How has the Finance Act 2024 changed the cash basis for small businesses?

The Finance Act 2024 (FA 2024) did include a change to the cash basis rules, and with the focus on other pressing tax matters included in the October 2024 Budget, this change has been overlooked in some respects.

The cash basis has been in place since 2013/14, giving the option to elect for the cash basis if certain conditions were met. FA 2024 Schedule 10 makes the cash basis more widely available with a change to the eligibility conditions. The changes came into effect from 2024/25, and it’s important to note that it becomes the default where conditions are met. An overview of the rules and the changes is given below.

What is the cash basis?

The cash basis is a simpler way of accounting that makes it easier for smaller unincorporated businesses to report their income and expenses.

It allows those businesses that are eligible to account for income and expenses when money is received or paid out and not on the date goods or services are invoiced. There is no need to do a balance sheet and profit and loss account. Instead, the business accounting records only need to show money when it comes in or goes out.

As receipts are recognised as income of the period in which they are received and expenses are outgoings of the period in which they are paid, there is no need to account for debtors, creditors, stock, and work in progress.

A small business would still be subject to any adjustment required or authorised by law in calculating profits for income tax purposes.

Before 2024

Before the changes introduced by FA 2024, businesses could only use the cash basis if their turnover was less than £150,000, and a business had to leave the cash basis where their turnover exceeded £300,000 in certain circumstances. To use the cash basis, a business had to opt in.

Where businesses had a shorter period, the £150,000 and the £300,000 were reduced, and in the 2023/24 transition period for basis period reform, where the basis period was more than 12 months, the amounts were proportionately increased.

From 2024

The changes make the cash basis the default method of calculating profits for all businesses regardless of size, with businesses having to opt to use the accrual basis instead. The election has effect for the tax year for which it is made and for any subsequent tax year.

It is important to note that the changes affect sole traders and partnerships but do not apply to property businesses, companies, or those entities already excluded from the current cash basis regime.

There are further excluded trades, such as a partnership that includes a limited company member and traders who claim the herd basis or make averaging claims, for example.

It is worth reviewing the list of excluded trades to ensure your clients can use the cash basis.

Prior to 2024/25, there was also a limit of £500 on the amount of interest that the business could deduct for tax against the profits for the year; this limit is abolished from 2024/25, allowing tax relief for full interest costs as long as they are wholly and exclusively for the purpose of the trade.

So, what will these rules mean in practice for your clients?

If you’re a sole trader or partner, the cash basis is the default way to work out your income and expenses when you file your self-assessment tax returns for the 2024/25 tax year onwards.

From 6 April 2024, you will need to start keeping records for the 2024/25 tax year using the cash basis, unless you either:

• Choose to use traditional accounting.
• Cannot use cash basis (excluded trades).

Many traders will want to continue using the traditional accounting basis as the adjustments needed to bring them in line with the cash basis will need to be considered.

If traders want to use traditional accounting or cannot use the cash basis accounting, they must opt out of the cash basis by ticking the opt-out box when filing their self-assessment tax returns.

The above is merely an overview of the change in the rules, and further reading and advice should be sought if necessary. The legislation is within ITTOIA 2005.

Nick Lovett
Tax Manager

For more information, please contact us at: consultancy@vantagefeeprotect.com