Cash based accounting for sole traders and partnerships
What is cash based accounting?
Under cash based accounting, a business declares its profits based on its sales receipts less business expenses – there is therefore no need to adjust for prepayments or accruals.
There is also no need to account for stock, WIP or bad debts.
This should make accounting much simpler for sole traders and partnerships.
Cash based accounting: Thresholds
For 2017/18, you can’t start using cash accounting if your business receipts are higher than £150k (2016/17: £83k unless you were a universal tax credit claimant when it was £166k). Your business receipts are combined if you run more than one business.
There is also an exit threshold of £300k for 2017/18 – so if you are currently using cash based accounting you will need to exit the scheme if your business receipts are higher than £300k.
The limits have increased significantly in the 2017/18 tax year as HMRC believe this will make it easier for sole traders and partnerships to meet the new Making Tax Digital requirements.
Cash based accounting: Who can't use the scheme
The scheme is for sole traders and partnerships - although, as with limited companies, Limited Liability Partnerships are not allowed to use the scheme.
There are also certain specific businesses which are not allowed to use cash based accounting as follows:
- Lloyd’s underwriters
- farming businesses with a current herd basis election
- farming and creative businesses with a section 221 ITTOIA profit averaging election
- businesses that have claimed business premises renovation allowance
- businesses that carry on a mineral extraction trade
- businesses that have claimed research and development allowance
- dealers in securities
- relief for mineral royalties
- lease premiums
- ministers of religion
- pool betting duty
- intermediaries treated as making employment payments
- managed service companies
- waste disposal
- cemeteries and crematoria
To use cash based accounting, you simply tick the relevant box on your tax return.
Cash based accounting: New rules for capital expenditure
Whilst the limits for using the cash based scheme have increased significantly in 2017/18, there are more restrictions on what can, and can’t, be claimed for capital expenditure.
From 6th April 2017 no deduction will be available for capital expenditure on:
- A business or part of a business
- Any asset that is not a ‘depreciating asset’ (see below)
- Any asset not acquired or created for use on a continuing basis in the trade
- Land (except for the provision or installation of a depreciating fixture)
- Non-qualifying intangible assets (see below)
- Education or training
- Financial assets
An asset is a ‘depreciating asset’ if it is reasonable to expect that within 20 years:
- It will be at the end of its useful life, or
- Its value will have declined by at least 90%
An intangible asset will be ‘non-qualifying’ unless it is expected to cease to exist within 20 years. Transitional rules are proposed for the first year the new rules apply. You can still claim a deduction in 2017/18 if:
- You would not be allowed a deduction under the new rules,
- But would have been allowed a deduction under the old rules
Whilst cash based accounting may be simpler than invoice based accounting, bear in mind the following:
- If your business makes a loss you will not be able to offset these losses either against other income in the same tax year or against profits from a previous year. You will only be eligible to carry these losses forward.
- Under cash based accounting you can only claim up to £500 in interest and bank charges.
- Accounts drawn up under the cash basis may not be accepted by banks or other lenders if you are trying to get finance for your business. You may therefore still need to prepare accounts using the accrual basis.
- If your business is more complex (eg high levels of stock) then cash based accounting may not suit you.
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