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TAXguide 04/24: The cash basis for trades: Q&As

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Published: 08 May 2024 Update History

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ICAEW's Tax Faculty hosted a webinar on 18 April 2024 explaining the cash basis for the self-employed, including the changes that apply from the 2024/25 tax year. Answers to questions asked during the webinar are provided in this TAXguide.

At the 2023 Autumn Statement, and following a period of consultation, the government announced that significant changes would be made to the cash basis to enable and encourage more businesses to use it. The changes apply from the tax year 2024/25.

Under the cash basis (Ch3A, Part 2, Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005)), an individual carrying on a trade may calculate their profits on a ‘cash in, cash out’ basis, rather than using the traditional accruals method of accounting. This is simpler for many individuals as it removes the need for year-end adjustments such as the calculation of accruals and prepayments. Up to and including tax year 2023/24, the person had to elect to use the cash basis. For 2024/25, the cash basis is the default basis for many businesses and the person has the option of electing to use the accruals basis. Note that some businesses are excluded from using the cash basis.

Other changes taking effect for 2024/25 onwards include the removal of:

  • the turnover tests. To enter into the regime during the period from 2017/18 to 2023/24 the person’s cash-based turnover from their trade must be £150,000 or less (doubled for Universal Credit claimants) for the year. To stay in the regime, their turnover must not exceed £300,000. These limits are removed for 2024/25 onwards, potentially extending the cash basis to some extremely large UK and international businesses;
  • the cap on the amount of the deduction for finance costs. Up to 2023/24, the maximum deduction for loan interest and incidental costs of finance is limited to £500 per year. This limit is abolished for 2024/25 and subsequent years; and
  • the restrictions on loss relief. From 6 April 2024, a loss calculated using the cash basis may be offset in the same way as a loss calculated on the accruals basis. This means that it will be possible to relieve the loss against other income in the tax year under the sideways loss relief provisions (though note that there are also more general restrictions on the use of sideways loss relief).

For further information, including the pros and cons of moving to the cash basis, see the TAXline article Changes to the cash basis for traders.

On 18 April 2024, ICAEW's Tax Faculty hosted a webinar explaining the cash basis, including the changes that apply from the 2024/25 tax year. A recording of the webinar is available to watch on demand. Answers to questions asked during the webinar are provided below. All legislative references below relate to ITTOIA 2005, unless specified otherwise.

Note: the cash basis rules for landlords and the cash accounting scheme for VAT are unchanged.

Eligibility

Q1: Can you explain a bit more about excluding tax years where the averaging rules or the herd basis apply? Does this mean that you can't make an averaging or herd basis election if you are on the cash basis?

Section 25B says that a trade is an excluded trade where an election under chapter 8 (herd basis rules) or chapter 16 (claim for averaging of fluctuating profits) has effect in relation to the trade for the tax year, meaning that it is not possible to use the cash basis for that year.

Section 221A confirms this in relation to averaging elections by saying, “Nothing in this Chapter applies in calculating the profits of a trade on the cash basis”. Similarly, s111A (in relation to the herd basis) has the same wording.

Under s124(7), “a herd basis election has effect for every period of account in which the farmer— (a) carries on the trade, and (b) keeps a production herd of the class to which the election relates.”

Hence, if you have already made a herd basis election, you cannot then use the cash basis to calculate the profits of the tax years that are subject to the election.

Averaging claims are made for two or five consecutive tax years in which the taxpayer is or has been carrying on the trade, profession or vocation (s222). Hence, it is not possible to use the cash basis to calculate profits for any tax years to which the averaging election applies.

It conversely follows that if you decide to use the cash basis, you cannot make herd basis or averaging elections that would apply to the tax years for which you are calculating profits under the cash basis.

Capital acquisitions/disposals

Q2: Where a piece of plant is sold at a capital profit, is this taxable under the cash basis?

The cash basis works by taxing profits based on the cash coming into and out of the business. It therefore follows that the expenses incurred in buying an asset are deductible when paid and any proceeds received on the disposal of the asset are taxable when received. Where an asset is disposed of for more than it was acquired, the net effect of that is the business owner is taxed on the difference.

There are some exceptions to this. For example, cars are still dealt with in the usual manner under the capital allowances rules (ie, pooled based on the CO2 emissions of the car). The alternative for dealing with cars is to treat the car as being owned by the individual, rather than the business and then claiming a deduction per mile using the business mileage rates (see HMRC’s manuals at BIM75005).

Q3: How are disposal proceeds for vans taxed for the cash basis with varying private use adjustments in previous years?

Section 96A(4)–(6) treat taxpayers as having made a partial or whole disposal of an asset used in their business if the percentage of their business use of the asset compared to total use reduces or falls completely to nil. The deemed disposal proceeds are calculated as the market value of the asset at the time of the reduction times the percentage amount of reduction.

The legislation says that such disposals occur “at any time”. This suggests that if there are multiple reductions in an accounting period, each reduction results in a separate deemed disposal.

However, as there is no requirement to assess any deemed disposals until after the period has ended, it should be possible to take a reasonable approach and consider the period in the round. For example, if there was a steady fall in business use throughout the period, it would seem reasonable to treat the disposal as relating to the total reduction during the year based on the average market value of the asset during the year. However, if there was a particular decision at some point during the year to reduce business usage or increase personal use, then the disposal and market value should be determined with reference to that point in time.

Example

(Reproduced from HMRC’s manual at BIM70020.)

Hugo buys a van for use in his trade on 6 April 2015. The van costs £5,000, which he pays in cash, and the business use proportion is 90%.

Hugo makes up his books to 5 April 2016 – his cash basis expenses will include £4,500 (£5,000 x 90%) for the purchase of the van.

Hugo’s wife starts using the van for weekly supermarket trips in April 2016. Hugo works out that the business use proportion has decreased to 70%. At that time, the market value of the van is £4,000. The amount to be taken into account as a cash basis receipt for the year to 5 April 2017 is the ‘relevant proportion’ of the market value of the van at the time the business use decreased.

The relevant proportion is the difference between the private use before and after the increase, so 30% less 10%.

The cash basis receipt is £800 – 20% of £4000.

There is no corresponding cash basis expense if the level of business use subsequently increases.

Q4: Is it possible to disclaim the cost of acquiring capital assets (eg, to preserve personal allowances)? This could well lead to losing the benefit of buying an asset.

Unless it falls into one of the exceptions set out at s33A, expenditure on capital items is fully deductible under the cash basis. It is not possible to “disclaim” this expenditure, as such, because it is part of the cash basis profit or loss for the year. However, a business is perfectly entitled to manage its finances and defer expenditure into a subsequent period if it would otherwise result in the loss of personal allowances or the creation of unbelievable losses, for example.

Q5: How do the rules work where you acquire an asset that will become a fixture of the building used by the business?

Under s33A(4)(d), no deduction is allowed for an item of a capital nature incurred on, or in connection with, the provision, alteration or disposal of land. However, this does not prevent a deduction being made for expenditure that is incurred on the provision of a depreciating asset which would become a fixture of a building. The exception to this is where the expenditure is incurred on, or in connection with the provision of:

(i) a building;
(ii) a wall, floor, ceiling, door, gate, shutter or window or stairs;
(iii) a waste disposal system;
(iv) a sewerage or drainage system; or
(v) a shaft or other structure in which a lift, hoist, escalator or moving walkway may be installed.

This means that it is not possible to carve out part of the expenditure incurred on purchasing a building or making certain additions/alterations to the building. Otherwise, expenditure on fixtures is fully deductible, despite being capital in nature.

Transitional adjustments

Q6: If a debtor held over from the period under the accruals basis is not received until year two after transitioning to the cash basis, when does the transitional adjustment have effect?

The adjustment is treated as arising on the last day of the first period of account on which the new basis is adopted (s232). Hence, even if the outstanding debtor is not paid in that year, the transitional adjustment is still made in that year. The rationale is that it essentially gets you back to a clean slate straight away so that you are only taxed on amounts you actually receive in the first and subsequent periods under the cash basis.

Q7: How is stock dealt with on transition to the cash basis?

If the previous tax return was prepared on the accruals basis, the taxable profit figure might have been adjusted for the value of stock held by the business at the year end. An adjustment is required the first time a cash basis tax return is prepared, so that the business gets tax relief on the cost of that stock.

Example

(Reproduced from HMRC’s manual at BIM70065.)

At the end of the last tax year before the cash basis, the business had goods that had cost £475 in its year end stock. In working out last year’s business profits on the accruals basis, the £475 cost of that stock would not have been included as an expense. In the first tax year using the cash basis, the business pays £18,000 to suppliers.

If an adjustment was not made in the first cash basis tax return, the business would not get tax relief for that £475. The adjustment is done by adding this to the amounts paid for purchases in the cash basis period.

Transitional adjustment:

  Amount 
Total cash payments to suppliers  £18,000
plus: last year’s closing stock
£ 475
Adjusted cash basis purchases
£18,475

Q8: How do you deal with capital allowance pools on transition into the cash basis?

Capital allowance pools only apply under the cash basis under specific circumstances (eg, to allow for the deduction of expenses relating to the purchase of cars). If a business has a capital allowance pool value outstanding on transition into the cash basis, that balance is allowed as a deduction in the first period under the cash basis.

Example

(reproduced from HMRC’s manual at BIM700657)

A business purchased equipment some years ago. It had been paid for in full and the expenditure had been pooled in the main capital allowances pool. Allowances had been claimed on the balance in the pool. At the end of the final period before the cash basis started the balance in the pool that would have been carried to the start of the new period was £1,545. In the cash basis period, new equipment costing £1,250 has been purchased.

A transitional adjustment is required to ensure the business gets tax relief for the £1,545 that has been spent on equipment in previous periods (this amount has not been relieved for tax because the capital allowances had not yet been claimed).

  Amount 
Amount paid for new equipment in the cash basis period
£1,250 deduction
Transitional adjustment:

Capital allowances not yet claimed
£ 1,545 deduction

Both these amounts are treated as allowable expenses in calculating trade profits using the cash basis.

Q9: What if expenditure is incurred in a period where the accruals basis applies on items that would qualify for capital allowances but neither the AIA nor writing down allowances have been claimed on that expenditure by the time the business transitions into the cash basis?

If the cost of an asset has not been relieved through the annual investment allowance (AIA) and has not been included in a capital allowances pool, deductions for that expenditure will be lost on transition to the cash basis. It is therefore important to pool any remaining expenditure not already claimed for before transitioning to the cash basis so this can be reflected in the value of the pool to be deducted as a transitional adjustment.

Timing of payment/recognition

Q10: If you pay for bills by credit card under the cash basis are those costs deemed paid at that point or when the credit card is paid?

A purchase on a credit card is treated as incurred when it is charged to the credit card, not when the credit card is paid off.

Q11: An asset is paid for by HP. Is it the HP repayments that are counted as the cash payment?

Yes, if the arrangement is to pay for the asset over a series of instalments, each of those instalments counts as a cash expense. It is therefore not possible to claim a deduction for the whole cost of the asset on its original acquisition.

Q12: Are there any anti avoidance provisions in place to stop people manipulating the tax rate appliable to the "income" by accelerating or deferring items of income or expense?

There are no anti-avoidance rules specific to the cash basis that explicitly prevent businesses from accelerating or deferring income and expenses to fall within a different marginal income tax bracket, for example.

Section 106C applies if anything is done in relation to the trade and there is a difference between amounts brought into account in calculating the profits of the trade for the period and amounts that would have been brought into account if that act had been carried out on arm’s length terms. This is primarily in place to make adjustments for the value of goods and other items being taken from the business by the owner for personal use (see HMRC’s manuals at BIM70015). This provision could in theory also be used to adjust transactions with third parties not agreed on arm’s length terms, including agreeing to delay or defer the related income or expense, though this more like to be the case if the transaction was, for example, with a company owned by the business proprietor.

Q13: Are there any rules regarding pre-trading expenses?

The rules at s57 apply to business using the cash basis as well as those using the accruals basis. Therefore, any relevant expenses paid up to seven years prior to the start of trade will be deductible as if they have been paid on the date the trade commenced.

Q14: If crypto or another form of payment-in-kind is received as consideration for the sale of goods or services is this taxable on receipt or only when converted to cash?

Payments-in-kind are treated in the same way as cash receipts and are taxable when received, based on their cash value at that point. If such assets are subsequently converted into cash, a further taxable profit will arise if the item has risen in value while it is held by the taxpayer.

Stock/work in progress

Q15: Is work-in-progress deemed to be the same as debtors and not included in cash basis accounts?

Yes, if income is received from customers to reflect the value of the work done to date then that will be taxed on receipt, but no further adjustments are made for the value of work carried out that hasn’t been paid for.

Tax adjustments

Q16: Are use of home adjustments allowed under the cash basis?

Yes, these are available on the same basis as under the accruals basis. You can find more details in HMRC’s manuals at BIM75010.

Tax return entries

Q17: What happens to balance sheets shown in the tax return on transition to the cash basis?

The requirements for providing a balance sheet are not expected to change. The Self-employment (full) pages of the self assessment return (SA103F) only require an entry at boxes 83–99 if the business has a balance sheet.

Q18: Is it too late to apply for the cash basis for 2023/24 and if not, how do you apply for it?

The election needs to be made by 31 January 2026 (the anniversary of the filing deadline for the return).

Q19: Could a taxpayer file cash-based quarterly MTD accounts and then full accruals accounts at the end of the financial year?

The exact requirements for quarterly reporting under MTD for income tax are still be determined but it is expected that these would not require accruals-based adjustments. As such, they may be the same or similar to the taxable results for a cash basis business with an accounting period that follows the tax year. If a business is following the accruals basis, it would then need to make an end of year adjustment to convert its cash results into a taxable profit or loss calculated under ordinary (non-cash basis) rules.

Foreign taxes

Q20: If you suffer foreign tax on foreign earned income, it will often be the case that the foreign tax payment is made after the end of the accounting period in which the related income is received. Should you accrue for the foreign tax payment to ensure it is matched to the related income?

Relief for foreign taxes can either be given by way of credit relief or as a deduction in calculating the profits.

Credit relief is claimed by completing the foreign pages of the self assessment return and will be unaffected by the timing of the payment of the foreign tax. The credit must simply be matched against the taxable amount included in the self-employment pages.

Claiming foreign tax as an expense under s112, Taxation (International and Other Provisions) Act 2010 is generally advantageous when there is no UK tax payable owing to allowances or losses. Section 112 reduces the income by the amount of non-UK tax for the purposes of the Tax Acts, but does not specifically treat it as a trading expense.

Therefore, the timing of the payment is not relevant to the ability to claim the relief provided that the payment is made before the claim is made by way of credit relief or as a deduction.

Tax Faculty

This guidance is created by the Tax Faculty, recognised internationally as a leading authority and source of expertise on taxation. The Faculty is the voice of tax for ICAEW, responsible for all submissions to the tax authorities. Join the Faculty for expert guidance and support enabling you to provide the best advice on tax to your clients or business.

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