In last week’s Budget one of the points mentioned which caught my attention was the proposal of allowing certain tax payers to use a cash accounting method when preparing accounts. We now know a little more about this, so what does it mean for your business?
What do we mean by cash accounting?
If you prepare a set of accounts using this basis, you will only account for income once it is received and you only account for purchases once you have paid for them.
A few simple examples
- A trader buys £6,000 of stock and pays for it on the same day. He then sells it for £12,000 and is paid in time for his year end.
- The result is income of £12,000 less costs of £6,000 = profit of £6,000.
- He would pay tax on the £6,000 profit.
- Our same trader only pays for the half of his stock by his year end and he needed his customer to pay in full to afford the balance.
- His customer pays in full just before his year end.
- This scenario still gives £6,000 profit, as before.
However, under the proposed new system, he would be taxed on the following
- Sales received of £12,000. Although £6,000 of stock was used to create the sales at his year end he had only paid £3,000 for it. On a cash basis his profits would be
- £12,000 less £3,000 = £9,000.
- £3,000 additional profit to be taxed in this year.
Of course next year, he would have a further £3,000 of costs to take off his profit, but is having to wait until a later date to get this tax relief.
- Our same trader pays £6000 for stock, but does not make a sale before his year end.
- He will get tax relief on this stock even though he has not made a sale.
This example shows how the new proposal could help cash flow. Under the current rules, he would carry this stock forward and use it against future sales. In this case, the tax payer benefits for the year in which he purchases the stock.
So who can use the scheme?
Initial press suggests that this new scheme will be available to sole traders with sales of less than £77,000. It does not appear to be available to Limited Companies but we will know more later this year.
When will the scheme be available for use?
The Government is planning to introduce the scheme from April 2013, so it will affect tax payers on their 2013/14 tax returns.
This proposed scheme is certainly of some interest and we will need to see what anti-avoidance legislation might be put into place when it is introduced. The scheme’s intention to help smaller businesses is great; as it appears very simple to apply and should help cash flow.
However, from experience I know that the scheme could encourage some traders to delay billing until after the year end, if there is any chance of creating a lower tax bill. This will simply shift tax liability from one year to the next and is likely to create its own problems. Anti-avoidance legislation may clarify rules, if it doesn’t; the scheme may have limited use.
EJBC Chartered Accountants