Sarah Laing looks at how the cash basis may be used for calculating taxable income.
Since 2013/14, certain unincorporated small businesses have been able to choose to use the ‘cash basis’ when calculating taxable income, under which participants are taxed on the basis of the cash that passes through their books, rather than being asked to undertake complex and time-consuming calculations designed for big businesses.
Cash basis limits
When the scheme was first introduced, small businesses could use the scheme if the aggregate of their cash basis receipts in the previous tax year did not exceed the VAT threshold for the year. However, in the Spring Budget 2017 it was announced that the cash basis threshold would be significantly raised, from £83,000 to £150,000. This change has subsequently been enacted and applies for 2017/18 onwards.
The exit threshold above which the cash basis may not be used is set at double the entry threshold. This means that (from 6 April 2017 onwards) the exit threshold is £300,000.
Certain types of businesses are not permitted to use the cash basis, including limited companies and limited liability partnerships.
How does it work?
The cash basis operates by reference to the tax year. This means small businesses can calculate their taxable income for the tax year by adding or subtracting:
- receipts in connection with the business received in the tax year;
- payments made in the tax year to cover allowable expenses; and
- amounts allowed for simplified expenses.
The cash basis operates on a VAT-inclusive basis - the full amount of receipts and payments are counted, including any VAT element. If a business is registered for VAT, any VAT paid to HMRC will be an allowable expense, and any VAT refund received from HMRC will be taxable as a receipt in connection with the business.
It is worth noting that under the cash basis, bank and loan interest costs and financing costs, which include bank loan arrangement fees, are allowed up to an annual amount of £500. If a business has interest and finance costs of less than £500 the split between business costs and any personal interest charges does not have to be calculated. Businesses should review annual business interest costs; if it is anticipated that these costs will be more than £500, it may be more appropriate for the business to opt out of the cash basis and obtain tax relief for all the business-related financing costs.
Tax relief for losses
Businesses considering using the cash basis need to consider the loss relief provisions, particularly where business losses are envisaged going forward.
Under the cash basis provisions, business losses can only be carried forward to set against future profits of the same trade and, therefore, they will not be able to be carried back or set off ‘sideways’ against other income or capital gains. The only exception to this rule is that where a trade has ceased, losses can be set against profits of the same trade for the year of cessation and the three years prior to the year of cessation.
Joining and leaving
Use of the cash basis is optional; but once a business has elected to use the cash basis, they will be obliged to continue to use it until either they are no longer eligible (for example, business income exceeds the annual exit threshold), or there has been a change in circumstances so that it is more appropriate for profits to be calculated in accordance with generally accepted accounting practice and the business elects to calculate profits in that way.
