Operating as a Sole Trader or Partnership
Your business may qualify to use cash basis accounting procedures – a way of working out income and expenses for Self Assessment tax returns.
Reasons to use Cash Basis
In most cases, cash basis and accrual basis are simplified methods used for business accounting and record keeping.
Note: Running a small business on the cash basis accounting system may suit you better. If not, you must use the traditional accrual basis of accounting instead.
The cash basis method is much simpler for working out business taxes and finances. You only declare money when it actually comes into, and goes out of, the operation.
Why is this important?
This is a big advantage for small businesses – especially at the end of the financial tax year. You do not need to pay Income Tax on revenue unless you receive it in your particular accounting period.
Reasons Not to use Cash Basis
There are situations where cash basis accounting procedures will not suit a business. As a rule, the process is unlikely to benefit an organisation if it:
- Needs to secure finance. The lender may want to see a full set of accounts drawn up using traditional accounting. Banks will want to see what the company owes and what is due before agreeing to a loan.
- Wants to claim bank charges or interest over £500 as allowable expenses.
- Has losses to offset against other taxable income (called ‘sideways loss relief’).
- Runs a complex business operation (e.g. high volume levels of stock products).
Note: Always discuss your situation with a tax professional if you need help. Contact an accountant or a legal adviser for expert advice about business accounting.
Cash Basis Accounting Eligibility Criteria
Your small business can only use cash basis accounting procedures if:
- It operates a self-employment system (either as a sole trader or a partnership).
- The turnover is not more than £150,000 per year.
What if you are running more than one business on the cash basis scheme? In this case, you must run them all on the same program. But, note that the combined turnover of all the businesses must not go over £150,000.
Using Cash Basis when the Business Grows
If the business expands you can continue using the scheme. But, only while the total business turnover stays at £300,000 (or less) per year. If it goes above £300,000 you must start using traditional accounting in the next tax return.
Who Cannot use Cash Basis Reporting?
Cash basis accounting rules do not accept limited companies or limited liability partnerships. Some specific types of business operations do not qualify for the scheme either, such as:
- Businesses that carry out a mineral extraction trade
- Businesses that have already claimed research and development allowance
- Businesses that have already claimed business premises renovation allowance
- Cemeteries and crematoria
- Certain types of farming businesses with a current herd basis election
- Dealers in securities
- Farming and creative businesses with a section 221 ITTOIA profit averaging election
- Intermediaries treated as making employment payments
- Lease premiums
- Lloyd’s underwriters
- Managed service companies
- Ministers of religion
- Pool betting duty
- Relief for mineral royalties
- Waste disposal
Note: Use traditional accrual accounting if you are ineligible for cash basis. Read ‘How to calculate your taxable profits: HS222 Self Assessment helpsheet‘ for advice.
Start Using Cash Basis Accounting HMRC
Make the calculations at the end of the tax year. You should work out the taxable profit from cash basis income and expenses records. Select the ‘cash basis box‘ on the form when you send in your tax return.
Note: You can only use cash basis accounting for the 2013 to 2014 tax year onward. What if you send a late tax return for tax years before 2013? You must use traditional accounting to calculate your accounts for any previous years.
Change from Traditional Accounting to Cash Basis
You can switch from traditional accounting to cash basis. But, you may need to make some adjustments when you make the change. You can get further information on the HS222 helpsheet or from a tax professional.
Recording Cash Basis Income and Expenses
You have responsibilities for keeping business records and paperwork if you are self-employed. You need records of income and expenses to work out profit margins for the tax return.
How to Record Income
Cash basis reporting means you only record the income you actually received in the tax year. You do not need to record any ‘owed money’ until you receive it.
You wrote an invoice on the 19th of March 2021 for a customer. But, the business did not receive the money until the 19th of April 2021.
Thus, you would record this income in the 2021 to 2022 financial tax year.
Cash basis accounting rules allow you some choice on recording the money. You can record it on the date the money enters your account or on the date that a cheque gets written. But, whichever one you choose it must be the same method used for each tax year.
Important: All forms of payment types count (e.g. cash, card, cheque, payment in kind, or any other method).
How to Record Expenses
You can deduct business expenses as costs from income to work out the taxable profit. Doing so means your allowable expenses reduce the amount of Income Tax you pay.
But, you can only count the business expenses that you actually paid for. Any money that the business owes out does not count until it gets paid as an expense.
Examples taken from a list of allowable business expenses for self-employed workers using cash basis include:
- Administration costs (e.g. printing, stationery).
- Buying goods for resale (e.g. stock items).
- Day to day running costs (e.g. bills for electricity or fuel).
- Items used in the business (e.g. computer, machinery, vans).
- Interest and charges up to £500 (e.g. interest charged on bank overdrafts).
You can use the simplified expenses scheme from 2013/14 tax year onward to calculate:
- Business costs for vehicles.
- Living in the same premises as the business.
- Working from home.
Cars and other Business Equipment
Special rules will apply if you buy a car for the business. In most cases, you will claim it as capital allowances on business cars. But, this only applies if you are not using simplified expenses to work out expenses for that car or vehicle.
Cash basis accounting is different from traditional accounting. You claim other equipment kept and used in a business as a normal allowable business expense. Thus, you do not claim it as a standard capital allowance.
Note: You can switch from claiming capital allowances to cash basis. But, you may need to make adjustments when you make the change. Read further information on the HS222 helpsheet or contact a tax professional.
Keeping Cash Bases Records
You only need to send in a tax return to HM Revenue and Customs – not the business records. But, you do need to keep the paperwork for at least six years in case HMRC ask to inspect them in a tax compliance check.
Cash Basis for VAT Registered Businesses
You can start using cash basis accounting even if your business is VAT registered. But, the income must be not more than £150,000 for the tax year.
How does that work?
Simply put, you can choose to record the business income and expenses including or excluding VAT. However, whichever one you choose, you must treat all income and all expenses in the same way.
Businesses that choose to include Value Added Tax in their cash basis accounting must also record:
- All VAT payments made to HM Revenue and Customs as business expenses.
- All VAT repayments received from HM Revenue and Customs as business income.
HMRC Help Guides
- Check if simplified expenses will suit your business.
- How to tell HMRC about a change to your business address?
- Guide to Income Tax allowances and reliefs.
Note: The short video presented by HM Revenue and Customs (HMRC) will help you determine whether cash basis accounting will make life easier as a self employed business.