Cash-basis and Simplified-expenses Accounting Schemes

Introduction The cash-basis and simplified-expenses income tax accounting schemes are voluntary processes that can be used to account for income and expenses under tax self-assessment.

While the schemes don't alter the type of expenses that can be claimed or change the tax liability or the rules for determining taxable profits, they do alter the timing of when income and expenses are accounted for and when they are claimed, and can make certain expense claims simpler.

Here we outline who is eligible for the schemes, how they work, how they relate to tax self-assessment, the process for joining and leaving the schemes, and some of the advantages and limitations of the schemes.

What is tax self-assessment? Self-assessment applies to sole traders, partnerships and limited liability partnerships (LLPs). By law, you have to notify HM Revenue & Customs (HMRC) if you have any income that makes you liable to pay tax. Once you become self-employed, you need to complete a self-assessment return each year. Even if your business trades at a loss, you must complete a self-assessment return to claim loss relief.

A self-assessment is a declaration of all the income and capital gains received in any income tax year, starting on 6 April and ending on the following 5 April. Anyone asked by HMRC to make a self-assessment must do so by law, and they must include all their sources of income for that year.

The self-assessment tax return asks about all income, including income from various sources such as self-employment, UK savings and investments, capital gains, share schemes, partnerships, land and property.

Tax reliefs that are deducted from income for tax purposes are also claimed in the self-assessment for that year. This can include, for example, pension contributions, charitable donations and maintenance payments.

The expenses connected with running your business are included in the self-employment pages of the return. These are known as allowable expenses and include:

Costs of goods bought for resale or goods used.
Wages, salaries and other staff costs.
Phone, fax, stationery and other office costs.
Rent, rates, power and insurance costs.
Repairs and renewals of property and equipment.
Accountancy, legal and other professional fees.

How the schemes operate and relate to tax self-assessment Taxable profit is calculated after all legitimate business expenditure has been deducted. In order to be able to calculate net profit (and pay the correct amount of tax), it is important to know which business expenditure can or cannot be claimed as an allowance against tax, and how to calculate this accurately, in order to complete your self-assessment tax return.

Previously, all income and expenses needed to be recorded using the accruals basis. This required income to be recorded when customers were invoiced or outgoings to be calculated when an expense was incurred. But this meant that, at the end of the tax year, you might have had to pay tax on money that you hadn't yet received.

The cash-basis scheme, which was introduced on 6 April 2013, gives you a choice. Instead of using the accruals basis, you can choose to account for income and expenses on the basis of amounts received and paid. This means that you pay tax only on money you have received from customers, after deducting the business items you have paid for.

The simplified-expenses scheme introduces standard flat rates for certain expenses, meaning less complex calculations and quicker completion of paperwork at the year end.

Both schemes operate on a cash flow basis, so you only need to record income when it is received and expenses when they are paid. Many people find this much easier than having to record details of when the work was done or invoiced and when the expense was incurred.

Which firms qualify for the cash-basis scheme? The cash-basis scheme is only available to small firms. The eligibility criteria are:

Only sole traders and ordinary partnerships can join the scheme.
The business turnover is less than £150,000 a year.
If someone carries on two trades at the same time during the year, the combined turnover must be less than £150,000 in the year.
Certain types of business are excluded from the scheme. These include limited companies, LLPs, Lloyd's underwriters, organisations that have claimed research and development allowances, and firms in certain sectors, for example dealers in securities, managed service companies and waste disposal firms.

Joining and leaving the cash-basis scheme Anyone planning to join the cash-basis scheme must elect to enter the scheme by ticking a box on their self-assessment tax return. In the case of partnerships, the person responsible for the partnership tax return must elect to join the scheme.

An existing business that has been using accruals accounting might need to make adjustments to its income and expenditure on joining the cash-basis scheme. If needed, a tax professional could help with this.

Once in the scheme, you will be expected to remain in it unless your commercial circumstances change so that it is no longer appropriate. For example, you can stay in the scheme if your business turnover remains less than £300,000, but if turnover grows beyond that, you must leave the scheme and go back to using accrual accounting to calculate your tax liabilities.

How to complete a tax return using the cash basis Under the cash-basis scheme, the tax return only includes the income that has actually been paid at the end of the tax year (in other words, it excludes income invoiced, but not received). The expenses should be those that have actually been paid - not money owed.

Receipts are defined as all amounts received in connection with your business. This includes payments by cash, card, cheques, payments in kind, tips, commissions, grants and money from the disposal of assets, amounts received for selling or leasing capital assets or rights, as well as 'additions for non-commercial transactions' (such as amounts you need to add back in if you have taken stock for personal use). When your business ceases trading, the value of trading stock and work in progress are treated as receipts.

Limitations to the cash-basis scheme There are certain limitations to using the cash-basis scheme and it is important to be aware of these before opting to join. Professional advice can help explain the advantages and disadvantages in an individual situation and may also help with deciding whether it is right for the business. Limitations of the cash-basis scheme include:

Business losses can be carried forward to future years, but not carried back or set off 'sideways' against other income. This could work against taxpayers who would otherwise offset the tax losses against other sources of income, such as employment income.
There is a limit of £500 for interest paid on loans to the business - this is a potential issue for new businesses that invest heavily in capital assets.

How does the simplified-expenses scheme work? The simplified-expenses scheme can be used by individuals who are either inside or outside the cash-basis scheme. Any unincorporated business (including a partnership that does not have a corporate partner) can join the simplified-expenses scheme.

Under the simplified-expenses scheme, you can claim flat fees instead of working out the actual business costs for specific types of expenses claims.

Flat-rate allowances under the simplified-expenses scheme The scheme allows for flat-rate allowances to be claimed on three types of simplified business expenses: 1. Motor vehicles. 2. Working from home. 3. Living on the business premises.

Motor vehicles A flat-mileage rate can be used for business vehicles, including cars, vans and motorcycles:

You can claim a flat-mileage rate for use of vehicles rather than calculating the deductions due for purchase costs and actual running costs of the vehicle. However, you cannot make a flat-mileage claim if capital allowances have previously been claimed for the vehicle or if any expenses incurred in purchasing the vehicle have already been deducted in calculating profits.
You can choose to make the flat-rate claim on a vehicle-by-vehicle basis. Once the flat rate has been adopted for a specific vehicle, you must carry on using this basis.
The mileage rate is 45p per mile for the first 10,000 miles and 25p per mile after that for cars and vans; and 24p per mile for motorcycles for any mileage.
For example, if a car travelled 14,000 business miles during the tax year, the claim would be for 10,000 miles x 45p = £4,500 and 4,000 miles x 25p = £1,000, giving a total claim of £5,500 for the year.

Working from home Under the simplified-expenses flat-rate scheme, you can claim a flat rate of expenses according to the time you spend running your business from home. This is often easier than apportioning the use of your home between business and private use, with the complex calculations this entails (and, in any event, claiming more means that you cannot use the simplified-expenses regime).

The flat rate can only be claimed if the time you spend running your business from home exceeds 25 hours a month.
The flat rate includes the business share of utility bills, but does not include the share of telephone and internet bills - these have to be calculated separately.

The rates that can be claimed per month are £10 for 25-50 hours work at home per month, £18 for 51-100 hours, and £26 for 101 or more hours a month.

For example, if you trade from home for 27 hours per month for 8 months of the year and 60 hours per month for 4 months of the year, the claim would be for 8 months x £10 = £80 and 4 months x £18 = £72, giving a total claim of £152 for the year.

Living on the business premises This claim applies where the business premises are also the home, for example, in a bed and breakfast or a care home. Instead of apportioning the premises use between business and private use, you can claim a flat rate for your expenses claim:

The flat-rate claim is based on the number of people living at the premises. This can vary, for example if a child returns from university at the end of a term.
The rates for one occupant are £350 per month, for two occupants £500 per month, and for three or more occupants £650 per month.
For example, if two occupants live at the premises for 8 months and three occupants for 4 months, the claim would be 8 months x £500 = £4,000 and 4 months x £650 = £2,600, giving a total claim of £6,600 for the year.

Hints and tips

Advice should be sought from an accountant before deciding to opt for the cash-basis or simplified-expenses schemes.
Records should be kept up to date so that tax liabilities can be planned in advance.
All receipts should be kept and the purpose of the expenditure should be recorded at the time it is made.
Self-assessment can be made easier by getting accounts prepared as soon as possible after the accounting year end.

Contact Ashored for help and support with completing your Corporation Tax Return.