Gabelle Tax Analysis: Cash accounting for smaller businesses

On 25 May we commented on the consultation document dealing with the proposed new cash accounting scheme for smaller trading businesses. Draft legislation, together with a technical note, was published on 21 December 2012 with a view to the proposals coming into force on 6 April 2013.

Overview

The broad thrust of the original proposals is reflected in the draft legislation:

  • The cash basis will be optional for unincorporated businesses and partnerships (not LLPs) if receipts for the year are less than the VAT threshold (currently £77,000), or twice that (£154,000) for recipients of Universal Credit (for which a monthly return on a cash basis is required for unincorporated businesses).
  • Businesses must leave the cash basis after their receipts exceed twice the amount of the VAT registration threshold.
  • Certain trades are prohibited. These include dealers in securities, managed service companies, and IR35 companies.
  • Receipts for this purpose are inclusive of VAT and include refunds of VAT. Receipts also include payments in kind and disposals of non-durable assets.
  • Expenses are deductible when they are paid, and include the acquisition of non-durable assets. Expenses are inclusive of VAT, and include payments of VAT.
  • There are special rules for certain types of expenditure. There is a simplified basis for expenditure on motor vehicles (which is mandatory) and the use of home, and premises used as both a home and for business (which is optional).

Expenditure on vehicles

Expenditure in connection with cars and motorcycles used for the business is not directly deductible. Instead the business must claim a standard deduction based on business mileage. For cars the business can claim 45p a mile for the first 10,000 miles and 24p a mile thereafter; for motorcycles the business can claim 25p a mile.

The business can opt to use the mileage rate for vans so long as there has been no previous claim for the acquisition of the van as a deduction.

Businesses that do not use the cash basis have the option to use the mileage rates for cars and motorcycles.

Use of home for business purposes

Businesses that use a home for business purposes can opt to use a standard deduction based on the amount of time spent working at home. The rates are £10 for 25-50 hours a month; £18 for 51-100 hours a month; £26 for 101+ a month.

Alternatively, businesses can claim an allowable proportion of actual expenses.

Premises used both as a home and for the business

Where business premises are used partly for private purposes as a home, an adjustment can be made based on the number of occupants using the premises as a home each month. The adjustment is deducted from the actual expenditure. For 1 occupant the deduction is £350 a month, for 2 occupants £500 as month, and for 3 or more occupants £650 a month.

Special rules for loan interest

The general rule is that no deduction is allowed for interest paid on a loan. However, a deduction can be claimed where interest represents part of the purchase cost, for example the interest element of a hire purchase charge. Loan interest in excess of £500 on cash borrowing is not deductible.

Conclusion

The cash basis of accounting will be attractive for many small unincorporated businesses, although the transition into or out of the scheme will need to be managed carefully to ensure that there is no double counting or omission of income or expenditure.

The taxable profit should be easy to understand, as this will relate very closely to the cash position, with automatic relief for bad debts.

There are a number of points that will need to be borne in mind, if an individual is considering opting for the cash basis. First, sideways loss relief is not available for losses arising under the cash basis; secondly, the relief for motor expenses may not be as attractive as claiming all expenses and capital allowances with a disallowances for private use – this will depend on the vehicles concerned and on the number of business miles (rather than on the proportion the private miles bear to the total miles in the year).

Attached is a draft letter for you to use to write to your clients to advise them of these changes.

Paul Howard is a Director at Gabelle LLP. He can be contacted at paul.howard@gabelletax.com or via TaxDesk on 0845 4900 509.