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A guide to Simpler income tax system for small businesses, contributed by ACCA

HMRC has published draft legislation which includes the transitional rules for the cash basis and simplified expenses rules for small businesses.

The cash basis

From the 2013/14 tax year, self employed individuals or partnerships carrying on a small trading business will be able to choose to be taxed on the cash basis rather then being asked to do accounting adjustments designed for more complex businesses.

However, the new rules will not be available for every small business. The excluded persons are companies, limited liability partnership, Lloyd’s underwriters, a person with a section 221 ITTOIA profit averaging election or a business with a current herd basis election.

Also excluded from the cash basis are certain trades such as dealers in securities, lease premiums, managed service company, waste disposal, intermediaries treated as making employment payments, ministers of religion, pool betting, cemeteries and crematoria.

Businesses can enter the cash basis if their receipts for the year are less than the amount of the VAT registration threshold (currently £77,000) or twice that (currently £154,000) for recipients of universal credit. Businesses must leave the cash basis after their annual receipts exceed twice the amount of the VAT registration threshold (currently £154,000).

The key aspects of the cash basis are that:

  • it is an optional scheme which small unincorporated businesses can elect to use
  • it will work on cash received (including all amounts received in connection with the business such as disposal of non-durable assets and VAT refunds)
  • cash spent on expenses that are wholly and exclusively for the purpose of the trade, including capital expenditure on non-durable assets (but excluding business entertaining and purchase of property or other ‘investment’ assets). However, interest payments are allowed up to a limit of £500 without the need to establish that the borrowing is financing capital employed in the business
  • there is a mandatory requirement to use a fixed allowance for business mileage (rather than deductions for actual expenditure on purchasing, maintaining and running a motor vehicle or motor cycle, apportioned between business and private use). This is mandatory for the use of cars or motorcycles by businesses using the cash basis
  • expenses are inclusive of VAT and include payments of VAT
  • business losses may be carried forward to set against the profits of future years but not carried back or set off ‘sideways’ against other sources of income
  • there is an optional flat rate allowance for business use of home (rather than deductions for actual amounts, apportioned between business and private use)
  • there is an optional three tier banded rate for the adjustment for private use of business premises (rather than a deductions for actual amounts apportioned between business and private use)
  • the legislation provides the framework for transitional rules on entering or leaving the cash basis, the purpose of which is to ensure that income and expenses are only taxed/allowed once. The transitional rule also includes the usual adjustment of spreading the income over the following six tax years when the business leaves the cash basis.

Simplified expenses

The draft legislation includes the framework for three types of simplified expenses. Under the new rule the allowable expenditure may be calculated using a simple flat rate allowance rather than a potentially more complex apportionment of actual expenditure.

Businesses that do not elect to use the cash basis will have the option to use any or all of the simplified expenses as they wish. The simplified expense rule is entirely optional and outside the cash basis. The three types are highlighted below.

Expenditure on vehicles

Businesses that do not use the cash basis have the option to use the mileage rate for cars and motor cycles. Businesses using other vehicles, such as vans, can use the mileage rate if they wish or can claim the purchase, lease and running costs as a deduction, as they do currently.

Use of home for business purposes

Businesses that use the home for business purposes can opt to use a standard monthly deduction (of £10(for 25-50 hours per month), £18 (for 51-100 per month) or £26 (for 101 or more per month)) based on the amount of time spent working at home. Alternatively businesses can choose to claim an allowable portion of actual expenses.

Business premises used both as a home and for the business

Where business premises are used partly for private purposes as a home a standard monthly adjustment (of £350 (one occupant), £500 (two occupants) or £650 (three or more occupants)) can be made based on the number of occupants using the premises as a home. Alternatively businesses can choose to identify the allowable portion of actual costs if they prefer.

It appears that the new rules are aimed atreducing the administrative burden of a business and shows the government’s intention to make it easier for small businesses to calculate their taxable income, as well as providing them with more certainty over their tax affairs.

Further guidance on the simplified rules for small businesses is available.