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February 9, 2017

Changes to the Cash Basis of Accounting

Upcoming changes to the cash basis are set to simplify the administrative burden for more unincorporated businesses and landlords.

The Current Rules

The Accruals Basis

Businesses are normally required to prepare their accounts according to the UK’s generally accepted accounting principles (GAAP).

This includes ‘accruing’ for income and expenditure; i.e. income is included as it is earned and expenses are deducted as they are incurred.

Example 1

A sole trader with a 12 month period ending 5 April 2016 pays £1,000 on 5 January 2016 for a 12 month insurance policy. The sole trader can only deduct £250 (3 months’ worth) of insurance expenditure on their 2015/16 tax return. The remaining £750 can be included as an expense in their 2016/17 tax return.

Example 2

A landlord charges £700 of rent per month. The current tenant falls into arrears for the last 3 months of 2015/16. Despite not receiving the full rent due, the landlord is still required to declare rental income of £8,400 (12 months’ worth of rent) on their 2015/16 tax return.

The Cash Basis

The cash basis is designed to offer a simpler alternative of accounting for the self-employed and certain partnerships (landlords, LLPs, and partnerships with corporate member are excluded).

Eligible business with total receipts of less than or equal to the VAT registration threshold (£83,000 in 2016/17) can elect to use the cash basis.

Businesses using the cash basis are required to exit the scheme once receipts exceed twice the VAT registration threshold (£166,000 in 2016/17)

The key advantage of using the cash basis is that income is accounted for as it is actually received and expenses are deducted as they are actually paid.

The cash basis also places a number restrictions on the business:

  • Losses can only be used against future trading income.
  • Capital allowances cannot be claimed on plant and machinery (any capital purchases/disposals are included as normal expenditure/income).
  • No deductions are allowed for the cost of cars.
  • Interest (excluding for some leasing arrangements) is capped at £500.
  • The cost of goods taken for personal use is disallowed.

The Proposed Rules

From 6 April 2017, eligible business with total receipts of less than or equal to £150,000 will be able to use the cash basis.

Businesses already on the cash basis will be required to exit once their receipts exceed £300,000.

As part of the government’s Making Tax Digital project, the cash basis will also be extended to landlords. The receipts limits are not expected to apply to landlords.

Further detail on these proposed changes will be included in the Finance Bill 2017 which is due to be published on 20 March 2017.

Contact us today to discuss your tax requirements.
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