When looking to minimise his or her overall tax liability, a sole trader cannot consider the business in isolation – it is also necessary to consider other income and gains in the year, as this will impact on the individual’s tax position and therefore on any tax planning that is undertaken. For example, if the sole trader has already used his or her capital gains exempt amount realising personal gains in the tax year, it may be advisable to delay realising a business gain until the start of the following tax year.
Basis Of Accounts Preparation – Cash Basis v Accruals Basis
One of the decisions that needs to be made is the basis on which the accounts are to be prepared. Sole traders and unincorporated businesses whose turnover (computed on a cash basis) is £150,000 or less can choose whether to prepare accounts using the cash basis or whether to use traditional accounting and prepare accounts using the accruals basis.
Decide which basis of accounts preparation best suits your business.
The Cash Basis
The cash basis is the simpler option. Under the cash basis, the trader need only take account of money in and money out. Income is only recognised when the cash is received. An advantage of this is that it provides automatic relief for bad debts. On the flip side, relief for expenses is only given when the bill is paid, Simplified rules also apply in relation to capital expenditure where the cash basis is used. Unless the expenditure is of a type (such as cars and land) for which is deduction is expressly disallowed, capital expenditure is simply deducted in working out the profits of the business; there is no need to worry about capital allowance (except in relation to cars).
The cash basis will not suit every business. For example, it may not suit your business if you want to claim relief for interest or bank charges of more than £500, as under the cash basis, the deduction for these items is capped at £500. Likewise, the cash basis may not be suitable if you have losses and substantial non-business income and wish to claim sideways loss relief. You may also prefer to stick with traditional accounting if your business is more complex, for example, if you have high and varying levels of stock.
If you decide that the cash basis is for you, you need to elect for it to apply (by checking the requisite box on your tax return). If you are entering the cash basis for the first time, transitional rules apply to ensure that income is neither double counted or slips through the net as you move from the accruals basis to the cash basis, and similarly, that relief for expenses is not given twice or not at all. Once a trader is within the cash basis, they can remain in it as long as their turnover does not exceed £300,000. For universal credit claimants, the cash basis entry and exit thresholds are doubled. If the exit limit is reached, the sole trader will need to move back to traditional accounting.