For small businesses, cash basis accounting can offer some welcome relief, says Clive Lewis, head of enterprise at the ICAEW
Small businesses with an annual income of less that £79,000 are being encouraged by HM Revenue and Customs (HMRC) to take advantage of the cash basis scheme rather than use full accounting rules. But I would urge businesses to review whether it is right for them before switching. HMRC suggests that businesses providing services, such as hairdressers, window cleaners, taxi drivers, gardeners, painters and decorators, plumbers and electricians, are most likely to benefit from the cash basis scheme.
The cash basis system enables the smallest companies to record money when it actually comes in or goes out of their business such as cash, card payments and cheques. This compares to traditional accounting (accruals basis) when firms record income and expenses when they invoice customers or receive a bill.
Cash basis might suit smaller businesses because they won’t be taxed on their sales until they have actually received the money for them and if the debtor never pays, they won’t have to claim for bad debt relief.
Businesses can also opt for simplified expenses. This involves using flat rates, instead of calculating actual business expenses. It can be used for business costs of vehicles and business use of home. If business premises are used as a home, there is also a simpler way to deal with private use by the owner and their family.
The problem for HMRC is that although the cash basis has been live since April 2013, very few outside the tax profession know about it.
The only way HMRC will know how many people choose to use it is by how many tick the box on the 2014 tax return to say they have. This is likely to raise problems; for example, how many taxpayers will say they have used the cash basis because they have no idea about accruals and they were previously doing it that way anyway? There then may be people who wonder if the cash basis means they had undeclared income and therefore do not want to tick the box. It will be interesting to see how HMRC explains all of this on the tax return and guidance notes for the general public.
Whether you choose the cash or accruals system, if you don’t keep adequate records or you do not keep them for the required period of time, you may have to pay a penalty.
Keeping your records up to date will help you have all the information you need to fill in your return correctly. If you send HMRC an inaccurate return, it could end up costing you.
You won’t have to pay a penalty if you can show that you took reasonable care to get your return right but still made a mistake. Some of the ways in which you can show you’ve taken reasonable care include:
• Keeping full and accurate records
• Regularly updating your records
• Keeping your records secure
• Checking with HMRC or a tax adviser if
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