Our experts at DSR Tax Claims know how hard it is to find good, quality information about HMRC’s tax regulations that is easy to understand, and that’s why we have created these handy guides to tell you everything you need to know. Our aim is to make life easier for our clients and that is why we want to share our expertise with you. You can also call our friendly team on 0330 122 9972 – we’re the tax experts you can trust.
What is cash basis accounting?
If you are a sole trader or small business owner, you will need to find a method of accounting for your income and expenses for your business so that you can fill in your Self Assessment tax return. ‘Cash basis’ accounting is a simple method of accounting which can suit small businesses, sole traders and partnerships better than traditional accounting.
With cash basis accounting, you only declare any income or expenses as they come in or out of your business, which means that you won’t have to pay income tax on any money you are waiting to receive but haven’t yet received. You only account for it once it has been received by your business, not when you send the invoice.
Cash basis accounting isn’t suitable for all small businesses. If any of the following apply, you might be better served by using traditional accounting methods:
- If you will be claiming bank interest or bank charges of more than £500 as a business expense
- If you run a complex type of business, for example, if your business holds high levels of stock
- If you have losses which you will want to offset against other taxable income, known as sideways loss relief to HMRC
- If you need to obtain financial backing for your business, for example, asking a bank for a business loan. In these cases, the lender is likely to want to see traditional accounts showing what income you are due and what you owe before they decide whether to loan you any money.
Who is eligible to use cash basis?
Not every business or small trader is eligible to use cash basis accounting. You can use cash basis accounting if the following apply to you:
- If you have a turnover of £150,000 or less per tax year
- If you run a small self-employed business such as a business partnership or sole trader type of business
If you run more than one business, all of the businesses you run must use the cash basis accounting method and their combined turnover still has to be below the £150,000 threshold.
If you use cash basis accounting and your business grows so that your total business turnover is above £150,000, you can still stay with cash basis accounting as long as your total business turnover is less than £300,000 per tax year. If your turnover is above that you will need to use traditional accounting when you submit your next Self Assessment tax return.
Who can’t use cash basis accounting?
Not all small businesses can use cash basis accounting. Limited companies and limited liability companies aren’t eligible to use cash basis accounting. The following types of business are also not eligible to use cash basis:
- Farming businesses with a current herd basis election
- Businesses which have claimed ‘business premises renovation allowance’
- Businesses which carry out mineral extraction
- Businesses which have claimed research and development (R&D) allowance
- Securities’ dealers
- Lloyd’s underwriters
- Religious ministers
- Lease premium businesses
- Cemetery and crematorium businesses
- Waste disposal businesses
- Intermediaries who are involved in making employment payments
- Creative or farming businesses with a section 221 ITTOIA profit averaging election
- Pool betting duty businesses
Businesses who can’t use cash basis will need to use traditional accounting when working out their taxable income for their Self Assessment tax return.
How do you get started with cash basis?
At the end of each year, you need to work out your taxable profit from your cash basis income and expenses records, which should show all the income your business has received and all its expenses. You also need to tick the ‘cash basis’ box on your Self Assessment tax return when you submit it.
You can only use cash basis accounting for tax returns for tax year 2013/14 onwards so if you are submitting a late tax return for years before this, you will need to use traditional accounting when working out your taxable income.
If you want to swap from traditional accounting to cash basis accounting, you might need to seek professional help from a tax professional or legal adviser because there will be certain adjustments you need to make. This includes working out how much you are owed by your customers on the date you switch to cash basis, how much stock you hold on that date and how much you have already paid in expenses for the following tax year. You will also need to calculate how much you owe your suppliers on that date and how much you have received from your customers for work you haven’t yet completed or goods not yet supplied.
How do you record your income and expenses for cash basis accounting?
HMRC will expect you to keep records for all your income and your business expenses so you can work out your profit for that tax year for your Self Assessment tax return. You don’t need to send your income and expense records to HMRC along with your tax return but you do need to keep your records for at least 5 years in case HMRC asks to check them.
When recording your income, you only record it when you receive it. If you are owed that money but you haven’t yet received it from your customer, you don’t record it – even when you have invoiced in one tax year and you don’t receive the money until the following tax year. For example, if you invoiced a customer for work on 1st March 2017 but didn’t receive the money until 27th April 2017, the income should be recorded in your 2017/18 tax return even though it was invoiced during the 2016/17 tax year.
You can decide whether you record when the cash is received or paid (for example, if you are paid by cheque, you can decide whether you record it when you receive the cheque or when the funds enter your account) but you need to use that method each time and for each tax year. All kinds of payment count, whether they were cheque, cash, card, bank transfer or payments in kind.
When HMRC refers to expenses, they are talking about certain business costs which you can deduct from your income to calculate your taxable profit. Your allowable expenses will reduce the amount of Income Tax you owe.
With cash basis, you can only include the expenses you have actually paid for. You don’t count money you owe until you have paid it.
The following are all allowable expenses:
- Your day-to-day running costs, such as electricity, broadband, fuel costs, phone charges and so on
- Your admin costs, such as stationery
- The cost of things that you need to use for your business, such as computers, phones, vehicles or machinery
- Any goods which you buy to resell
- Bank interest and charges up to £500 per tax year.
There are many other allowable expenses, such as clothing expenses or legal costs. The HMRC website gives a full list of allowable expenses. If your business expense is on that list, you can use it to offset the amount of taxable profit you declare to HMRC. The expense does have to be incurred for business purposes though, you can’t claim a personal expense as an allowable expense.
For tax returns for the 2013/14 tax year onwards, you can choose to use the simplified expenses scheme when calculating your business expenses for running a vehicle, working from home or making adjustments if you live in your business premises. These simplified expenses are flat rates which you can use if you don’t want to work out your actual business costs. You can only use these simplified expenses if you are a sole trader or in a business partnership which doesn’t have a company as a business partner.
If you buy a car for your business, you can claim that purchase as a capital allowance although you can’t claim them as a capital allowance whilst also using simplified expenses in your accounts. If you are using cash basis accounting, you claim other equipment (such as computers) as a normal allowable business expense rather than as a capital allowance.
What about VAT registered businesses?
If you are VAT registered, you can still use cash basis accounting as long as your income is below the £150,000 threshold during that tax year. When you record your income and expenses, you can either record them including or excluding the VAT as long as you treat both income and expenses in the same way. If you are including VAT in your expenses, you have to record VAT payments you make to HMRC as business expenses and VAT repayments you receive from HMRC as income.
How can DSR Tax Claims help?
We know that choosing an accounting method can be a complicated affair, even with our helpful guides to tell you everything you might need to know. It’s all very well reading about it and knowing what HMRC’s stand on it is – but how do you apply that to your own circumstances? It can seem like an absolute minefield but help is always available and you don’t need to battle through this alone. Our team of experts at DSR Tax Claims are always on hand to help our clients and our excellent standing with HMRC means that we can make sure you don’t fall foul of their regulations, while claiming your maximum tax relief. We can even take care of all that paperwork and deal with HMRC on your behalf too. Call our friendly team on 0330 122 9972 – we’re the tax experts you can trust.