This consultation covers HMRC’s proposals to simplify accounting and reporting for unincorporated businesses. The proposals come under four main headings.
- Increasing the entry threshold for the cash basis
- Reforming basis periods
- Simplifying reporting requirements
- Reforming the capital/revenue divide within the cash basis
Increasing the entry threshold for the cash basis
The cash basis of reporting was introduced in April 2013 and is currently used by over a million small businesses. Under the cash basis, businesses are only required to keep records of their income and expenditure rather than producing accounts under the accruals basis. The current turnover threshold for the cash basis is aligned with VAT threshold currently £83,000. A higher threshold applies for self-employed universal credit claimants where the entry threshold is for turnover up to twice the VAT threshold, currently £166,000.
Once a business’s turnover exceeds double the VAT threshold in any tax year they must cease using the cash basis.
Under the cash basis, in addition to preparing accounts based on income received and expenses paid, certain capital expenditure such as plant and machinery used for the business can be taken into account in calculating the taxable business profits using cash basis.
All unincorporated businesses (cash basis or otherwise) also have the option to use a flat rate to calculate certain expenses including motor expenses, use of home for business and private use of business premises. (The simplified expense rules are not considered by the consultation).
The consultation asks for opinions on what would be the appropriate entry and exit thresholds for the cash basis. HMRC avoids suggesting any particular increase but does refer to the potential to double the entry and exit thresholds.
The proposal is for the cash basis to remain optional and enable businesses to move to accruals accounting when this becomes more appropriate. However, the consultation also points out the existing legislation which states that an election to use the cash basis can only cease to have an effect where there is an actual change in circumstances which makes it more appropriate for its profits to be assessed in accordance with generally accepted accounting practice (UK GAAP).
Finally, the proposal states that the entry and exit thresholds for universal credit claimants would continue to be set at twice the standard entry threshold.
Reforming basis periods
HMRC acknowledge that the current basis period rules are complex, particularly in connection with commencement provisions, change of accounting dates and cessation. A policy aim is to simplify the rules around the basis period with a view to eliminating the overlap period. The proposal is to introduce accounting periods similar to those used for corporation tax. These define an accounting period as:-
a) Beginning when the company starts to carry on a business or immediately after the end of the previous accounting period, and
b) Ending on the earliest of 12 months from the beginning of the accounting period, an accounting date of the company or the date the company ceases to trade.
The self-employed would be able to choose short accounting periods and would not be required to complete accounts for a full 12 months. The taxable profits for any given tax year would be reached by aggregating the taxable profits for all accounting periods ending in that year.
It is hoped that by introducing this change of rules there would be no need to have any further rules to deal with changes of accounting date and that the choice of accounting period would be a matter of convenience for the particular business.
Unlike for corporation tax where tax returns are aligned with accounting periods, for income tax it would still be necessary to account for tax on a tax year basis in order to interact with other sources of income. Under the consultation we are invited to raise any specific concerns regarding the interaction with other income sources.
Finally, it is recognised that many businesses have existing accumulated overlap profits. Relief for these profits will continue to be available on cessation of the business; however no comment is made on utilising overlap relief in the event of a change of accounting date. In view of this it seems likely that all businesses should review their overlap position before the implementation of these new rules which is planned for April 2018.
Simplifying reporting requirements
Currently non-incorporated businesses can account for their profits on a cash basis or in accordance with GAAP. In addition to extending the entry level for the cash basis, HMRC is also consulting on reducing the burden for taxpayers using GAAP accounting. The proposals highlight the following areas where accounting year-end adjustments are required under GAAP, but which may be dispensed with for tax purposes:
a) Adjustments to closing stock
b) Adjustments for profits where contracts span the period end
c) Adjustments in respect of provisions for bad debts
d) Adjustments for prepayments and accruals.
a) Closing Stock
The proposal is simply to remove the requirement to value stock at the period end.
b) Work in Progress
The proposal is to remove the requirement to include work in progress in the accounts but with an exception of long term contracts, long term for this purpose being defined as one year.
c) Provision for Bad Debt
The proposal is to remove the requirement to provide for bad debt.
d) Accruals and Prepayments
The proposal is to remove the need to adjust for accruals and prepayments except where adjustments would have an impact of more than one year, i.e. income not recognised within more than a year of being earned, or expenses not being recognised more than a year in advance of being due.
Reforming the capital/revenue divide within the cash basis
This proposal is restricted to users of the cash basis. The proposal is that the current general disallowance of capital expenditure would be replaced by more limited disallowance for certain types of capital expenditure. The capital expenditure to be specifically disallowed would be in relation to assets which are not used in the business over a limited period.
Specifically the following types of asset would continue to be disallowed:
a) Real property and newly constructed buildings or structures
b) Intangible assets other than any with a definite fixed life of 20 years or less
c) Another business including goodwill
d) Financial instruments and equivalent assets
e) Any other asset which does not have a limited expected useful life or cannot reasonably be expected to decline in value over the time it is used
In addition to the above exclusions, capital expenditure on cars would remain a special case and outside the scope of the proposed adjustments.
Summary of Consultation Questions
Reforming the cash basis
- 1a: What level do you consider to be an appropriate turnover entry threshold for the cash basis?
- 1b: For a threshold not linked to the VAT threshold, should it be reviewed annually in the light of inflation or less frequently (please state recommended interval)?
- 2a: If the entry threshold were to be increased, do you agree that the exit threshold should continue to be set at twice the entry threshold?
- 2b: If the entry threshold were to be increased, do you agree that the UC exit threshold should continue to be set at twice the entry threshold?
Reforming basis periods
- 3: Do you agree with the proposed approach of following accounting periods? If not, what alternative approach would you support?
- 4a: Are there any other events or situations which would require additional rules?
- 4b: Would it be helpful to make any changes to tax accounting periods for any other types of income?
- 5: Are there other end of year adjustments not listed above which could be simplified within a reduced reporting framework?
- 6: Would you welcome the four relaxations proposed?
- 7: Do you think that the restrictions proposed are appropriate? If not, what restrictions would you suggest?
Reforming the capital/revenue divide within cash basis
- 8: Do you believe that simplifying the capital/revenue distinction as suggested in paragraphs above would simplify reporting for businesses within the cash basis?
- 9: Can you identify any specific caveats which might be needed to ensure that the new rule operates as intended? Are there any potential tax planning opportunities which the current rules would not prevent?
Assessment of impacts
- 10a: If the cash basis entry threshold is raised would you consider using the cash basis, or advising your clients or members to use it? If so please provide details of anticipated impacts, including both one-off and ongoing benefits and costs.
- 10b: If the proposed basis period reform is taken forward, how do you think this would impact on business admin burdens? If possible, please provide details of anticipated impacts, including both one-off and ongoing benefits and costs.
- 10c: If the reduced reporting framework is introduced, please provide details of how this will affect your business, clients or members, including details of both the expected one-off and ongoing benefits and costs for:
– Familiarisation with the new scheme and updating software or systems
– Having to make fewer adjustments than would be required under UK GAAP
- 10d: If the revenue/capital divide is simplified as suggested do you believe that this would simplify reporting for businesses within the cash basis? If so please provide details of anticipated impacts, including both one-off and ongoing benefits and costs.
10e: Please tell us if you think there are any other impacts, benefits or costs not covered above.
What do you think?
Other areas covered by the consultation
This is only one part of the consultation. See summaries of the other areas here.