Unincorporated small businesses will be able to account for their
income and expenditure on a cash basis. To clarify, unincorporated businesses
are sole trader and partnerships. Limited companies are not able to use the
scheme.
What is cash accounting?
Under
the current HMRC system you need to account for income and expenses as they are
incurred. This is known as accrual accounting and can be time consuming for
small businesses. Here’s a very simple example to illustrate this:
Let’s
say you invoice a client for work you carry out for them in March 2012 but the
client does not actually pay you until April 2012 which is when the money
reaches your bank account. You would need to account for this income during the
2011-2012 tax year because this is the period the income was earned, i.e. March
2012.
The
new system will allow you report the income in the period it was received,
April 2012 in this example, which falls into the 2012-2013 tax year and therefore
you will pay the tax on that income later than before.
Small
businesses will no longer need to spend time doing accounting adjustments and
other calculations designed for larger or more complex businesses.
Why is this new system
being introduced?
The
Government’s aim is for a tax system that is simple to understand and easy to
comply with and the objective of this new scheme is to make it easier and
quicker for small businesses to account for their income and expenditure.
Will I pay less tax?
No.
The scheme will certainly make accounting simpler for small businesses but it
does not mean that those businesses will pay less tax. In fact, many businesses
may find that they actually pay more tax! Each individual’s position needs to
be reviewed to establish which system is most efficient based on their own
circumstances.
Can any unincorporated small
business join the scheme?
Small
businesses that are unincorporated and with income of up to £77,000 (the same
as the VAT registration threshold) are able to choose whether to use the
simplified cash based scheme or it – there is a choice and it is not
compulsory. Once you are in the scheme your income turnover can increase up to £150,000
before you have to stop using it and switch to using the normal tax rules.
Any
small business using the new scheme is able to revert back to the existing rules
for calculating taxable profits if it wishes at any time. This is because the Government
have decided against imposing any restrictions on switching in and out of the
cash accounting regime. This could be potentially very beneficial from a tax
planning perspective although the practicalities of changing from one basis to
another would make it seem unattractive, particularly if changing the basis
frequently.
The
main differences of the new system compared to the current rules are summarised
by HMRC as follows:
- No need to understand rules designed for larger businesses
- No need to pay tax until cash is received
- No need to keep complicated records (for example stock, debtors and creditors), over and above those needed to run a business effectively
- No need to understand capital allowances
- No need to keep detailed records for certain key expenses – use a standard rate instead.
What are the pitfalls of
the cash basis scheme?
- Capital allowances cannot be claimed. Expenditure on assets used in a business is allowable under the cash basis but certain types of capital expenditure are still excluded.
- Purchases of long-lasting assets such as cars and properties are not allowable. Business losses can only be carried forward to set against the profits of future years and not carried back or offset against other sources of income as they can currently.
- Interest payments are only allowed up to a limit of £500.
Simplified
expenses
Another element of simplifying income tax for the
small business is “Simplified Expenses”. These are an easier way of calculating
costs associated with running a vehicle which is used for business purposes and
use of home expenses. The new rules allow expenditure to be claimed by using a
simple flat rate allowance, rather than a potentially complex apportionment of
actual expenditure which is how many businesses currently claim for vehicle expenses
and using part of their home for business purposes.
There are three areas where simplified expenses will
apply:
- Expenditure on vehicles – a standard fixed rate allowance can be claimed which will replace relief for actual expenditure on purchasing, maintaining and running a motor vehicle. Any small business using the cash basis must claim this way.
- Use of home for business purposes – optional for those businesses using cash accounting.
- Premises used for both home and for business purposes - optional for those business using cash accounting.
I have more than one
trade – can I still use cash accounting?
Yes
you can although if two separate trades are taking place is the combined income
total of both trades that will determine whether you are eligible to join the
scheme.
So, is it a good scheme?
Overall, the scheme should be very helpful
for small businesses, especially new start-ups. Accounting may become easier for
those businesses but tax planning becomes even more important to establish
which scheme is most tax effective on an on-going basis.
In
reality, I’m not sure how easy it will be to switch from one scheme to another
for practical reasons, particularly for those businesses who have large amounts
of stock to deal with or significant debtors and creditors. Any decision to change to
either scheme is likely to be made respectively and often some months after the
year end so establishing the value stock, creditors and debtors is likely to be time consuming and possibly difficult without
good accounting records.
I would be reluctant to recommend this scheme
to any business other than a very simple, cash based business without any
assets or liabilities. Why? Many small
businesses have significant levels of fixed assets, creditors, debtors and
stock which need greater control in terms of accounting than simply the amount
of cash spent. Also, if a business is growing then surely it’s essential to
have a good set of accounts prepared otherwise how can you be confident that
your business is doing well and review it’s performance?
Any small business owner who has any intention
of applying for loans or mortgages in the future should prepare a full set of
accounts to support their credit application as lenders will not be able to
asset the suitability of the applicant without knowing what financial commitments
that individual has in terms of assets and liabilities.
The cash
basis will increase opportunities for tax planning by delaying receipts and
accelerating payments towards the end of the tax year in order to minimise
profits and therefore tax payable. I am sure that many will take advantage of
these tactics in order to stay below the VAT registration limit to maintain eligibility
for the scheme. This could result in significant loss of tax revenue for the
Government. How is that going to help the UK recovery?
My
final comment is that the restriction of interest up to £500 seems unfair and
that all interest incurred for business purposes should be an allowable
business expense as many small businesses rely on borrowings during the early
years of setting up a business.