What is the cash basis?
The cash basis is a new system which sole traders and partnerships can use to prepare their business accounts and calculate their taxable profits. This section explains how unincorporated businesses calculate their profits for their self assessment tax return.
For most small businesses there are two alternative methods of calculating your self-employment profits, the accruals basis and the cash basis. Small businesses may also want to use some or all of the simplified expenses rules. You can navigate this section by using the quick links below.
The accruals basis, which is also called the GAAP ‘Generally Accepted Accounting Principles’ basis, uses basic accountancy principals to ensure that only receipts and expenses which apply to the accountancy year are recorded in that year. Before the introduction of the cash basis in 2013/14 all businesses should have been using the accruals basis when recording stock, debtors and creditors.
For example, if a furniture shop buys nine beds to sell and at its year-end there are three beds left then under the accruals basis only six beds would be treated as a purchase during the year, with the remaining three beds being treated as a stock asset for the following year.
Another example: Julie runs a delivery service business and has a year-end of 5 April. When Julie insures her delivery van the period of insurance is from 1 April 2016 – 31 March 2017 and the insurance payment is withdrawn from her bank account on the 4 April 2016. If Julie chooses to use the accruals basis on her self assessment tax return then the vast majority of the insurance payment will fall into the 2016/17 tax year as a pre-payment because most of the insurance period relates to the 2016/17 tax year.
If you want to use the accruals basis then no election is required on your self assessment return.
The cash basis was designed to make accounting and completing a self assessment tax return easier for the small unincorporated businesses, that is sole traders and partnerships. The cash basis was introduced from 6 April 2013 and so for self assessment tax returns for the 2013/14 tax year onwards.
The cash basis allows businesses to account for their income and expenses when they actually receive payment or when they actually pay for an expense. By using the cash basis you will not need to calculate your debtors and creditors at the year-end, nor perform a stock-take or estimate accruals and prepayments.
Using the same examples of the furniture shop and Julie’s delivery van illustrating the accruals basis, the examples below show how the cash basis would work.
For example, if a furniture shop buys nine beds to sell and at its year-end there are three beds left then under the cash basis the cost of all nine beds would be treated as a purchase during the year as long as the beds had been paid for during the same tax-year. There would be no stock asset at the year-end.
Another example: Julie runs a delivery service business and has a year-end of 5 April. When Julie insures her delivery van the period of insurance is from 1 April 2016 - 31 March 2017 and the insurance payment is withdrawn from her bank account on the 4 April 2016. If Julie elects to use the cash basis on her self assessment tax return then the full expense of the insurance payment will fall into the 2015/16 tax year because the payment was made during the 2015/16 tax year. There will be no insurance pre-payment and no accounting adjustment to be made in the 2016/17 tax year.
Most sole traders and partnerships with an annual sales or turnover of less than £83,000 for 2016/17 (£82,000 for 2015/16) can elect on their self assessment tax return to use the cash basis.
The entry threshold follows the VAT registration limit. You can choose to enter the cash basis even if you have voluntarily registered for VAT as long as your turnover is lower than the VAT registration limit which is £83,000 for 2016/17. For universal credit (UC) claimants the entry threshold is double, at £166,000.
You must leave the cash basis the year after your turnover is higher than the exit threshold which is £166,000.
If you have more than one business and you elect to use the cash basis for one of your businesses then you must also use the cash basis for all your other businesses. The total of the turnover of all your businesses is used when looking at the entry and exit levels of the cash basis.
There are certain businesses that are not allowed to use the cash basis: these include partnerships where at least one of the partners is not an individual and self-employed people using the profit averaging election. A complete list of the businesses that cannot use the cash basis can be found in the section below.
You must choose to use the cash basis as it is not a default option. If you want to use the cash basis then you must elect to do so by ticking the relevant cash basis box on the self assessment tax return. This is box 8 on the short self-employment pages of the tax retrun or box 10 on the full self-employment pages.
How do I account for income and expenses under the cash basis?
Under the cash basis, income is recorded when it is actually received; this may be a different date to the sales invoice.
Expenses are recorded when they are actually paid; this may be a different date to when the expense is made, for example when stock is delivered or a purchase invoice is received.
There are no strict rules of when income receipts or expense payments should be recognised by a business using the cash basis; however a business must use a consistent approach.
For example, a business must decide what date to use when receiving payments by cheque; is it when the cheque is received from the customer? Or when it is paid into the bank? Or when it is shown on the bank account but cannot be drawn against? Or when the cheque has cleared? So if a business decides to record income only after cheques have been cleared then that approach must be used consistently for all cheque receipts.
What business records do I need to keep under the cash basis?
Although HMRC expect businesses using the cash basis to have more simplified accounting than under the accruals basis, a business will still be expected to keep the proper business records required to complete an accurate self assessment tax return.
A business using the cash basis will still need to keep a record of its debtors, creditors and stock so that the business can work effectively.
Under the cash basis, bank and loan interest costs and financing costs, which include bank loan arrangement fees, are allowed up to an annual amount of £500.
If the business has interest and finance costs of less than £500 then the split between business costs and any personal interest charges does not have to be calculated.
Businesses should consider their annual business interest costs and if it is anticipated that these costs will be more than £500 it may be more appropriate for the business to use the accruals basis and obtain tax relief for all the business-related financing costs.
Hire Purchase interest is not included in the annual amount of £500 and can be treated as a separate expense.
What happens if I buy capital equipment?
Most capital equipment can be treated as an expense under the cash basis, but this does not include land, buildings, cars and motorcycles (capital allowances can usually be claimed on cars and motorcycles). This means that capital allowances on eligible capital equipment do not need to be calculated.
Any vehicle purchased when using the cash basis must stay in the cash basis even if the business then switches to use the accruals basis.
Under the cash basis, any trade losses can be carried forward to be utilised against business profits in the future. It is not possible to carry losses back to be used against profits made in previous years or to use losses against other income earned during the same tax year (known as sideways loss relief).
If your business has made losses then it may not be appropriate to use the cash basis as there are more ways to utilise losses by using the accruals basis.
What happens if I take business stock for personal use?
Sometimes small business owners take stock to use personally: if the business is using the cash basis then the stock can be accounted for at cost price.
Under the accruals basis, the principles set out in the Sharkey and Wernher case stipulate that any stock taken for personal use must be accounted for at market value at that time, although sometimes this can be complicated to calculate.
What happens if my business is VAT registered?
If your business is VAT registered but has sales under the cash basis entry threshold you are allowed to elect to use the cash basis. This will usually affect businesses which are voluntarily registered for VAT.
A business using the cash basis has a choice of whether to account for its receipts and expenses net of VAT (without including VAT) or gross (including VAT). If the business accounts for its income and expenditure gross of VAT then it must also include any VAT repayments as income and any VAT payments as business expenses.
If you are self-employed and claiming UC you can enter the cash basis if your turnover is twice the amount of the VAT registration limit (£83,000 for 2016/17), which is £166,000 for the 2016/17 tax year.
If you are self-employed and will be claiming UC when it replaces exiting benefits such as working tax credit then it is planned that you will need to report your business income and expenses on a monthly basis. Unfortunately the universal credit cash accounting will differ from the self assessment optional cash basis.
There are transitional rules when changing from the accruals basis to the cash basis. These are to ensure that overall taxable profits are correct by taxing income and deducting all expense payments only once.
The process of steps you will need to take to move from the accruals basis to the cash basis is made during the first year of using the cash basis. More detailed information on the transitional rules can be found in the section below.
If you elect to use the cash basis then you must continue to use it until either:
- your turnover increases above the exit threshold, which for 2016/17 is £166,000; or
- there are commercial reasons for leaving the cash basis, these include having financing costs of over £500 per annum or wanting to use sideways loss relief.
The following illustration shows when it may be appropriate to change from the cash basis for commercial reasons. Alison’s business used the cash basis in the tax year 2014/15, but during the tax year 2015/16 Alison has taken out a new business loan – the loan arrangement fee was £250 and the annual interest charge will be £400. Under the cash basis, Alison will only receive tax relief of £500 for the interest and loan arrangement fee even though the actual cost to her business was £650. By leaving the cash basis in 2015/16 Alison will be able to deduct all of the £650 as a business financing expense under the accruals basis.
Upon exiting the cash basis you will have to use the accruals basis unless your turnover becomes lower than £83,000 in which case you can choose and elect to use the cash basis again if you want to.
If you leave the cash basis then there are transitional rules when changing to the accruals basis. These rules are to ensure that overall taxable profits are correct by taxing income and deducting all expense payments only once.
The process of steps you will need to take to move from the cash basis to the accruals basis is made during the first year of using the accruals basis but the tax adjustment is spread over six years. However, this six year period can be shortened if you prefer. More detailed information on the transitional rules and the spreading adjustment can be found in the section below.
From 6 April 2013 new rules were introduced which aim to simplify calculating some business expenses by using a flat rate allowance. Although these rules were introduced at the same time as the cash basis, you do not have to be using the cash basis or even be eligible for the cash basis to use them.
There are three areas of simplified expenses and you can choose to use none, one or all of them. The three areas are: expenditure on motor vehicles, use of home for business purposes and premises used both as a home and for the business, and we will discuss the new rules in turn.
It is not possible to use the flat rate mileage rate if you have claimed capital allowances on a vehicle or used the cash basis to obtain tax relief when purchasing the vehicle, however cars and motorcycles cannot be expensed using the cash basis.
The flat rate expenses for business miles are as below:
- For cars 45p per mile for the first 10,000 business miles
- For cars 25p for the business miles after the first 10,000 miles
- For motorcycles 24p per business mile
To use this simplified flat rate expense you will need to keep a note of the number of business miles you have done, including details such as the date of the journey, your destination and the reason for your journey.
If you do not want to use the flat rate expense then you can claim capital allowances. There is more information on GOV.UK.
|However, if you claim capital allowances, or have claimed the cost of a qualifying vehicle as an expense, then you cannot switch to using the simplified flat rate expense until you change your vehicle.|
If you run your business from home you can opt to claim a standard allowance to cover your utility expenses. The allowance is based on the number of hours you work from home. The amounts allowable per month are:
- Use of home for business – 25-50 hours per month – £10 per month
- Use of home for business – 51-100 hours per month – £18 per month
- Use of home for business – 101 hours or more per month – £26 per month
Alternatively, it may be more beneficial to use the existing rules and claim a portion of actual allowable costs. Although this is more complicated to calculate there are guidelines and examples on GOV.UK.
If you live on your business premises, for example your business is running Bed and Breakfast accommodation, you will now be able to use a flat rate adjustment to calculate your personal expenditure (for example, utility costs and food). This flat rate allowance is then deducted from the businesses’ actual costs so that only the business cost is included on your self assessment tax return. The flat rate does not include costs such as rent, mortgage and council tax; these will have to be adjusted for on your self assessment tax return in addition to the fixed rate adjustment.
The fixed rate adjustment is based on the number of occupants at the business dwelling:
- 1 occupant £350 per month
- 2 occupants £500 per month
- 3 or more occupants £650 per month
However, you do not need to opt to use this standard deduction; you can continue to use an apportionment of actual costs between personal use and business use of the business property.
Who can use the cash basis?
The following businesses cannot use the cash basis and must use the accruals basis:
- those using the Herd basis;
- self-employed people using the profit averaging election;
- limited liability partnerships (LLPs);
- partnerships unless all the partners are individuals;
- those which have claimed business premises renovation allowance;
- those in the mineral extracting trade;
- property businesses;
- Lloyd’s underwriters;
- businesses which have claimed the Research & Development allowance;
- dealers in securities;
- those dealing in lease premiums;
- Ministers of religion;
- those claiming tax relief for mineral royalties;
- pool betting duty businesses;
- intermediaries treated as making employment payments;
- businesses dealing in waste disposals;
- cemeteries and crematoria businesses.
The transitional rules for changing from the accruals basis to the cash basis are listed below:
- Any sales income which was included under the accruals basis but not received until using the cash basis should be disregarded under the cash basis as it has already been accounted for.
For example, Brian uses the accruals basis for the 2014/15 tax year and at the end of the tax year he has sales income of £20,000 which includes £1,000 that has yet to be paid. When Brian prepares his accounts in order to complete his 2014/15 self assessment tax return, he includes his turnover (sales) as £20,000 and records debtors of £1,000. In 2015/16 Brian decides to use the cash basis and in May 2015 he receives payment for £1,000 for the income included in the 2014/15 tax return.
Under the cash basis, Brian would account for the £1,000 when he receives it, but as Brian is moving from using the accruals basis to the cash basis this would result in £1,000 being taxed twice, both in 2014/15 and 2015/16. Therefore, there is a transitional adjustment to the cash basis income in 2015/16 to reduce sales income by £1,000.
- Any expenses purchased using the accruals basis but not paid for until using the cash basis should be disregarded as expenses under the cash basis because tax relief has already been allowed.
Following on from the example above, Brian, who switches from using the accruals basis in 2014/15 to using the cash basis in 2015/16, purchases tools to use in his business in March 2015. Brian pays £300 for the tools in May 2015.
As Brian is using the accruals basis when he prepares his accounts and self assessment tax return for 2014/15, he will include the purchase of tools in March 2054 as a business expense.
The following tax year, when Brian is using the cash basis, he should account for all expenses when he actually pays for them and as he paid for the tools in May 2014 this would usually be treated as an expense in the 2015/16 tax year. However, Brian has already received tax relief for the tools in 2014/15 therefore the expense of £300 is ignored in 2015/16, and the total expenses for this year are reduced by £300 as part of these transitional adjustments.
- Under the accruals basis any closing stock held by the businesses at its year end should have not been deducted as an expense but treated as an asset. When joining the cash basis the stock is deducted as a purchase expense.
Continuing the example of Brian’s garden furniture business; at the end of 2014/15 Brian has closing stock of four chairs which he paid £200 for in February 2015. Under the accruals basis, this closing stock would be treated as an asset and not an expense, so Brian would have not yet received any tax relief for the £200.
When Brian switches to the cash basis, he will make an adjustment to treat the closing stock as a purchase expense and will increase his expenses by £200 in 2015/16.
- If the business is VAT registered and is recording income and expenses under the cash basis gross of VAT then it must include any VAT refunds as income and VAT payments as expenses. Transitional adjustments will be needed when switching from the accruals basis to the cash basis to ensure only VAT refunds and payments relating to the period under the cash basis are accounted for in this way.
For example, a business starts to use the cash basis and accounts for income and expenses without deducting VAT (gross of VAT). The business receives a VAT refund which relates to an earlier VAT period when the business was using the accruals basis; under the transitional rules the business must reduce its total income under the cash basis by the amount of this VAT refund.
- Some capital assets (except for cars, motorcycles, land and buildings), which have qualified for capital allowances under the accruals basis will still have a tax value left in their capital allowances pool (this means they have not received capital allowances up to their full cost value yet). When the business moves to the cash basis, any amounts which still haven’t received full capital allowances are treated as a cash purchase upon joining the cash basis.
Many small businesses should not be affected by this transitional rule because of the annual investment allowance and small pools write down allowance; however we illustrate this rule below.
For example, Brian has previously claimed capital allowances on machinery but at the end of the 2015/16 tax year the balance on the general capital allowance pool is £1,500. When Brian elects to use the cash basis in 2015/16 he will be able to treat the £1,500 as an expense in the 2015/16 tax year and no longer claim capital allowances.
The transitional rules for changing from the cash basis to the accruals basis are listed below:
- Any sales made under the cash basis where payment was received after moving to the accruals basis must be included as income under the accruals basis tax year otherwise this income will not be taxed.
For example, Alison runs a small business and elected to use the cash basis, however her annual financing costs were higher than £500 so she decides to move in the tax year 2015/16 from the cash basis to the accruals basis instead.
During March 2015 when Alison was using the cash basis, she made sales of £1,000 but at the year-end only £600 of these sales had been paid for and the business had debtors of £400. When Alison prepared her tax return under the cash basis for 2014/15 she only includes £600 of the March sales which was the income she actually received. During the next tax year (2015/16), Alison receives payment for the remaining £400 debt in May 2015. Under the transitional rules, Alison needs to account for the £400 income in 2015/16 even though she is now using the accruals rules because otherwise this income would not be taxed. Therefore Alison needs to increase her sales income in 2015/16 by £400.
- Any expenses incurred under the cash basis but not actually paid for until the business was using the accruals basis, must be deducted under the accruals basis.
Following on from the example above, Alison purchased some clothes to sell in her shop in March 2015 when Alison was preparing her self assessment tax return using the cash basis. However, Alison only paid for this stock in June 2015 when she was using the accruals basis. Alison would not have included the stock as an expense during the 2014/15 tax year as she did not pay for the stock until the following tax year. Therefore, an adjustment must be made under the transitional rules to include this stock as an additional expense in the 2015/16 tax year.
- If a business is VAT registered and under the cash basis records income and expenses gross of VAT (with VAT included), when the business moves to the accruals basis an adjustment must be made for any VAT refund or VAT payment which relates to a VAT period under the cash basis.
For example, if a business makes a VAT payment in the accruals basis which relates to a VAT period when the cash basis was used then a transitional adjustment must be made to include the VAT payment as an expense under the accruals basis.
- Capital expenditure will normally be treated as an expense under the cash basis and upon moving to the accruals basis will be treated as a capital allowance asset with no capital allowances left to claim.
The exception to this rule will be when an asset has been bought on hire purchase as only the cash payments made will be treated as an expense under the cash basis. After moving to the accruals basis, the remainder of the cost of the asset will either be treated as unrelieved expenditure in the general pool or be fully written down using the annual investment allowance.
For example, Alison has purchased a new till under hire purchase, which has a capital cost, excluding interest charges, of £1,500 and under the cash basis she has made payments of £400 towards the capital cost of the till. When Alison moves from the cash basis to the accruals basis, she will be able to treat the till as an asset qualifying for capital allowances and will include £1,100 (£1,500 less £400) as a general pool asset and claim capital allowances or claim the annual investment allowance for the £1,100.
The spreading adjustment
When leaving the cash basis, any additional income arising from the move to the accruals basis will be spread over six years and taxed 1/6th in each year. Using the examples above, if Alison calculates that she will increase her income by £600 by moving from the cash basis to the accruals basis in 2015/16 then this adjustment income would be taxed equally over six years, so there would be £100 additional income for each tax year from 2015/16 to 2020/21.
If you do not want to spread the adjustment income over six years you can elect to accelerate the charge and decide how much you want to make each tax year.
For example, Alison decides to use the spreading adjustment and so for the 2015/16 tax year only £100 of the adjustment income is taxed. However, the following year Alison decides she wants to pay tax on the income as soon as possible so she elects to treat the remaining adjusted income as falling in the 2016/17 tax year which increases her income by £500 and no further spreading adjustment is made in later years.
Alison must make an election to accelerate the spreading adjustment within one year of the self assessment tax return filing deadline. So in the case of the above example, Alison must make her election by 31 January 2019 (one year after the 2016/17 filing deadline).