UK: Simpler Income Tax For The Simplest Small Businesses

Last Updated: 18 January 2013
Article by Smith & Williamson

Introduction

The current legislation requires that the profits of a trade are calculated on an accruals basis in accordance with Generally Accepted Accountancy Practice (UK GAAP).

Capital expenditure is not an allowable deduction but a business can claim capital allowances in respect of certain capital expenditure, for example plant and machinery.

The OTS published their report 'Simpler income tax for the smallest businesses' in February 2012, indicating that small businesses were concerned about the difficulty and uncertainty involved in preparing a taxable income figure.

At Budget 2012 the Government announced that it proposed to introduce a new cash basis for calculating tax for small unincorporated businesses with effect from April 2013. A consultation process was followed by the publication of draft legislation on 11 December 2012. Treasury minister David Gauke commented: "We want the smallest businesses to be able to choose the method of accounting that works best for their business. The simplified system will provide this flexibility, give greater certainty, and simplify the tax calculations for many small businesses."

The draft legislation covers two separate points.

  • Eligible unincorporated businesses will be able to calculate taxable income on a simpler cash basis if this suits the business. Such businesses will not have to compute figures of debtors, creditors and stock, or distinguish between 'capital' and 'revenue' expenditure and will not have to compute capital allowances to arrive at taxable income.
  • The second measure will allow all unincorporated businesses to choose to use flat rate expenses for particular items of business expenditure.

Detailed proposals - cash basis

The new rules will apply to individuals for financial years starting from 1 April 2013 carrying on a trade or profession as self-employed sole traders, or in partnership with other individuals. In the first year of an election for the cash basis, turnover cannot exceed the "relevant maximum". The relevant maximum is the VAT threshold, or if the individual is a universal credit claimant, twice the VAT threshold. In the second or subsequent year where the cash basis election is made, there is only a turnover limit (the relevant maximum) if turnover in the previous tax year exceeded twice the VAT registration threshold for that year (whether the individual is a universal credit claimant or not). Thus where turnover for the previous tax year exceeds twice the VAT threshold for that year, in order for the cash basis election to be effective turnover for the current tax year cannot exceed the 'relevant maximum. The higher 'relevant maximum for Universal Credit claimants is because they will have to use the cash basis to report their income for Universal Credit purposes.

The cash basis will not be available to the following:

  • partnerships which have, or have had, at any time in the tax year partners who are not individuals;
  • limited liability partnerships;
  • individuals who have been Lloyd's underwriters at any time in the same tax year;
  • businesses with a current herd basis election;
  • cases where a claim has been made for averaging of fluctuating profits.

Eligible small businesses will be able to calculate their taxable income by taking business cash received in a year and deducting business cash expenses paid in a year, subject to adjustments required or allowed by tax law, for example on goods taken for personal use. This will mean they will generally not have to distinguish between revenue and capital expenditure (although certain capital expenditure and receipts will be excluded from assessment under the 'cash basis', see below).

A business will have to elect to enter the regime. The cash basis will be voluntary and taxpayers will be able to switch in and out. The Government's response to the consultation says "The choice of which basis to calculate tax should be a business decision and not constrained. The cash basis will be simpler without rules to restrict switching and the Government wishes to avoid tying businesses into the regime if it is no longer suitable for them."

The aggregate receipts of all the trades carried on by an individual will be considered when assessing whether turnover falls below the threshold. Receipts will include all amounts received in connection with the business, including income from disposal of non-durable assets and VAT refunds.

Expenses will have to be incurred wholly and exclusively for the purposes of the trade, but can include certain capital expenditure and payments of VAT. Business expenditure including stock, equipment, software, rent, wages and VAT paid will be deductible, but not expenditure on business entertaining, land, cars, motor cycles or "investment" assets. Where any items are used partly for private purposes, only the amount relating to business use will be allowable. There will be a limit on the amount of interest expense deducted under the cash basis to a maximum of £500 (including the incidental costs of obtaining finance), and particular provisions on cash rental payments.

The provisions for dealing with the transition when moving from accruals basis to cash basis and vice versa will be published shortly. It will be interesting to see how these interact with the provisions for adjustment income and expense in ITTOIA chapter 17.

Businesses using the cash basis will not be able to claim capital allowances.

The proceeds of sale of property or other assets that would not have been deductible as expenses will not be counted as receipts under the cash regime, nor will bank loans or other finance.

The cash basis for 2013/14 will be based on a financial year ending on any date between 31 March 2014 and 30 April 2014, with the subsequent tax year starting on the next day. The default accounting date for a cash basis business will be 5 April.

It will be possible to carry forward business losses against the profits of future years but it will not be possible to carry back losses or claim 'sideways' relief against other sources of income. In its consultation response the Government said: "The reasoning behind this decision is that most businesses for which the cash basis is suitable are less likely make losses, and the Government does not wish to complicate the system with extra tax avoidance rules to protect the Exchequer. The Government's decision not to impose any restrictions on businesses switching from the cash basis to the normal rules, means that any business using the cash basis would be able to switch to the normal tax rules if they wish and obtain sideways relief or any other features of the normal rules that are not available in the simpler cash basis."

There will be a requirement to use flat rate allowances for car expenses, and an option to use specified rates for the use of home as business premises (or use of business premises as a home). These simplified expenses allowances will also be available to businesses that do not apply the cash basis by option.

  • Car and motor cycle expenses will be based on business mileage rather than actual expenditure. The rate will be based on HMRC's approved mileage allowance payments, currently 45p a mile up to 10,000 miles, then 25p per mile, for cars and 24p per mile for motorbikes.
  • The monthly deduction for business use of home will be calculated by reference to the number of hours worked at home in that month (£10 for 25hours or more; £18 between 51 and 100 hours and £26 for 101 hours or more). The business will still have the option to claim the allowable portion of actual expenses. Where the premises is used mainly for business purposes and there is some non-business use, a monthly fixed deduction from total premises expenses depending on number of non-business occupants can be applied instead of calculating the portion of expenses deductible for business purposes.

Flat rate expenses -unincorporated businesses not using the cash basis

Legislation will be introduced in Finance Bill 2013, with effect for the tax year 2013/14, to allow all unincorporated businesses to deduct motor and 'use of home' expenses on a simplified flat rate basis at their option.

Barristers

Eligible barristers will be able to choose either to use the new cash basis and simplified expenses or the current accruals basis. The existing cash basis legislation for barristers will be repealed (except for barristers already using it, who can continue to use it for the remainder of their qualifying period.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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