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HMRC wants more businesses to use the cash basis

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Changes are needed if the proposed amends to the cash basis are to improve the experience of MTD ITSA for some sole traders.

23rd May 2023
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Proposed changes to the cash basis will make little difference unless the restrictions around interest deductions and loss claims are amended, say the Association of Tax Technicians (ATT). 

In 2012 the Office of Tax Simplification (OTS) called for small unincorporated businesses to be permitted to calculate their taxable profits using the cash basis instead of using accruals accounting. In truth many microbusinesses had been using cash-based accounting for years, as few bothered with the fuss of prepayments and accruals, unless challenged by their accountant or HMRC.

The OTS proposed limiting the use of the cash basis to unincorporated businesses with a turnover of no more than £30,000, but when the measure became law in 2013 this simplification was extended to any unincorporated business with a turnover of up to the VAT registration threshold. That turnover limit was raised to £150,000 in 2017 and businesses are permitted to carry on using the cash basis until their annual turnover exceeds £300,000.

Low take-up

HMRC estimates that up to 4.2m unincorporated businesses are now eligible to use the cash basis but only 29% of those businesses take advantage of that simplification. 

HMRC is consulting on ways to expand the cash basis in order to encourage greater take-up among self-employed businesses. 

The proposed changes include:

  • increasing or removing the turnover limits 
  • making the cash basis the default option for unincorporated businesses, as it is for individual landlords
  • increasing the £500 annual cap on interest and finance deductions (the cap doesn’t apply to landlords)
  • removing or relaxing the restrictions on loss relief, which currently only allow losses to be carried forward to set against profits of the same trade. 

Barriers to cash

The ATT feels that removing the turnover limits for using the cash basis, or even making it the default option, will not significantly increase take-up as there are three more fundamental barriers to its use. 

  1. Interest relief 

The current interest relief limit of £500 was set at the introduction of the cash basis in 2013, when the Bank of England base rate was 0.5%. The consultation paper suggests increasing this limit to between £625 and £1,000.

As the Bank of England base rate is now 4.5% the ATT argues that the interest relief limit should expand accordingly to between £5,000 to £10,000 per year. The Chartered Institute of Taxation (CIOT) suggests removing the interest restriction would be a better solution. 

  1. Loss relief 

New businesses often make a loss in their first few years of trading. The ability to offset these early losses sideways against other income in the same year, or to carry it back, provides some vital support for young businesses. The ATT would support the introduction of sideways loss relief under the cash basis, subject to the general loss reliefs cap in s24A ITA 2007. The CIOT believes that removing the loss restrictions altogether from the cash basis would be a positive change. 

  1. Trust and education 

Lenders such as banks often require their customers’ accounts to be drawn-up on an accruals basis to present a truer measure of the profitability of the business. This may be a false perception by those lenders as the cash basis can provide an accurate view of the health of the business over an entire year.

Many taxpayers may be ignorant of the benefits of the cash basis and how this accounting treatment fits with stock valuations or private use adjustments. The ATT suggests that more extensive HMRC guidance with examples to illustrate key points may encourage take-up of this simplified form of accounting. 

Is the cash basis necessary for MTD? 

The last question in that consultation asks for views on whether encouraging or expanding the cash basis will improve sole traders’ experience of Making Tax Digital for income tax self assessment (MTD ITSA). That is possibly the key reason behind the perceived need to expand the take-up of the cash basis. 

The quarterly updates required under MTD ITSA will be prepared on a cash basis, with no accounting adjustments for accruals until the end-of-period statement (EOPS) is submitted. The tax liability that will be reflected back to the taxpayer each quarter will be based on the quarterly cash figures. Where the business uses accruals accounting there could be a big difference between the total of tax reflected back to the taxpayer by HMRC and the actual tax liability for the year as calculated from the EOPS. 

The ATT believes that expanding the cash basis could improve the experience of MTD ITSA for some sole traders but using the cash basis does not remove the extra hassle and cost of the need to acquire MTD-compatible software and report to HMRC quarterly instead of once per year.

Replies (28)

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Tornado
By Tornado
23rd May 2023 18:21

Where the business uses accruals accounting there could be a big difference between the total of tax reflected back to the taxpayer by HMRC and the actual tax liability for the year as calculated from the EOPS.

A brilliantly subtle way of saying that Quarterly Returns are pointless.

Thanks Rebecca

Thanks (22)
Replying to Tornado:
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By Hugo Fair
23rd May 2023 21:34

"The tax liability that will be reflected back to the taxpayer each quarter will be based on the quarterly cash figures" ... is just one of the reasons why MTD (at least the QUs) must NOT be allowed to happen.

It doesn't matter what clever words the CS legal beagles find to attach to that 'quarterly forecast' coming back from HMRC, there will be situations where businesses and people end up bankrupt just because they believed that 'forecast' (and many more where they claim that to have been the cause).

PII for HMRC anybody!?!

Thanks (4)
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By Open all hours
23rd May 2023 19:46

Sure they do. They’d love us to think that their low standards are somehow acceptable.
Separate accounts for the bank, mind.

Thanks (3)
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By Hugo Fair
23rd May 2023 21:25

WHY (does HMRC want more businesses to use the cash basis)?

All other questions have a degree of superfluousness to them ... alongside some opinions with a rather obvious dollop of self-interest.

If you forget MTD (please), I can see no obvious benefit for a business in using the cash basis - except for those with a small turnover and where neither stock nor pre-sold service liabilities are part of the equation (i.e. where accruals aren't bringing much change to the table).

And it's really easy if you're accounting on an accruals basis to, in addition, run cashflow such that you're getting the equivalent of cash basis (but with potentially useful 'forecasting' off the back of it).
What is not so easy is to maintain your primary records on the cash basis, but then prepare accruals basis on top ... which is resource intensive if done quarterly or even monthly, but hardly helpful if left to the end of the year.

As an old boss used to say (in a slightly different context): "Do the hard bits properly and everything else becomes easy; but try to do the easy bits first and the hard bits may become impossible".

Thanks (9)
boxfile
By spilly
23rd May 2023 22:32

We’re finding that once the smaller businesses start to use software like Xero and Quickbooks, they are starting to just post from the bank feeds instead of entering supplier invoices and matching the payments to those.
Sales invoices are issued as normal though so not a true cash basis.
Maybe this is what HMRC is driving at - more use of ‘easy’ software, instead of correct accounting standards.
And we note that cash is very rarely recorded at all so potential for underreporting there.

Thanks (13)
By ireallyshouldknowthisbut
24th May 2023 08:53

One wonders if HMRC actually ever think for a minute there might just be more than one reason for doing your bookkeeping, other than paying taxes.

Such as, er, working out your businesses profitability?
I mean, what small business wants to do that!!!!

Sheesh.

There is also the issue of consistency. Cash basis will mean profits all over the place year to year which often means more tax (bouncing in and out of HR) and making it harder to get mortgages. Accruals at least matches reality a lot more and tends to be smoother in general.

This all comes from the massive overreach of HMRC as one user of small business accounts trying to dictate not only the method of preparation but whole basis of it.

HMRC need to wind their necks in here and get back to tax, and let accountants and bookkeeper deal with accounts and bookkeeping. HMRC just embarrass themselves every time they step outside of tax. Indeed they embarrass themselves when talking about tax, but at least it is their area. In theory.

Thanks (20)
Replying to ireallyshouldknowthisbut:
Tornado
By Tornado
24th May 2023 09:26

What about all the wildly varying cliff edges possibly at £10,000, £30,000, £50,000, £85,000.

It is bad enough keeping an eye on the VAT Registration Limit, but if any more limits are going to be introduced, I do wonder how this is going to be monitored by HMRC and will they have the resources to deal withe all the associated fines, penalties, interest and of course, appeals, that this sort of situation creates. I think this will apply more to the Cash Basis than Accruals as Cash Income will vary wildly with people falling over a cliff edge one day and jumping back on to it the next.

Those that dreamed up all of this chaos really are a bunch of Numpties.

Thanks (8)
Replying to ireallyshouldknowthisbut:
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By adam.arca
24th May 2023 09:30

ireallyshouldknowthisbut wrote:

One wonders if HMRC actually ever think for a minute there might just be more than one reason for doing your bookkeeping, other than paying taxes.

Such as, er, working out your businesses profitability?
I mean, what small business wants to do that!!!!

Sheesh.

There is also the issue of consistency. Cash basis will mean profits all over the place year to year which often means more tax (bouncing in and out of HR) and making it harder to get mortgages. Accruals at least matches reality a lot more and tends to be smoother in general.

This all comes from the massive overreach of HMRC as one user of small business accounts trying to dictate not only the method of preparation but whole basis of it.

HMRC need to wind their necks in here and get back to tax, and let accountants and bookkeeper deal with accounts and bookkeeping. HMRC just embarrass themselves every time they step outside of tax. Indeed they embarrass themselves when talking about tax, but at least it is their area. In theory.

This. Exactly this.

Just to pick up one point made by the ATT that the cash basis *can* (my emphasis) provide an accurate basis for accounts over a whole year, it should be obvious that “can” doesn’t mean “will.”

Sometimes the cash basis can provide consistent and comparable figures but more often it won’t.

Some businesses may be suitable for cash accounting, more won’t.

So what is the point of introducing an alternative to accruals accounting (which will always be consistent over businesses and over years within a business)? That has always seemed to me to be adding complexity and not simplifying at all.

And, yes please Mr HMRC, please get over yourself and realise that you’re merely a cog in the wheel of UK plc and not the end goal of all this effort by traders and their accountants.

Thanks (8)
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By S Roalf
24th May 2023 09:53

There is a further difference between cash and accruals basis around capital allowances. Why does HMRC want our clients to use cash basis?

Thanks (3)
Replying to S Roalf:
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By NotAnAccountant2
24th May 2023 10:01

S Roalf wrote:

There is a further difference between cash and accruals basis around capital allowances. Why does HMRC want our clients to use cash basis?

Because it's easy to automatically verify.

HMRC gets the bank feed from the bank, adds up the income, deducts the outgoings and calculates the profits. Open an investigation when they don't match what's reported on the tax return.

It's a no brainer, what could possibly go wrong?

Thanks (8)
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By jamiea4f
24th May 2023 09:56

Can we just agree that HMRC is a shambles and all these "improvements" will do is push more people away from complying. I'm guessing that however flawed the current system is most people will agree that it works, from what I can see this new proposal will just irritate people, including agents. Pointless waste of money.

Thanks (9)
By JCresswellTax
24th May 2023 10:11

We want HMRC to reply to letters, answer the phone and generally be better.

We don't always get what we want!

Thanks (21)
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By petestar1969
24th May 2023 10:33

This amuses me.

HMRC are very keen on the "cash" basis of accounting but still get confused when you say that a client bought a piece of kit for cash (instead of on credit), as they believe "cash" means a suitcase stuffed with bank notes...

Thanks (1)
Replying to petestar1969:
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By unclejoe
24th May 2023 10:55

"Suitcase" is far too posh. In my line of business cash means hidden under the crowbar and anglegrinder in a toolbag!

Thanks (3)
Replying to unclejoe:
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By Hugo Fair
24th May 2023 11:27

I thought that's where you found trace elements of the last inspector to ask one too many question!

Thanks (4)
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By Sue Murby
24th May 2023 11:34

Most of my clients are, i suppose, on a cash basis, purely because they pay their bills immediately. They don't have accounts with suppliers but may use credit cards. I enter the items on the credit card statements including say September statement which is not due for payment until October. To my mind that suggests an accruals basis. Also I accrue for my fees.

Furthermore many of them will have stock - that also is using an accruals basis. Some of them will buy large amounts of materials if they planning for a future exhibition or trade fair. The outgoing costs would be incurred in one year with the sales being made in the following year.

What worries me is the use of loss relief. Some clients have other sources of income and any loss may be set off against that. To be obliged to just carry losses forward is wrong in my opinion.

No mention of artists' averaging so can I assume that still applies?

Thanks (1)
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By tedbuck
24th May 2023 12:56

I really don't understand HMRC.

The people who will jump at the chance of cash accounting are those who get paid in arrears - most of us. So if we have £50,000 of debtors we won't have to pay until we are paid. So what would I do? I think I would issue all my invoices in month 12 and as few would be paid there would be no tax before the next 31st January - great as by then I shall have closed down and moved on.
Boy - are they Numpties - HM Rubbish and Custard!
As someone else said at least they won't have to disclose cash receipts as they are not digital so won't show. Thank goodness now we can say goodbye to the 'card only' people. I have noticed a proliferation of 'cash only' signs so I guess Jo Public is ahead of me - back to the good old days! Numpties doesn't even begin to describe them!

Thanks (4)
Replying to tedbuck:
By Nick Graves
24th May 2023 16:39

tedbuck wrote:

I really don't understand HMRC.

The people who will jump at the chance of cash accounting are those who get paid in arrears - most of us. So if we have £50,000 of debtors we won't have to pay until we are paid. So what would I do? I think I would issue all my invoices in month 12 and as few would be paid there would be no tax before the next 31st January - great as by then I shall have closed down and moved on.
Boy - are they Numpties - HM Rubbish and Custard!
As someone else said at least they won't have to disclose cash receipts as they are not digital so won't show. Thank goodness now we can say goodbye to the 'card only' people. I have noticed a proliferation of 'cash only' signs so I guess Jo Public is ahead of me - back to the good old days! Numpties doesn't even begin to describe them!

Don't forget to pay your 12-month's contract hire deposit on your new car and all of your annual trade subscriptions on that last day - it's gonna be a busy one for you!

Creative accounting is BACK!

Thanks (0)
Replying to Nick Graves:
Tornado
By Tornado
24th May 2023 16:49

Cash (and bartering) is not digital

An interesting observation which no doubt enables limitless scope for new business strategies to many.

HMRC are going to find that MTD will let them down in this area.

Double Numpties.

Thanks (3)
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By Yossarian
24th May 2023 13:04

Why not go one step further and use the Henry Ford basis? Ford considered bookkeeping and accountancy to be a total waste of time. His idea was when a customer pays you, you put the cash in a barrel. When a supplier needs paying you take cash out of the barrel and pay them. At the year end you weigh the barrel and if its heavier than last year you've made a profit, but if its lighter than the previous year you've made a loss. If a supplier comes to you for payment but the barrel is empty, oops you've just gone bust.

Thanks (3)
LL
By RickyRoark
24th May 2023 15:55

Reading through some of the comments and people seem to misunderstand the role of HMRC.

They do not exist to help accountants or the taxpayer. They exist to further their own growth and power.

They want to switch to a cash basis so they can collect tax as a % the moment your money hits your account. They do not care about you. They do not want accurate tax.

They are parasites wanting a salary. For reference: Twitter has less than 2,000 staff, has billions of interactions per day and has a slick/easy user interface. HMRC has 66,000+ employees, a terrible user interface for seemingly 100 different logins and cannot respond to you for months.

Thanks (7)
Replying to RickyRoark:
Chris M
By mr. mischief
24th May 2023 22:47

Whilst your post is mostly accurate, twitter is noticeably more rubbish since the Chief Space Cadet overpaid for it.

Thanks (0)
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By Crouchy
24th May 2023 15:56

HMRC want more cash basis as they probably think they'll have a higher tax take - spiked profits in a receipt heavy year will see more tax payers falling into higher rate tax, bigger POA's, child benefit claw back etc

In reality most will be wise to it and will spend heavily to lower their tax - many businesses won't have a clue how well they are actually doing and will spend (probably overspend) just to save tax

there won't be any winners in this situation

Thanks (0)
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By Michael C Feltham
24th May 2023 17:54

I've just spotted one anomaly.

It is a fact that HMRC's IT systems swap data, between Income Tax returns and VAT returns.

Indeed, some years back we had an idiot client who, despite my repeatedly warning him that his turnover was approaching the then VAT threshold for compulsory VAT registration, he ignored my (written) warnings and was eventually jumped on and firstly forced to register and then fined for failing to do so.

Now it is a fact supplier's invoices carrying an input charge, can be included in a VAT period return and the input tax offset against the output tax; EVEN THOUGH they have not as yet been paid. The criterion is the Tax Point.

Thus a trader adopting Cash Accounting, will find that there is a disparity between his VAT returns and his tax returns!

Thus HMRC are setting a trap for themselves...

Thanks (3)
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By Mr J Andrews
25th May 2023 09:21

......to improve the experience of MTD ITSA for some sole traders.........
What a joke . When the same traders aren't even aware of this wonderful experience.

Thanks (1)
Morph
By kevinringer
27th May 2023 15:51

Can HMRC please explain why:

..on the one hand, HMRC wants "simplification" such as cash basis and 3-line P&L..

..yet at the same time the very same HMRC wants to introduce unnecessary complexity of basis period reform and digital record keeping?

Thanks (0)
Morph
By kevinringer
27th May 2023 16:09

HMRC needs a reality check over the £500 interest restriction for cash basis because what I hear, the unrepresented using cash basis interpret it as total expenses, and claim the capital repayments too as an expense. Yes, I know that isn't correct. But if HMRC tell the self-employed that this is a simplification, then the self-employed are going to think that means it must be simpler than the current unrestricted interest-only. A restriction of £500 is not simpler. So the self-employed deduce the only simplification is gross repayments. This is a consequence of introducing a "simplification" when the "traditional" method still exists, because not only do we have 2 different methods in operation, we also have the transition rules from "traditional" to "simplification" and back. So that means we wend up with 4 different systems instead of 1. Yep, that's simplification in HMRC's eyes.

Thanks (0)
Morph
By kevinringer
27th May 2023 16:16

To add further complication to the £500 restriction, BIM70040:

"Payments of interest on purchases are not subject to the £500 limit, provided the purchase itself is an allowable expense, as this is not cash borrowing. For example, trade credit charged by suppliers of goods or services, interest charges for hire purchase or leasing of plant or machinery and credit card interest on allowable purchases are allowed in full."

My reading of the above is that if a sole trader used £20,000 of their overdraft to buy a van, that interest would not be subject to the £500 restriction. But if their overdraft fluctuated because it also financed working capital, then that element would be subject to the £500 restriction. But not if the working capital was used for purchase of goods or services. Does that mean we have to identify how the overdraft has been used so that the non-purchase element interest charge can be calculated for the sake of the £500 restriction? How can HMRC consider this a simplification? It's even more complex than the "simplification" of basis period reform. Whoever devises these "simplifications" within HMRC needs to get into the real world to see just how complex these actually are.

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