Mark McLaughlin looks at the potential future for the self-employed cash basis and the government’s consultation launched at Spring Budget 2023 on extending its scope.
Tax simplification is a priority for the government, particularly tax simplification for small businesses. The government seems intent on extending the ‘KISS’ (keep it simple, stupid) principle to income tax self-assessment (NB the KISS principle broadly states that most systems work best if kept simple rather than made complicated; therefore, simplicity should be a key goal in design, and unnecessary complexity should be avoided).
At the Spring Budget 2023, HMRC launched a consultation ‘Expanding the cash basis for the self-employed’ (tinyurl.com/HMRC-Condoc-ECB). HMRC wishes to ‘…improve user experiences of reporting in income tax self-assessment…for small businesses by simplifying the rules and extending eligibility for the cash basis’ and is looking at options to extend the cash basis for self-employed individuals.
The cash basis (ITTOIA 2005, s 25A, Pt 2, Ch 3A) was introduced in 2013 as a simplified regime for calculating taxable profits for businesses with straightforward tax affairs. It is available to unincorporated trading businesses and some partnerships. The cash basis has also been the default method of reporting by property businesses carried on by individuals since its introduction in April 2017; however, HMRC’s proposals are focused on self-employed businesses with trading income.
The regime allows businesses to calculate their taxable profit as the difference between income and expenditure when money is received or paid out. This eliminates accounting and tax complexities such as accruals and most capital allowances, and simplifies reporting.
HMRC’s consultation focuses on four proposals, which aim to increase the number of businesses able to benefit from the simplifications that the cash basis offers, making the rules easier to understand and apply, and to save owners of unincorporated business time filing their tax returns:
At present, the cash basis is optional for eligible businesses. However, eligibility depends on an ‘entry’ threshold and an ‘exit’ threshold. To join the cash basis, the business must have a cash basis turnover at or below £150,000 (or £300,000 if the individual claims universal credit (UC)). A person must leave the cash basis the year after the cash basis turnover from all of their trades exceeds £300,000, unless their turnover falls below the £150,000 (£300,000 for UC claimants) limit in that following year.
The government is primarily considering two proposals for the threshold:
HMRC estimates that an additional 26,000 businesses would be eligible to use the cash basis for both options.
The cash basis is currently an optional regime for trading income. Opting into the cash basis generally requires a box to be ticked on the self-employment pages of the self-assessment return.
The government is considering making the cash basis the ‘default’ method of calculating trading income for eligible businesses. This would mean that businesses would use the cash basis as standard. However, it would still be possible to opt out and use the accruals basis, or to switch between the cash basis and accruals basis depending on the needs of the business.
If implemented, it is likely that the default would operate by changing the box currently used in tax returns and requiring businesses to tick the box if they have used the accruals basis in that tax year, rather than asking if they used the cash basis.
Under the current regime (ITTOIA 2005, ss 51A, 56A, 57B), restrictions apply to the treatment of interest for cash basis users. A deduction for loan interest payments is generally prohibited under the cash basis, subject to two exceptions:
The government is looking at the £500 maximum deduction for interest payments and incidental costs of finance. The rationale behind the deduction is that it provides simplicity in saving businesses from having to draw distinctions between the business and personal elements of loan or overdraft financing. However, the government recognises that it dissuades businesses with interest payments larger than £500 from joining the cash basis. The government is therefore considering increasing the limit to £625, £750, or £1,000.
Loss relief is restricted under the cash basis (ITTOIA 2005, s 32A). Individuals are only able to use cash basis losses against profits from the same trade; the use of cash basis losses against other trades or general income is prohibited. Under the current regime, if a business making trade losses wishes to offset them against other income it is necessary to move out of the cash basis into the accruals basis.
The government is considering the removal of loss relief restrictions in the cash basis. Possible options include:
However, as the main driver for any loss relief forms is simplification, any changes would need to satisfy that criterion.
Interestingly, the consultation document hints at possible future benefits for businesses using the cash basis.
In December 2022, HMRC announced that it would be introducing making tax digital (MTD) on a phased basis, with businesses, self-employed individuals, and landlords with income over £50,000 being mandated in April 2026 and those with income over £30,000 being mandated from April 2027. In the meantime, the government is reviewing the needs of smaller businesses for MTD for income tax self-assessment, and particularly for businesses under the £30,000 threshold.
The government initially considered that regular quarterly updates in MTD would align more easily with the simplified cash basis regime. This was on the basis that in-year transactional data has a much closer link to the end of year tax position under the cash basis than the accruals basis, and that the cash basis reduces the number of adjustments needed to business records under the current income tax system.
However, the consultation document states: ‘In the cash basis, the closer link between a business’s transactions and its end of year tax position means that voluntary in-year tax estimates, based on cash transaction quarterly update data, may be more relevant to customers than under the accruals basis’ (emphasis added).
This statement seems to suggest that the government might make quarterly reporting voluntary for businesses using the cash basis, but compulsory for businesses using the accruals basis. However, whether this happens remains to be seen.
The government’s stated aim of expanding the cash basis is to ensure that as many businesses as possible are able to benefit from this ‘simplification’. However, the government’s intentions are not purely altruistic, as cash basis users are considered less likely to make mistakes requiring HMRC interventions. HMRC comments:
‘As there are fewer adjustments to make, and fewer tax rules to apply, there are fewer opportunities to misunderstand accounting practice or tax law and get something wrong in a tax return.’
Of course, this benefits the taxpayer as well, because fewer mistakes should mean fewer time consuming HMRC enquiries for taxpayers (or their professional advisers) to deal with.
HMRC’s consultation ‘Expanding the cash basis for the self-employed’ ends at 11.45pm on 7 June 2023. Responses should be sent to T Brown at HMRC ([email protected]) and headed ‘Cash basis’.
For commentary on the cash basis generally, see Income Tax 2022/23 at 8.28 and following.
Mark McLaughlin CTA (Fellow) ATT (Fellow) TEP is Editor and a co-author of Tax Planning (Bloomsbury Professional).
