The Chancellor has announced that the cash basis is to replace accruals for the self-employed as standard accounting process for 2024/25.
Who will cash basis accounting affect?
The measure will affect self-employed businesses and partners with trading income but will not affect companies or property businesses, or businesses that are otherwise excluded from using the trading income cash basis, such as partnerships with a corporate member, limited liability partnerships, or businesses that have made a claim for farmers’ or artists’ averaging.
Promising to make it “easier for small businesses as they set up and grow” the Chancellor has announced the expansion of the cash basis of accounting to replace the accruals basis for self-employed taxpayers and partnerships from April 2024. This follows a consultation earlier in the year.
Will I have to start my new business on cash basis accounting?
Currently, a business has to elect to use the cash basis, usually through notifying HMRC as part of the Self Assessment tax return. The accruals basis is the default method of calculating profits, and the cash basis is an ‘opt-in’ regime.
This measure changes this to set the cash basis as the default method of calculating trading profits. An election will no longer be required to use the cash basis, and businesses will calculate their trading profits using the cash basis unless they make an election to use the accruals basis.
This is a fundamental change with the potential to create very different profits for a lot of businesses currently using the accruals basis (accounting for income and expenses when earned and incurred). Taxpayers deciding not to opt out of the cash basis will face a complicated transition in 2023/24, on top of the unavoidable basis period reform headache.
Currently, the default position is for businesses to use the accruals basis of accounting to calculate their taxable profit. Businesses with total receipts below the £150,000 entry threshold are eligible to elect to use the cash basis, although many will opt to use the accruals basis, and are forced to leave in certain circumstances where their turnover exceeds £300,000. This measure removes this turnover restriction entirely. The new measures look to turn that process on its head, making the cash basis the default position for all self-employed taxpayers and partners, with an option to elect for the accruals basis.
This move has the potential to tackle one of the biggest stumbling blocks to the implementation of Making Tax Digital for income tax self assessment (MTD ITSA) by allowing taxpayers to turn the data they have readily to hand – bank statements – into the required quarterly reports, rather than having to process accruals-based adjustments to make quarterly data and estimates more meaningful. (By the way, the Autumn Statement revealed that the proposed end-of-period statement under MTD ITSA will no longer be required.)
Although HMRC are selling this as a simplification for self-employed traders it seems pretty obvious that its main goal is remove a serious obstruction in the road to Making Tax Digital. Along with the basis period reform, HMRC are creating digital alignment of trading records so that MTD can operate effectively in calculating quarterly profits and tax liabilities.
Basis period reforms involve moving from the ‘current year’ basis to a ‘tax year’ basis, meaning that business profits will be calculated for the tax year rather than for the period of account (ie their accounting year) ending in the tax year. This would align the treatment of trading income with non-trading income.
The move to this new tax year basis will involve a transitional (catch-up) year for many sole traders and partnerships that do not use 5 April or 31 March as their accounting date. This will advance tax liabilities for many. The original proposal was to make this change from 2023/24, but the change has been delayed until 2024/25, with 2023/24 as a transitional year.
Open to manipulation
Although undeniably simpler to administrate, the cash basis is arguably easier to manipulate than the accruals basis. A taxpayer wanting to massage their figures to push profits into the next tax period can choose to pay their suppliers early, or ask their customers to hold off on settling their invoice for a week or a month to ensure the income falls into the subsequent tax year.
Many professionals are of the view that HMRC should get their software to work properly rather than throwing important accounting frameworks into the bin in the pursuit of their discredited MTD strategy. Another case of the tail wagging the dog?
Should I seek cash basis accounting advice?
Yes, accounting and taxes aren’t simple at the best of times. We believe that ‘requiring’ small businesses to make a ‘rushed’ decision during the business start-up phase will add to the pressure. An accountant can help you understand the full implications of either starting up on cash basis accounting or switching to cash basis accounting. This includes changes in how you recognise income and expenses, and how it may impact your overall financial reporting.
James Murray, Accountant in St Albans said:
“Strategic decision-making is essential for small businesses. Moving to cash basis accounting or starting on cash basis account might seem simple, but will it affect the tax that you pay? In answer, yes, changing accounting periods or using the cash basis of accounting can, for some business, result in paying more tax. It is important to speak to your local accountant as soon as possible to find out the best path forward for your business.”
Moving to the ‘tax year’ basis
We expect this change could have a negative impact for many small businesses in and around St Albans if not dealt with ‘tax efficiently’. Moving to the ‘tax year’ basis could result in an increase their tax burden. However, if managed strategically, this tax burden could be massively reduced. It is important to speak to your accountant about moving to MTD ‘tax year’ accounting period.
James or Chris at Visionary Accounts, St Albans can help. Speak to our team about cash basis accounting or a move to the ‘tax year’ accounting period. Call 01727 730550 or email firstname.lastname@example.org.