit if the money has actually been received in the tax year. It does not matter how the payment is made. The money counts as income on the date that the payment is received rather than the date on which the invoice is raised.
Example – When income counts for tax purposes
Bill and Ben are sole traders.
Bill opts to use the cash basis to work out his taxable profits for 2013/14 onwards. He prepares accounts to 31 March each year.
Bill raises an invoice for £2,000 on 25 March 2014. The invoice is paid by cheque on 10 April 2014. Under the cash basis the income forms part of the income for the year to 31 March 2014, and is taxable in the tax year 2014/15.
Ben continues to use the accruals basis. Like Bill, he also raises an invoice for £2,000 on 25 March 2014. The invoice is paid on 15 April 2014. However, under the accruals basis the key date is the invoice date and the amount invoiced on 25 March 2014 is treated as income of 2013/14.
Using the cash basis can generate cashflow advantages, as income may be taxed later under the cash basis than under the accruals basis.
The same rule applies to expenses, in so far as they are only taken into account under the cash basis when the bill is actually paid, rather than by reference to the invoice date as would be the case under the accruals basis. This means that under the cash basis, relief may be given later than under the accruals basis. The rules that determine which expenses are deductible are the same under both the cash and the accruals basis; it is only the timing of the relief that differs.
Is the cash basis suitable for me?
The cash basis can be used by sole traders and partnerships whose total business income is less than the current VAT threshold (£79,000 a year). Businesses that have registered for VAT voluntary can use the cash basis as long as their total business income is less than the VAT registration limit. VAT registered business must treat VAT payments made to HMRC as expenses and VAT repayments as income.
Once a business has elected to use the cash basis, it can continue to do so as long as its total business income does not exceed £158,000. Certain businesses, including limited companies and limited liability partnerships, cannot use the scheme. A list of excluded businesses can be found on the gov.uk website (see www.gov.uk/simpler-income-tax-cash-basis/who-can-use).
Businesses that qualify can opt to use the cash basis from 2013/14. This can be done by ticking the cash basis box on the self-assessment return.
If your affairs are simple you may wish to save work by opting to work out profits and losses on the cash basis. There is no need to work out debtors and creditor or prepayments and accruals.