Cash basis changes from the 2024/25 tax year

There are two different ways to prepare a set of unincorporated business accounts in order to arrive at your taxable profits: cash accounting or accruals basis accounting.

Simpler accounting (the cash basis) was introduced in April 2013 and is modified in 2024 to make it the default tax accounting method for small business.

Elections

Previously, the accrual basis was the default method for calculating taxable profits, and businesses had to opt-in to use the cash basis. From 2024/25, the cash basis will become the default method, and businesses will need to opt-out if they wish to continue using the accrual basis.

The previous turnover thresholds of £150,000 to join the cash basis and £300,000 to leave the cash basis have been removed entirely. This means that all unincorporated businesses, regardless of their size or turnover, can now use the cash basis for calculating taxable profits.

Who cannot use the scheme

Limited companies and limited liability partnerships cannot use cash basis.

There are also some specific types of businesses that cannot use the scheme:

• Lloyd’s underwriters
• farming businesses with a current herd basis election
• farming and creative businesses with a section 221 ITTOIA profit averaging election
• businesses that have claimed business premises renovation allowance
• businesses that carry on a mineral extraction trade
• businesses that have claimed research and development allowance
• dealers in securities
• relief for mineral royalties
• lease premiums
• ministers of religion
• pool betting duty
• intermediaries treated as making employment payments
• managed service companies
• waste disposal
• cemeteries and crematoria.

No limit on interest deductions

Under the cash basis, interest and finance cost deductions are currently limited to £500. As interest rates rise, this cap will impact more businesses, making the cash basis less viable. To address this issue, the cap will be removed, starting 6 April 2024. From this date, unincorporated businesses using the cash basis will be able to fully deduct interest and finance costs.

Removal of loss relief restrictions

Under the current cash basis rules, the ability to relieve losses is limited. Sideways loss relief is not allowed, meaning a cash basis loss cannot be set against other income from the current or previous tax year. Additionally, it is not possible to carry back a loss made in the first four years of the business against income from the previous three years, and relief against capital gains is also denied.

These restrictions will be lifted from 6 April 2024. From that date, the loss relief options under the cash basis will be aligned with those available when accounts are prepared under the accruals basis.

Transitional adjustments: entering the cash basis

For new businesses submitting their first tax return, no transitional adjustments will be needed. When using the cash basis to calculate trade profits or losses for a tax year, a business is taxed on the amount of receipts less payments within that tax year. If a business previously calculated profits according to generally accepted accounting practice (accruals basis), where income and expenses are accounted for when earned and incurred rather than when received and paid, the first cash basis year might include amounts received from customer debtors who had not settled their debts by the end of the previous tax year.

Similarly, payments made to suppliers during the cash basis period might include settlements for purchases made in the previous tax year.

Transactions like these necessitate transitional adjustments. Without these adjustments, a business would be taxed twice on those sales (once in the previous tax year when the amount was earned and again in the cash basis period when the amount was actually received) and would similarly receive tax relief twice on those purchases.

HMRC provides extensive guidance on transitional arrangements, covering various situations:

• Customer debts: The business had debts owed to it by customers at the end of the previous tax year (see BIM70065).
• Supplier debts: The business owed money to its suppliers at the end of the previous tax year (see BIM70065).
• Trading stock: The business held trading stock at the end of the previous tax year (see BIM70065).
• Unequal cash payments/receipts: The business profits in the previous tax year included items not equally represented by cash payments or receipts, such as accrued expenses, prepayments, or income received in advance (see BIM70066).
• Capital allowances on equipment: The business had claimed capital allowances on equipment purchases, with allowances still to be claimed at the end of the last tax year (see BIM70067).
• Capital allowances on cars: The business had been claiming capital allowances on cars (see BIM70067).
• Instalment payments for equipment: The business has been paying for equipment in instalments, with some instalments left to pay at the end of the last tax year (see BIM70067).
• Unpaid capital items: The business bought capital items and claimed full allowances before joining the cash basis, but did not pay anything until the cash basis period (see BIM70067).
• Business succession: The business is taken over by a successor, with an election under s266 CAA 2001 to treat the equipment as sold to the successor by the predecessor (see BIM70068).
• VAT inclusive figures: The business is VAT registered and prepared its last tax return using VAT inclusive sales and purchases figures (see BIM70069).
• Finance leases: The business used equipment under a finance lease (see BIM70069.

Implications for businesses

These changes will significantly impact unincorporated businesses, particularly those with higher turnover levels that were previously ineligible for the cash basis. The cash basis method is generally simpler and more straightforward, as it recognises income and expenses when cash is received or paid, rather than when invoices are issued or received.

However, businesses should carefully evaluate the advantages and disadvantages of switching to the cash basis, as it may have implications for tax planning and cash flow management. For example, businesses can potentially accelerate or delay income and expenses to manage their tax liabilities more effectively under the cash basis.

Overall, the cash basis changes aim to reduce administrative burdens for small businesses and align with the government's efforts to modernise the tax system through initiatives like Making Tax Digital.

VAT cash accounting scheme

There are no changes to the VAT cash accounting scheme. A business can use cash accounting if it is registered for VAT and its estimated VAT taxable turnover is £1.35m or less in the next 12 months.

However, a business cannot use cash accounting if it:

• uses the VAT flat rate scheme (the flat rate scheme has its own cash-based turnover method)
• is not up to date with its VAT returns or payments
• has committed a VAT offence in the last 12 months, such as VAT evasion.

Additionally, a business cannot use the scheme for the following transactions and must use standard VAT accounting instead:

• where the payment terms of a VAT invoice are six months or more
• where a VAT invoice is raised in advance
• buying or selling goods using lease purchase, hire purchase, conditional sale, or credit sale
• importing goods into Northern Ireland from the EU
• moving goods outside a customs warehouse.

A business must leave the scheme if its VAT taxable turnover exceeds £1.6m.