HMRC is consulting on extending the cash basis system

How sensible would this be?

The cash basis accounting system, which was first introduced in 2013/14, allows businesses to declare money at the point it either comes in or goes out of the business rather than by the date displayed on invoices or bills.

It’s an alternative to traditional, accrual accounting and is much simpler to use, yet many accountants are concerned about the method becoming more widespread. That’s because it relies on bank statements rather than strategic, forward-thinking accounting methods which brings deeper understanding and insight into a business.

There are strict limits around the types of businesses that can and cannot make use of the cash basis system. At the moment, limited companies, limited liability partnerships and companies with annual sales or turnover of over £150,000 can’t use this system. Nor can specific businesses including waste disposal companies, those who have claimed R&D allowance and farming businesses with a current herd basis election.

HMRC wants to encourage more businesses to use cash basis accounting and believes there are three million businesses that are already eligible but do not use it as a method.

The proposals set out in the HMRC consultation include:

• Making cash basis accounting a default option for trading income.
• Increasing the turnover thresholds to allow more businesses to use cash basis accounting.
• Relaxing current restrictions on using relief for losses made in the cash basis, which would particularly help start-up businesses.
• Increasing the £500 limit on interest deductions to either £625, £750 or £1,000, reflecting higher borrowing costs since 2013.

HMRC are keen for accountants to share their views and give suggestions on how else the cash basis accounting method can be made more attractive for larger numbers of businesses. The consultation closes on 7 June 2023.

So what do accountants think of these proposals? Why do some businesses use cash basis while others don’t? And what’s behind HMRC’s push to encourage more businesses to use it? We spoke to accountants for their thoughts.

Relaxing cash basis restrictions will make accounts and tax returns easier for small clients

Tom Fisher MAAT, Client Manager, Abbeygate Accountancy

Accountants and clients need to be aware of the potential benefits and limitations of using cash basis. HMRC proposals are around simplifying accounting for small businesses and reducing the burden of record-keeping, which can be particularly helpful for those with limited resources or accounting expertise. The current cash entry threshold is up to £150,000. HMRC is looking to extend this to match the £1.35 million threshold that the VAT cashing accounting has.

Relaxing these restrictions will make it easier to prepare accounts and tax returns for smaller clients, while providing an overview of how the business is running to date based on its ins and outs. It also allows HMRC to gain more accurate returns submitted to them, resulting in lower costs for the Government and, likely, more accurate accounts sent to HMRC due to simplification.

Some businesses use cash basis accounting because it can be eaier, less time-consuming and require less expertise than accrual basis accounting. It can also be beneficial for businesses with irregular income and expenses. Other businesses may prefer the accrual basis of accounting because it provides a more accurate picture of financial performance over time.

Businesses considering adopting cash basis accounting methods should first determine if they are eligible. They should also ensure they are keeping accurate records of cash transactions, separating business and personal finances, and keeping track of outstanding invoices and bills.

Verdict: Relaxing cash basis restrictions will make it easier for small businesses to prepare accounts and tax returns.

Extending cash basis may help streamline taxable profit calculations

Neil Parsons, Managing Director, Wolters Kluwer Tax & Accounting UK

Extending the cash basis is another simplification-focused suggestion and may prove a helpful way of streamlining the calculation of taxable profits for a larger number of businesses, moving the upper limit from £150,000 to £1.35 million. It’s important to note that both the consultations for modernising income tax and expanding the cash basis are open to responses and queries until 7 June 2023. This is a chance for taxpayers and advisors alike to influence the tax framework.

Verdict: Extending the cash basis may be a helpful way of streamlining calculation of taxable profits for more businesses.

Cash basis accounting can help reduce tax liability for businesses

Tom Walker, Partner, Wellers

Extending the cash basis is a really interesting area, with the consultation looking at several options. The first is aligning the threshold with what is currently used for the VAT cash accounting scheme. This means that businesses with a turnover of less than £1.35 million can benefit.

Another suggested avenue is to remove the turnover threshold entirely, which would allow any-sized business to use the cash basis – so long as they are not prevented from doing so for another reason.

Additional options include setting the cash basis as the ‘default’ method of calculating trading income for eligible businesses, increasing the £500 limit on interest deductions under a cash basis, and relaxing restrictions on using relief for losses made under the cash basis.

Fundamentally, the cash basis is a simpler and easier method to calculate tax than traditional accounting methods as it only requires recording money when it comes in and out of a business.

It helps reduce the tax liability of businesses that have long payment terms or slow-paying customers, as they will only pay tax on money received during the accounting period.

This further helps businesses manage their cash flow, as they do not have to pay tax on income that they haven’t received yet; of particular interest to industries such as manufacturing where there is often a delay between supplying the products and receiving payment.

Verdict: The cash basis is a simpler and easier method to calculate tax and can help reduce tax liability of businesses with long payment terms or slow-paying customers.

Making cash basis the default approach for trading businesses won’t sit well with some accountants

Andrew Constable, Tax Partner, Moore Kingston Smith

The cash basis is a significant simplification for trading businesses that choose to make use of it. The potential benefits will increase with the introduction of Making Tax Digital (MTD), as under the cash basis the quarterly update figures will tie more closely with those used in the final tax calculations, meaning quarterly updates could generate a more meaningful understanding of tax liabilities.

The cash basis was introduced with restrictions relating to the deductibility of interest and loss relief, which have never seemed entirely logical. Their removal would be sensible, eliminating a disincentive to join the regime for those who would otherwise benefit.

However, the cash basis won’t be appropriate for all businesses. Some will always prepare their accounts on an accruals basis (such as those with significant stock, WIP, debtors or creditors who need to understand their results in light of these) or because stakeholders require them to. Larger businesses are likely in this position, so increasing the turnover threshold (or removing it) may not make much difference to take-up of the cash basis.

HMRC has suggested making the cash basis the default approach (as has been the case for unincorporated property businesses since 2017). While this could increase take-up, the idea that trading businesses would be nudged into an approach not in accordance with accounting practice won’t sit well with some accountants.

Verdict: Making cash basis the default approach for trading businesses won’t sit well with some accountants.

Encouraging businesses to adopt DIY cash basis methods in lieu of finance professionals is a huge risk

Claire Bartlett, Director, Arden Bookkeeping

HMRC needs to make the benefits of cash basis accounting clearer. My understanding is HMRC is telling business owners ‘you don’t need accountants or bookkeepers, you can do it yourself with cash basis accounting.’

In my view, cash basis accounting doesn’t provide any sort of forecasting – it’s about historical records and bank statements. Cash flow and forecasting are critical to business success – bank statements don’t tell you anything.

It also creates a culture where business owners don’t fully understand their business, because they’re only focused on bank statements. It doesn’t help create the right business mindset and it completely eliminates the forward-thinking, advisory, strategic side of things.

For some very small start-ups, there are some benefits of using cash basis accounting, but this should only be a short-term solution. The accounting function can be daunting, so it can take the pressure off new business owners initially. But from my perspective, accrual accounting is much more strategic, beneficial and effective for business growth.

Ultimately, extending cash basis accounting is part of HMRC’s MTD strategy – they’re doing everything they can to minimise pressure on the department. They’re currently on a path to eliminate as much human interaction as possible in the accounting space. But I think leaving sole traders to do their own accounts opens up the potential for errors, so HMRC will still need to find resources to sort the errors out and send out related communications.

I’ve seen the mess that happens when people try to do accounting themselves and come to us to try and resolve things – so HMRC telling people they can do it themselves will cause more issues later on. It’s a huge risk.

Verdict: Encouraging more businesses to adopt DIY cash basis accounting in lieu of accountants and bookkeepers is a huge risk and will cause more problems later on.

Annie Makoff is a freelance journalist and editor.