Following a consultation, the cash basis is being simplified and will become the default basis of accounts preparation for unincorporated business from 6 April 2024. What are the implications of this decision for you?
Cash basis v accruals basis
The cash basis is a simplified basis of accounts preparation which only takes account of cash in and cash out. Income is only recognised when received and expenses when paid. There is no need to match the income and the expenditure to the accounting period to which it relates and, consequently, no need to determine debtors and creditors or prepayments and accruals.
As income is only recognised when received, relief is given automatically for bad debts. The rules for giving relief for capital expenditure are simpler too as the expenditure can simply be deducted in calculating the taxable profit unless it is of a type for which such a deduction is expressly prohibited. The main exclusions are cars (for which capital allowances can be claimed instead) and land and buildings.
Pro advice. Under the cash basis, a cap of £500 applies to the deduction of interest and finance costs. The options for relieving losses are more limited than under the accruals basis, e.g. sideways loss relief is not permitted. The cash basis is currently only available to businesses with turnover below the turnover threshold.
The accruals basis is the traditional basis used to prepare accounts. Income and expenditure are matched to the period to which they relate, meaning debtors, creditors, accruals and prepayments must be reflected in the account.
Only qualifying revenue expenditure can be deducted in calculating taxable profit, with relief for capital expenditure being given via the capital allowances system. Relief for bad debts can be claimed.
Change 1 - turnover
To widen the appeal of the cash basis, a number of simplifications are being introduced.
Currently, the cash basis can only be used by unincorporated businesses whose turnover (as calculated under the cash basis rules) is £150,000 per year or less. Once a business is within the cash basis, it can remain in it until its turnover reaches £300,000 per year. Where this is the case, it must return (or move) to the accruals basis from the start of the next accounting period. These limits are doubled for universal credit claimants.
However, it was announced at the time of the Autumn Statement that the turnover threshold is to be removed, meaning that from 6 April 2024, the cash basis can be used by most unincorporated businesses regardless of their size.
Pro advice. The operation of the interest rate cap and the restriction on the use of losses have hitherto acted as a deterrent to joining the cash basis. These limitations are also lifted from 6 April 2024.
Change 2 - interest relief
Under the cash basis, deductions for interest and finance costs are currently capped at £500. With rising interest rates, the cap will affect more businesses, rendering the cash basis unsuitable for them. To address this, the cap is abolished from 6 April 2024, so that from that date unincorporated businesses using the cash basis will be able to deduct interest and finance costs in full.
Change 3 - loss relief
The ability to relieve losses is limited under the cash basis. Under the current rules, sideways loss relief is not permitted. A cash basis loss cannot be set against other income of the current or previous tax year, nor is it possible to carry a loss made in the first four years of the business backwards against income of the previous three years. Relief against capital gains is also denied.
These restrictions are lifted from 6 April 2024, bringing the loss relief options under the cash basis into line with those available where accounts are prepared under the accruals basis.
Pro advice. Clients currently using the accruals basis because of the cash basis limitations should review whether, in light of the lifting of the restrictions, use of the cash basis will be preferable from April 2024.
Elections
Currently, an unincorporated business that wishes to use the cash basis must elect to do so. However, from 6 April 2024 the position is reversed and the cash basis becomes the default basis, unless the trader is an excluded trader (see Follow up ). Consequently, unincorporated businesses that want to use the accruals basis will need to elect to do so. This will normally be done on the self-assessment tax return.
Once an election has been made to use the accruals basis, it applies for the tax year for which it is made and for subsequent tax years unless cancelled (or the trader becomes an excluded trader).
Pro advice. Clients already using the accruals basis who wish to continue to do so from April 2024 will need to elect to do so. The failure to make an election will mean that they will need to prepare their accounts using the cash basis.
Moving between the two
The difference in the cash basis rules and the accruals basis rules mean that some transitional adjustments are needed when moving from one to the other to ensure that income is not taxed twice (or not at all) and that expenditure is not relieved twice or not at all.
Example. If a trader who prepares accounts to 31 March 2024 using the accruals basis undertakes a job in March 2024 for which the customer is invoiced £2,000 on 27 March 2024, the invoice will be taken into account in calculating the profit for the year to 31 March 2024. If the trader does not elect to use the accruals basis for the year to 31 March 2025 and the invoice is paid on 10 April 2024, without adjustment, it will also be taken into account in calculating the taxable profit for the year to 31 March 2024.
Adjustments may also be needed in relation to stock ordered in one year and paid for in the next.
As the rules for relieving capital expenditure are different under the cash basis and the accruals basis, adjustments may be needed where writing down allowances have been claimed under the accruals basis and the capital expenditure has not been fully relieved to ensure that the unrelieved expenditure is deducted under the cash basis.
The transitional arrangements needed on moving between basis are explained fully in HMRC’s guidance at BIM70060ff (see Follow up).
Pro advice. You and any clients moving from the accruals basis to the cash basis will need to identify where transitional adjustments are needed to avoid being taxed twice on the same income.
Planning opportunities
The cash basis offers some opportunities to save tax by accelerating or delaying income and expenditure. For example, if a trader using the cash basis is a basic rate taxpayer in 2023/24 but expects to be a higher rate taxpayer in 2024/25, delaying paying invoices around the tax year end so that they fall in 2024/25 rather than 2023/24 will mean that relief is given for the expenditure at 40% rather than 20%.
Likewise, if the trader is a higher rate taxpayer in 2023/24 and expects to be a basic rate taxpayer in 2024/25, delaying invoicing at the tax year end so the invoices are paid in 2024/25 rather than 2023/24 will mean the income is taxed at 20% rather than at 40%.
If you are using the accruals basis to prepare your accounts you should assess whether a move to the cash basis would be beneficial and identify what areas of adjustment will be needed. If you wish to continue to use the accruals basis be aware that from April 2024 you will need to elect to do so.
Follow up
HMRC Guidance: BIM70060
Excluded traders
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.