HMRC Cash Accounting – April 2013

HMRC Cash Accounting – April 2013

From 1 April 2013, the self employed have been able to account for their income and expenditure on a cash basis. Limited companies are not able to use the scheme.

What is cash accounting?

Under the previous HMRC system, self employed individuals were required to account for income and expenses as they were 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 2018 but the client does not actually pay you until May 2018, which is when the money reaches your bank account. You would need to account for this income during the 2017-2018 tax year because this is the period the income was earned, i.e. March 2018.

The new system will allow you report the income in the period it was received, May 2018 in this example, which falls into the 2018-2019 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.
Does this mean 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.

Can any unincorporated small business join the scheme?

Small businesses that are unincorporated and with income of £150,000 or less are able to choose whether to use the simplified cash based scheme. You can stay in the scheme up to a total business turnover of £300,000 per year.

The main differences of the new system compared to the previous system 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”.
Simplified expenses are a way of calculating some of your business expenses using flat rates instead of working out your actual business costs. 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 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 may 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.