01 February 2013
Simpler Income Tax for the Simplest Small Businesses
Cash Accounting for Small Businesses
From April 2013, cash accounting for tax purposes will be permitted for small unincorporated
businesses (sole traders and partnerships). This cash based income tax system will be available to businesses with turnover (cash income) of up to £77,000 per annum, which corresponds with the current VAT registration threshold. A business can opt in and out of the scheme as it chooses, and once in the scheme a business is permitted to stay within it until annual cash based turnover
There is a higher entry threshold of £154,000 for those reporting their income on a cash basis for the purpose of Universal Tax Credit in order to align the two schemes. The quid pro quo is that a simplified list of allowable expenses such as trading expenses, acquisition of plant and machinery and some interest charges will be deductible, but certain other expenses will not be deductible in calculating taxable profits under the cash accounting scheme.
Please note that not all small businesses are in fact permitted to use this new type of tax calculation. Examples of excluded businesses include farmers or creative artists that have a current averaging claim (or who use the herd basis), financial trading businesses, Limited Liability Partnerships and Limited companies.
Some facts about the cash basis:
- The cash basis must be operated on a fiscal year basis – that is from 6 April to 5 April.
- The taxable profit is the amount of receipts, less allowable business payments, less a ‘simplified expenses’ calculation.
- There are three aspects to simplified expenses:
- A standard mileage rate for business use of cars or motorcycles
- Flat rate expenses for business use of home
- Flat rate adjustment for personal use of business premises
With simplified expenses a business must record how many business miles are travelled each
year by car or by motorcycle, and estimate how many hours are spent working from home.
The standard mileage rates will be mandatory for cars and motorcycles, but could also be used
for other vehicles such as vans. This will not however be possible if a claim has already been
made for a vehicle under the capital allowances regime.
A flat rate expense for business use of home would provide a deduction either as a single flat
rate or on a ‘three tier’ basis. A similar adjustment for personal use of business premises needs
to be made if applicable, which will be based on a three tier banded flat rate adjustment to
actual costs, which is supposed to reflect private use of the premises.
- Unless there is a material element of private use, it is proposed that telephone and internet costs should be allowed in full.
- HMRC will review and update current guidance on subsistence costs for small businesses where there are costs incurred in travelling away from the base location.
- Instead of apportioning the cost of stationery and related items, HMRC have proposed that estimates should be made of business costs, for example on a ‘per letter’ basis.
There are many potential complications with the proposed cash accounting system. These include
consideration for reductions in business use of assets, transactions which are not entered into on an arm’s length basis, receipts which are in the form of ‘money’s worth’ being treated as income and also exclusions to interest costs on borrowing.
Furthermore it is proposed that the figures will operate on a VAT inclusive basis, and any VAT paid to HMRC is to be treated as an expense, and any VAT repaid to the business is to be treated as income. This would obviously combine well with the flat rate accounting scheme for VAT, and it should be noted that use of the cash basis for VAT accounting is a condition of the scheme.
There is further guidance (and restrictions!) on the ability for a business to claim relief for losses or
rather, excess expenditure; it has suffered on the basis of cash accounting.
It is probably safe to say that the term ‘simplified’ being used to describe this scheme may not be accurate. In fact, in order to make an informed choice about the appropriate set of rules to use, small business owners will need a clear grasp of some quite complex issues. Otherwise, use of cash accounting could potentially increase the income tax liability for a small business.
If you would like to explore the potential impact of the cash accounting scheme on your business, please contact your local Wilkins Kennedy advisor.
t: 01784 435561