The UK government held a consultation on cash basis rules in 2023 as part of its wider aim to simplify taxation for small businesses.
Before April 2024 and the new tax year, more than 66% of eligible businesses were not formally using the cash basis, although the government believes many could benefit from its simplicity.
In reality, the number of taxpayers using the cash payment method is likely much higher than reported because the number of taxpayers does not realize that they need to opt out of the standard accrual basis.
The result of simplifying and expanding the cash method should therefore provide a more accurate picture of the use of cash in UK unincorporated businesses.
In this article we explain the cash basis changes introduced on April 6, 2024, which customers will be affected and how you can help your customers.
Here’s what we cover:
What has changed in cash accounting?
The results of the consultation resulted in four main changes.
- Cash basis has become the standard method of calculating taxable profits. Until now, accrual accounting was the standard method. However, after the changes come into effect, companies will need to opt out in order to continue using accrual accounting.
- The turnover thresholds for businesses to use cash have been completely eliminated. The previous limits for businesses meant their turnover had to be under £150,000 to be included in the cash base. And once they reached £300,000 they had to stop using it and move to the accrual basis.
- The previous £500 limit on interest deductions for cash payments will also be removed. This adapts the rules to the accrual basis.
- The previous restrictions on claiming deductions for losses incurred on a cash basis have also been removed, bringing the rules back in line with the accrual basis.
When did the cash basis rules change?
The expansion of the cash bill came into force on April 6, 2024.
Companies affected by the changes
These changes affect all companies without legal personality, i.e. individuals who are self-employed (sole proprietors) or who control a partnership.
These companies now have the opportunity to create an invoice on a cash basis, regardless of their sales.
Should your customers use cash or accrual accounting?
As an accountant, you most likely already use the accrual basis of accounting to prepare your client accounts and will see no advantage in switching to the cash basis.
There are several reasons why accountants should not recommend cash basis to their clients simply because they are now eligible under the new rules:
- If you create monthly management accounts for your client to track their business performance and accounts receivable/accountable positions, switching to a cash basis would make this impossible.
- If your client’s business sells inventory, accrual accounting is necessary to reconcile revenue with associated expenses so that you and your client can track inventory profit margins and get an accurate picture of financial performance over specific periods .
- Third parties such as banks often require accounting prepared in accordance with UK GAAP in order to approve loans and advances. Using the cash basis essentially leaves your client without a balance sheet, preventing them from demonstrating their strength when it comes to borrowing money.
There are certain situations where it is beneficial for business owners to use cash, such as lawyers and barristers who are paid through the legal aid system and may wait years after an invoice is issued before receiving payment.
Under accrual accounting, they would be disadvantaged because they would pay taxes on their income long before they receive it.
In general, however, accountants doubt that removing the turnover restriction on cash-based reporting will encourage more companies to adopt cash-based reporting because they ultimately need the information provided by accrual accounting to make informed business decisions.
It’s more likely that the rule changes will help taxpayers without accountants accurately report their cash accounts.
Most people who create their own accounts use the cash basis because they don’t know there is another option. Regardless of whether they reproduce them correctly or not, they will use them.
How to help your customers with cash basis changes
For customers who currently use the accrual basis and will continue to do so, the only change required when preparing their tax return is to check the box to opt out of the standard cash basis.
No changes are required for existing Cash Basis customers. In fact, creating digital records will make preparing income tax returns even easier under Making Tax Digital, as the quarterly reports will be driven by a bank feed.
For any clients changing their reporting basis, whether from cash accounting to accrual accounting or vice versa, you will need to guide them through the necessary adjustments in the first year of transition to ensure all income and expenses are recorded correctly.
For example, income in the first cash basis year may include amounts received from customer debtors at the end of the previous taxable year.
If your customer sends an invoice on March 30, 2024 and it is unpaid at the end of the year, they have already recognized that revenue under the accrual method.
If the money appears in the bank account on a cash basis in the following tax year, it must be deducted from these accounts, otherwise the income will be counted twice.
Likewise, payments to the customer’s suppliers during the cash basis period may include settlement of amounts owed for purchases made in the previous tax year.
So if the payments are made non-cash from the bank account in the following tax year, they must be excluded, otherwise the expenses will be counted twice.
Further transitional adjustments may be required if:
- Your client had debts to customers at the end of the previous tax year
- Your client held trading shares at the end of the previous tax year
- Your client had claimed capital allowances for the purchase of equipment and there were still allowances to be claimed at the end of the last tax year
- Your customer is VAT registered and has prepared his most recent tax return using sales and purchase figures including VAT
- Your customer used equipment as part of a finance lease
- Your client’s business profits in the previous tax year included other non-cash items such as accrued expenses, prepaid expenses, or prepaid income.
Further information about these transition adjustments can be found in HMRC’s Business Income Manual.
Final thoughts on the cash basis changes
In most cases, it will be a simple decision to continue to prepare customer accounts on an accrual basis, either due to the complexity of the customer’s business or due to third party reporting requirements.
If a customer decides to switch to cash payment to take advantage of its simplicity, it is important that they first understand both the advantages and disadvantages.
Here, your valuable advice will help you make the best decision.
Editor’s Note: This article was first published in February 2024 and has been updated for relevance.