This blog is written to set out details of a new way in which small businesses can produce their accounts for tax purposes with effect from the year 2013/14. At present all business accounts must be produced in accordance with generally accepted accounting practice which is made up of a considerable volume of accounting principles, as set out by the National Accounting Bodies. These principles apply almost equally to the largest stock market quoted company and a small part-time business venture. To simplify matters the Government has been considering and consulting over an alternative basis for small businesses and Finance Bill 2013 includes provisions for a simplified system which is based upon income received fewer expenses paid, i.e. the cash basis.
Who Can Use the Cash Basis?
The new basis will be available from the tax year 2013/14 for sole traders and partnerships with a turnover (including VAT if registered) up to £79,000 per annum (or £158,000 per annum for those also claiming universal tax credits). The new basis is not available to limited companies and limited liability partnerships or to farmers using the herd basis, farmers and creative artists with profit averaging claims, Lloyds underwriters and partnerships which include a corporate entity as a member.
It will not be compulsory to use the new basis and indeed it will be possible to opt-in and out of the basis from one year to another depending upon the relevant circumstances (although this will involve dealing with transitional adjustments each time there is a change). Once the new basis has been adopted it will however be possible to remain within it until turnover reaches £158,000 before being compulsorily transferred back to the standard generally accepted accounting practice basis.
Key Features of the New Basis
Under the generally accepted accounting practice basis businesses in producing their accounts must not only take into account all receipts and payments during the accounting period but also balance sheet items such as trade debtors, trade creditors, accruals, prepayments, deposits and stock, plus identify items acquired for use over a period of time such as plant and machinery. The cash basis looks simply at monies in fewer monies out to determine taxable profits. In most cases therefore this should be a much easier figure to identify and will mean that the calculation of the balance sheet items of trade debtors etc can be dispensed with. It should however be appreciated that the cash basis of establishing profitability, whilst simpler to calculate, does not produce a complete picture of business performance. For instance, a business could appear quite profitable on a cash basis, (for example, if it is selling goods for immediate payment but buying them on ever-increasing levels of credit from suppliers) whereas in reality, its performance may be quite poor. However, in many cases, the cash basis is likely to give a reasonable indication as to the performance of a particular business and it should be appreciated that over the whole life of any business the total of the cash basis profits and those generated under the generally accepted accounting practice basis will be the same, although how such profits are allocated into individual accounting periods will differ.
If the cash basis is used then figures will have to be drawn up to date each year ending between 31 March and 30 April. It should also be noted that adjustments will be required in respect of receipts in kind and non-commercial transactions to prevent avoidance. Also, claims for interest relief (except on HP agreements) will be limited and the acquisition of a motor car will not be a permitted deduction (although capital allowances will still be available).
Who is Likely to Benefit from the Cash Basis?
Whilst each case must be considered on its own merits, the following are generally likely to benefit from the use of the cash basis:-
- Where there are practical difficulties in establishing balance sheet items such as debtors, creditors, accruals, stock levels, etc.
- New businesses with only basic records (unless losses are involved)
- Businesses with high (and overtime increasing) levels of debtors and stock compared to creditors as the cash basis will defer profits (and therefore tax payments) into later periods.
- Businesses already using the cash basis for VAT purposes.
- Those who are prepared to accept a slightly less accurate calculation of profitability in return for their accounts being easier to produce and therefore involve slightly lower costs of production.
- Taxpayers who are also using the cash basis in respect of universal tax credit claims.
Who is Unlikely to Benefit from the use of the Cash Basis?
- Those businesses with little in the way of balance sheet items, such as debtors, creditors, etc.
- Loss-making businesses, since under the cash basis the use of losses against non-business income to claim a tax refund will not be permitted.
- Taxpayers who need an accurate fully calculated profit figure for the purpose of raising funds via banks etc.
- Businesses that rely upon supplier credit but have little in the way of debtors and stock as the cash basis will defer tax relief on unpaid balance sheet date invoices.
- Traders who are likely to incorporate in the near future as the cash basis is not available to limited companies and on incorporation, it is always important to establish appropriate levels of debtors, creditors, stock, etc to transfer over to the new entity.
- Businesses who wish to adopt a balance sheet date in the year other than between 31 March and 30 April which is compulsory for cash basis users.
The full details of the cash basis will not be available until the Finance Act 2013 becomes law, probably in about July this year, but in principle, it is likely that it may be available for use by your business in due course. Remember that it only applies for the year ended 5 April 2014 onwards so it will not be appropriate until tax returns for that year are completed sometime during the latter part of 2014. However, I thought I would give you early notice of the relevant proposals so that you are aware of the possible option available to you in due course. At the relevant time, I will discuss with you whether it is appropriate and beneficial for you to take up this option based upon your particular circumstances.