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From 6 January 2024, the main rate of class 1 National Insurance contributions (NIC) deducted from employees’ wages is reduced from 12% to 10%. From 6 April 2024, the main rate of self-employed class 4 NIC will reduce from 9% to 8% and class 2 NIC will no longer be due. Those with profits below £6,725 a year can continue to pay class 2 NIC to keep their entitlement to certain state benefits. Our guidance will be updated in full in spring 2024.

Updated on 6 April 2023

Accounts: cash basis

Sole traders and partnerships must prepare business accounts to show all the income and expenses of the business for the period covered by the accounts. Traditionally, business accounts are prepared on an accruals basis, but smaller businesses may be able to use what is known as the ‘cash basis’, which is designed to be a simpler way of preparing accounts.

Content on this page:

General principles

Whereas the accruals basis looks at income earned and expenses incurred, 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 debtors and creditors at the year-end, nor perform a stock-take or estimate accruals and prepayments as you would if you were using accruals basis accounting.

Example: cash basis

For example, if you are self-employed and your business sells sports equipment and you prepare your accounts to 5 April each year, then when you prepare your accounts for the year ended 5 April 2023 using the cash basis:

  • If you sold 100 footballs in March 2022 for £700 to your local football club and they paid for the footballs on 20 April 2022, then you would include this income as sales income in your accounts for the year ended 5 April 2023.
  • If you bought 12 table tennis tables and paid for them all in December 2022, and had 6 tables left still to sell at 5 April 2023, under the cash basis the cost of all 12 table tennis tables would be treated as a purchase during the year ended 5 April 2023. There would be no stock asset at the year-end.
  • You have annual vehicle insurance payable on 1 January each year. Under the cash basis, the full amount paid on 1 January 2023 is an expense in the accounts for the year ended 5 April 2023, even though the premium is for the year 1 January 2023 to 31 December 2023, and 9 months of this period falls into the year ended 5 April 2024. There will be no insurance prepayment and no accounting adjustment to be made in the 2023/24 tax year.

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, but 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.

If you want to use the cash basis for your self-employed accounts, you must elect to do so on your self assessment tax return by ticking the relevant box in the self-employed section of the tax return as it is not the default option. This is box 8 on the short self-employment pages of the tax return or box 10 on the full self-employment pages.

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 should still need to keep a record of its debtors, creditors and stock so that the business can work effectively.

Eligibility

Most sole traders and partnerships with annual sales or turnover of less than £150,000 can elect on their self assessment tax return to use the cash basis.

For universal credit (UC) claimants the entry threshold is double, at £300,000.

If your business is VAT registered but has sales under the cash basis entry threshold of £150,000 (or £300,000 if claiming universal credit) you are allowed to elect to use the cash basis.

You must leave the cash basis the year after your turnover is higher than the exit threshold which is £300,000. We cover this is more detail under the heading Leaving the cash basis below.

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.

If you are a partner in a partnership, then you must look at the position of the controlling partner (this is a partner who has the right to more than half of the assets in the partnership) to see if you are eligible to use the cash basis. HMRC’s Business Income manual provides further guidance on this.

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 on GOV.UK.

Universal credit claimants

If you are self-employed and claiming universal credit (UC) you can enter the cash basis if your turnover is less than £300,000 for the 2022/23 and 2023/24 tax years.

If you are self-employed and claiming UC then you will need to report your business income and expenses to the Department for Work and Pensions (DWP) on a monthly basis. Unfortunately, universal credit cash accounting is different to the self assessment optional cash basis.

Specific expenses rules

Interest and finance costs

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 and finance 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.

Interest on hire purchase and trade purchases are not included in the annual amount of £500 and can be treated as separate expenses.

Capital equipment

Most capital equipment can be treated as an expense under the cash basis, but this does not include land, buildings and cars (capital allowances can usually be claimed on cars). This means that capital allowances on eligible capital equipment (that is capital equipment other than cars) do not need to be calculated.

Any vehicles (apart from cars) purchased when using the cash basis must stay in the cash basis even if the business then switches to use the accruals basis (so you cannot claim the expense using the cash basis and then include the vehicle in a capital allowance pool).

Trading losses

We explain about the various ways trading losses can be used to reduce your tax in detail on our Trading losses page. Under the cash basis, any trade losses can be carried forward to be offset against business profits in the future. It is not possible to carry losses back to be used against profits made in the previous three tax years (unless your business stops trading) or to use losses against other income earned during the same tax year (known as sideways loss relief) as you can do if you prepare accounts on the accruals basis.

If your business has made losses, then it may not be appropriate to use the cash basis as there are more ways to get tax relief for losses by using the accruals basis.

Leaving the cash basis

If you elect to use the cash basis then you must continue to use it until either:

  • your turnover increases above the exit threshold of £300,000, 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.

Example: Alison

Alison’s business used the cash basis in the tax year 2021/22, but during the tax year 2022/23 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 is £650. By leaving the cash basis in 2022/23 Alison will be able to deduct all of the £650 as a business financing expense under the accruals basis.

After leaving the cash basis, you will have to use the accruals basis unless your turnover becomes lower than £150,000, in which case you can choose to elect to use the cash basis again if you want to.

Changing to accruals basis

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 steps you will need to take to move from the cash basis to the accruals basis are 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. The best way to explain this is by considering an example:

Example: Emilio

Emilio runs a small gift shop and has prepared his accounts to 31 March each year under cash basis rules up to and including his accounts for the year ended 31 March 2022. Points to note regarding Emilio’s accounts for the year ended 31 March 2022, the details from which were included on his 2021/22 tax return:

  1. During March 2022, Emilio made sales of £1,000 but at the year-end only £400 of these sales had been paid for and therefore the business had debtors of £600. When Emilio prepared his accounts for the year ended 31 March 2022, he only included £400 of the March sales, as this was the income he actually received. Emilio received payment for the remaining £600 debt in April 2022.
  2. Emilio purchased some clothes to sell in his shop in March 2022. However, he only paid for this stock in June 2022.
  3. Emilio purchased a new till under hire purchase, which had a capital cost, excluding interest charges, of £1,500 and he had made payments of £400 towards the capital cost of the till by the end of March 2022.

However, Emilio took out a small loan to help with redecoration costs for the premises and as his annual finance costs will now be more than £500 per annum, he decides to move to the accruals basis of accounting for his accounting year to 31 March 2023 onwards. The effect of this on the above is as follows:

  1. 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. Therefore, Emilio needs to account for the income of £600 in 2022/23 even though he is now using the accruals rules because otherwise this income would not be taxed. Emilio needs to increase his sales income in 2022/23 by up to £600, depending on his spreading adjustment (as explained under the heading, The spreading adjustment below).
  2. 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. Emilio would not have included the clothing stock as an expense during the 2021/22 tax year as he 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 2022/23 tax year.
  3. 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 have been 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 capital allowances pool or be fully written down using the annual investment allowance.

Therefore, when Emilio moves from the cash basis to the accruals basis, he will be able to treat the till as an asset qualifying for capital allowances and will claim either the annual investment allowance for £1,100 (which is the total cost less payments made so £1,500 less £400) or include £1,100 as a general pool asset and claim writing down allowances.

The spreading adjustment

When leaving the cash basis, any additional income arising from the move to the accruals basis is spread over six years and taxed 1/6th in each year.  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 it to be in each tax year.

Example: Isha

Isha wants to move from the cash basis to the accruals basis of accounting for her accounting period ending on 31 March 2023. She had sales income of £2,400 from the year ended 31 March 2022 which she had not received by 31 March 2022. She received this income in the first few months of her accounting period for the year ended 31 March 2023 and so this is additional income for 2022/23 by moving from the cash basis to the accruals basis in 2022/23.

Isha’s adjustment income of £2,400 would be taxed equally over six years, so there would be £400 additional income for each tax year from 2022/23 to 2027/28.

The following year, 2023/24, Isha decides she wants to pay tax on the adjustment income as soon as possible so she elects to treat the remaining adjusted income of £2,000 (which is the total adjustment income less the amount taxed in 2022/23 £2,400 - £400) as falling in the 2023/24 tax year which increases her income by £2,000. No further spreading adjustment is made in later years.

Isha must make an election to accelerate the spreading adjustment within one year of the self assessment tax return filing deadline. So, Isha must make her election by 31 January 2026 (one year after the 2023/24 filing deadline).

More information

Our guide to self-employment is intended to supplement the material in this section. We wrote this guide to help advisers (non-tax) who advise low-income self-employed individuals and also for self-employed people who want more detailed information in one accessible place. The guide explains the less common tax rules and contains more detailed information including a case study showing how to prepare accounts and what to include on your 2022/23 tax return when using the cash basis.

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