04/16/2024 | Press release | Distributed by Public on 04/16/2024 17:18
The UK government ran a consultation during 2023 on the cash basis rules as part of its wider focus to simplify tax for small businesses.
Prior to April 2024 and the new tax year, more than 66% of eligible businesses didn't officially use the cash basis, even though the government believes many may benefit from its simplicity.
In reality, the number of taxpayers using the cash method is probably much higher than what is reported because of the number who do not realise they need to opt out of the default accrual basis.
So the result of simplifying and expanding the cash method should create a more accurate picture of cash basis use across UK unincorporated businesses.
In this article, we break down the cash basis changes that were implemented on 6 April 2024, which clients are affected and how you can help your clients.
Here's what we cover:
There are four main changes that have come about from the results of the consultation.
The expansion of cash basis accounting came into force on 6 April 2024.
These changes affect all unincorporated businesses, as in individuals who are self-employed (sole traders) or control a partnership.
Now, these businesses have the option to prepare accounts under the cash basis regardless of their turnover.
As an accountant, it's most likely you are already using the accrual accounting method to prepare your client accounts and won't find any advantage in switching to the cash basis.
There are several reasons why accountants shouldn't recommend cash basis to their clients solely because they are now eligible under the new rules:
There are certain situations where it is beneficial for business owners to use cash basis, for example, barristers and solicitors who are paid by the legal aid system and can potentially wait years after raising an invoice before receiving payment.
Under accrual accounting, they would be disadvantaged by paying tax on income long before they receive it.
But in general, accountants are doubtful that removing the turnover limit on cash basis reporting will encourage more businesses to take up the cash basis because ultimately they need the information provided by accrual accounting to make informed business decisions.
It's more likely that the rule changes will help those taxpayers without an accountant to accurately report their cash basis accounts.
Most individuals preparing their own accounts are using the cash basis because they don't know there is another way, so whether they are reflecting it accurately or not they will use it.
For clients who are currently using the accrual basis and will continue to do so, the only change required when preparing their tax return is to tick the box to opt out of the default cash basis.
For existing cash basis clients, no changes are required. In fact, digital record keeping will make income tax return preparation even easier under Making Tax Digital because the quarterly reports are driven by a bank feed.
For any clients switching their reporting basis, whether from cash basis to accrual accounting or vice versa, you'll need to guide them through the adjustments required in the first transition year to ensure all income and expenses are accounted for correctly.
For example, receipts in the first cash basis year might include amounts received from customer debtors at the end of the previous tax year.
If your client sends an invoice on 30 March 2024, and it's unpaid at year-end, under the accrual method they have already recognised that income.
When the cash appears in the bank account the following tax year under cash basis, it will need to be deducted from these accounts otherwise the income will be counted twice.
Similarly, payments made to the client's suppliers in the cash basis period might include settlement of amounts owed for purchases made in the previous tax year.
So when the payments are made out of the bank account in the following tax year under cash basis, they'll need to be excluded, otherwise the expenses will be counted twice.
Other transitional adjustments could be required if:
You can read more about these transitional adjustments in HMRC's Business Income Manual.
In most cases, it will be a simple decision to continue preparing client accounts under the accrual accounting basis, either due to the complexity of the client's business or because of third party reporting requirements.
If a client decides they want to switch to the cash basis to take advantage of its simplicity, it's important they first understand both the advantages and disadvantages.
This is where your valuable advice will guide them in making the best decision.
Editor's note: This article was first published in February 2024 and has been updated for relevance.