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Cash basis: Opportunities for tax planning

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The shift from accruals to cash-based accounting for the self-employed has caused some uncertainty. Amy Chin explores the implications, challenges and opportunities that have arisen from this change.

7th May 2024
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With the purported goal of simplifying tax returns for many businesses, the Autumn Statement brought a change to the default method of preparing accounts for tax purposes from accruals to cash-based accounting for self-employed taxpayers and partners. This is an automatic switch unless the taxpayer opts to stick with accruals.

This announcement sent frissons of confusion, shock and baffled indignation through the accountancy profession with many suspicious that the government's motive was more around facilitating their much-maligned MTD project than making things simpler for taxpayers.

Mind the GAAP

Switching to the cash basis will not be appropriate for many businesses for myriad reasons. Turning your back on the accruals – appropriately nicknamed 'matching' – concept is likely to lead in many cases to wildly fluctuating bottom lines as expenses are recognised in one year and the related income in another. 

Returns filed using cash accounting will send some taxpayers swinging between tax bands, for example, if income made on credit is severely understated in the year it's earned, only to spring up, taking taxable profits above the next threshold, when the money comes in.

The potentially inconsistent tax bills will make budgeting and cash flow a challenge and could lead to nasty surprises, which in the worst-case scenario might be laid at the accountant's feet.

While the concerns around cash accounting by default are valid, and the vast majority of businesses will (sensibly) opt to stick to accruals, there is potential for upside in some situations which should be closely considered when advising clients.

Simpler to administrate

The government reasons that the cash basis is simpler. Rather than calculating and posting complicated adjustments for accruals, prepayments, opening and closing stock, and capital allowances (to name but a few), accounts can be prepared purely from the bank statements on a cash-in-cash-out basis.

This will undoubtedly make for simpler, swifter quarterly reporting, handily coinciding with the launch of the private beta for making tax digital for income tax (MTD IT as HMRC is now calling it). Not opting out of the cash basis could be an attractive option to anyone concerned about the amount of time required to comply with the additional reporting requirements.  

Dealing with stock is simpler under the cash basis. Instead of time-consuming valuations and stock counts (wave goodbye to FIFO and AVCO), stock will be accounted for at cost when purchased. 

The simplification extends to drawings, as the business owner will account for any stock taken from the business for their own use at cost rather than market value. Much easier to calculate, and easier to prove from an audit perspective, but considerably less meaningful in terms of actual business performance.

Tax planning opportunities

The option to bypass the accruals concept and file tax returns based on cash was always available, but only to businesses with total receipts below £150,000 and with certain other caveats in place – a cap of just £500 on interest deductions; and loss-relief only available to be carried forwards against future profits. The change for 2024/25 removes these restrictions, presenting larger businesses with opportunities for tax planning.

A sole trader or partner sailing dangerously close to, or just above, an income tax threshold in 2024/25 due to unusually low (cash) expenses that year could choose to request that certain customers hold off on settling their invoices until after the year end. Under cash accounting that income would be recognised in 2025/26 and as long as expenses return to the normal level the taxpayer should remain below the threshold in both years.

Similarly, a business with sufficient space in the warehouse might tweak the timing of stock purchases, or pay supplier invoices early to avoid tipping over, for example, the £100,000 cliff edge when the personal allowance taper kicks in.

In a tax year where profits are unusually low, but expected to bounce back the following year, delaying payments to suppliers could keep taxable profits under the next threshold in both years.

Where a business has a substantial chunk of unrelieved capital allowances sitting in the main pool, switching to the cash basis would see the whole amount released as an expense in the transition year, significantly reducing the tax bill that year.

It is, of course, vital to acknowledge that there will be other factors involved in these scenarios including relationships with suppliers and customers and other business needs. Reducing the tax bill should not be the only consideration.

Opportunity knocks

Whether the cash or accruals basis will be most beneficial for the individual taxpayer requires careful consideration and discussion between taxpayers and their agents.

Without sufficient forewarning and planning, the potential for skyrocketing taxable profits (and therefore higher than usual taxes) if the basis is changed threatens to cause friction in the agent/taxpayer relationship.

Opportunities may also present themselves to accountants seeking new business as unrepresented taxpayers, many of whom are already facing a complicated transitional year under basis period reform, may need to seek advice when weighing up the consequences of opting to stick with accruals, or twisting by default to the cash basis.

Replies (4)

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By Justin Bryant
07th May 2024 15:21

All else being equal, if you change from accruals to cash accounting, there is only likely to be a major change in the opening and closing P&L (and hence tax), as the +ve and -ve timing differences required by matching tend to cancel each other out for other operating periods in between (unless the taxpayer does major one-off long term construction projects etc.), so it's no big deal overall in my view and to the extent that's wrong it would be mostly swings and roundabouts (except for the odd bit of tax efficient tinkering as Amy says à la post 5th April Goldman Sachs bonuses - which is probably nothing to get too excited about).

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Replying to Justin Bryant:
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By mumpin
07th May 2024 20:58

I'm not sure what you mean about opening and closing P&L's. Is that year 1 to year 2?
Anyhow, think of someone starting a business (say retail) who needs to invest £30k in stock. Previously they might also have had a tax bill after year 1. It was difficult to explain this to them as they were massively cashflow negative. Now they won't get a tax bill.
Seems a good simplification to me.

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Replying to mumpin:
By Ruddles
08th May 2024 14:44

mumpin wrote:
I'm not sure what you mean about opening and closing P&L's. Is that year 1 to year 2?

No, I suspect Justin was referring to the impact in the first and last P&Ls. As he says, in ordinary course most y/e adjustments tend to cancel each other.

In the majority of cases I would also see this simplification as a good thing.

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By FactChecker
07th May 2024 21:32

A wonderful illustration of the correlation between "The government reasons that the cash basis is simpler" ... and "The government is simple (minded)."

Try explaining almost any of the wonderful new 'opportunities' (so clearly set out above) to either an MP or indeed the average S-E taxpayer ... and then tell them this is a simplification - whilst watching their belief in you as an advisor crumble in front of their eyes.

BTW it's NOT a mere suspicion "that the government's motive was more around facilitating their much-maligned MTD project than making things simpler for taxpayers" ... it was categorically stated (at the PAC shortly before the most recent 'adjournment' of MTD) that it was *essential* to bring in Basis Period reform in order for MTD ITSA to be able to work - and that Cash-basis would make this 'simpler'.

No-one seems to have pushed HMRC on the obvious two follow-up questions:
1. If Basis Period was fundamental, then why was this only discovered 8+ years downstream?
2. What's the trade-off of cash-basis vs simpler + how will MTD work if you stay with accruals?
Certainly I've heard no answers from HMRC ...

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