Over the past few months I have had the pleasure of working with the HMRC to get to grips with, and hopefully contribute to, some new legislation, which will let the smallest unincorporated businesses choose an alternative accounting method to arrive at their taxable profit figure.
The measures come into force for the tax year ending 5 April 2014 and should hopefully find their way into the Finance Act 2013, alongside today’s other budget changes.
The government has recognised that the self-employed, who are making a vital contribution to the UK economy, are being hindered by complicated tax rules that are only really applicable to larger businesses.
The aim of the legislation is to support entrepreneurs; possibly leaving employment to become self-employed, which is an increasing trend particularly in the last few years, enabling them to start their businesses with far less fear and mystery over tax rules.
Despite whatever the government do however, I would say, in the majority of cases, many self-employed people will still want the support of an accountant, but a simpler, more understandable system should allow these taxpayers to have insight into their tax liability as it accrues rather than in a mad panic at the end of the year.
I will just cover off the scheme at a high level, but further detail can also be found on the HMRC’s own website.
Cash Based Accounting
The draft legislation provides that, for unincorporated businesses (i.e. sole traders and partnerships of individuals), if the annual receipts are under £77K (in line with this year’s VAT registration threshold) they can optionally enter the scheme to use ‘Cash Based Accounting (CBA) to calculate their business profit/loss for income tax purposes. They are able to stay in CBA until their receipts exceed £154K per year, when for the following accounting periods they must use the traditional accruals based accounting.
CBA is more understandable for the business owner. It means worries around stock balances and unpaid invoices all disappear – it’s simply a case of the money in and money out. Businesses will still need to track disallowable expenses, such as entertaining – this does not change and the other thing to bear in mind is that the limits around AIA (Annual Investment Allowance) are removed so assets purchased (excluding cars and motor cycles) can just be accounted for on a cash basis in that accounting period irrespective of their purchase cost. There will be a £500 limit on interest charges that can be claimed and any personal consumption of stock can be accounted for at cost price both for the recognised receipt and the actual payment.
Cash Based Accounting and VAT
The target audience for CBA is non-VAT registered businesses. However, due to voluntary registrations and the level of the exit threshold (which is twice the entry limit) it will be possible to be VAT registered or to become VAT registered whilst also in CBA. Receipts and payments must be accounted for in the normal way – on a VAT inclusive basis for the non-VAT registered and VAT exclusive for the VAT registered.
In addition to CBA, there are also some new options on the way motor vehicles and use of home for business is accounted for. Motor vehicles can either be dealt with as today using capital allowances and actual maintenance and running costs (apportioned for private use) or, under the new rules, using a fixed rate for each business mile travelled. The fixed rate is determined by rules around the total business mileage rates and type of vehicle. For use of home, again there is an option to use apportioned actual costs or a fixed rate based on usage i.e. time spent at home working. There are also some additional rules around use of business premises for private use.
What do you think?
I would be interested in your opinion on this; it certainly has generated a lot of debate amongst the Sage One team and other bodies commenting on this. Personally I feel the aims are right, but am slightly concerned around some of the side-effect complexity, certainly when I consider the accrual based accounting systems already out there and existing practices. Small businesses will still need to provide accounts to financial institutions such as banks that may not be set up for CBA or the simplified expenses methods.
The take up rate will I suspect be slow and will be concentrated on newly-formed businesses, not just because of the entry level threshold, but because of the complexity around change and transition. Accountants also will want to understand which scheme will benefit their clients the best, so there will be a period of evaluation and getting to grips with which types of businesses this will suit.
The HMRC do not want the self-employed or their accountants to consider this scheme in terms of what impact it will have on the tax liability. They see this as a means of simplifying the tax calculation process and legitimising what a lot of self-employed are already doing and understand. I think to some extent this may be the outcome for some, but the natural instinct of an accountant or taxpayer, when making these types of choices is to ask “which method will cost me the least amount of tax?”
In order to limit the temptation to do comparisons each year, HMRC have introduced a rule that once you have elected into the cash basis you will have to stay in it until your business/commercial circumstances change. Will this have the desired effect?
I hope you found this summary useful. As I say, I would be interested in your views, so feel free to leave a comment below. Over the coming days and weeks I will be explaining how our Sage One Cashbook service can be used if you have opted to use the CBA tax scheme I will also get into some detail around the mileage and vehicles and use of home etc.
Sage One Cashbook is perfect for self-employed people using a cash-based accounting system and at just £5+VAT per month is great value, especially when you consider that FREE 24hr telephone and email support is included in the price! Take a closer look at http://uk.sageone.com/cashbook
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