25th July 2024
In April 2024, the UK government implemented significant changes to the cash basis for calculating taxable trading profits for income tax purposes. These changes, outlined in the Finance Bill 2023-24, aim to simplify accounting for unincorporated businesses, potentially benefiting a wide range of sole traders and partnerships.
Overview of the Cash Basis
Under the cash basis, businesses calculate their profits based on actual cash received and paid out, rather than using the traditional accruals method which requires adjustments for receivables and payables at year-end. This method has been particularly beneficial for smaller businesses due to its simplicity, as it eliminates the need for complex year-end adjustments.
Key Changes
As of April 2024, the cash basis became the default method for all eligible unincorporated businesses. Previously, only businesses with turnover up to £150,000 (£300,000 for Universal Credit claimants) could opt for the cash basis. The turnover threshold has now been removed, allowing even larger businesses to utilize this simpler accounting method. However, certain businesses remain excluded, including partnerships with corporate partners, LLPs, and those using the herd basis or making averaging claims.
One of the most notable changes is the removal of the £500 cap on interest deductions. This change allows businesses to claim full interest expenses, potentially leading to substantial deductions, especially given the recent rise in interest rates. This alteration aligns the treatment of interest with that of larger corporate entities, although it remains to be seen if further restrictions might be introduced to prevent potential abuses.
The new rules also expand the options for loss relief. From 2024, businesses using the cash basis can offset losses against general income of the same tax year or carry them back to the three previous years. This provides more flexibility in managing taxable income and could prove beneficial during economic downturns or in the early years of a new business.
Implications for Businesses
For Existing Cash Basis Users
Businesses already using the cash basis no longer need to monitor their turnover to determine eligibility. This removes administrative burdens and allows for continuous use of the cash basis regardless of turnover fluctuations.
For Accruals Basis Users
Businesses that were using the accruals basis need to make an active decision if they wish to continue with this method in their 2024/25 account. Transitioning to the cash basis involves several considerations, including potential transitional adjustments to prevent double taxation or double deductions of income and expenses. Additionally, businesses need to decide how to handle remaining capital allowances pools, particularly for assets like cars which do not qualify for full deduction under the cash basis.
The particular benefit in accounting on the cash basis is that you are only taxed on income actually paid for. This therefore gives immediate tax relief on bad debt and helps to plan year end spending in order to maximise tax reliefs.
Additional Considerations
Despite the simplification offered by the cash basis, larger businesses might still need to prepare GAAP-compliant accounts for other purposes, such as obtaining loans or grants. This could reduce the perceived administrative savings of switching to the cash basis. Furthermore, the lack of alignment between the income tax and VAT cash accounting schemes could create complexities for businesses dealing with both.
The recent changes to the cash basis present a significant shift in how many unincorporated businesses manage their tax affairs. While the removal of the turnover threshold and the enhanced relief options offer greater flexibility, businesses must carefully evaluate the implications to determine the best approach for their specific circumstances.
Please talk to your usual contact at Thompson Jenner to find out how we can help.
