From 1 April, the default system of accounting for self-employed individuals and trading partnerships will shift from the current accruals method to cash-basis accounting.
While this might sound confusing, this should actually simplify your accounting as you’ll only need to account for the cash that comes into and leaves your business directly. You won’t need to account for money owed to or from you, so supplier invoices and outstanding costs won’t need to be included.
While the cash basis will become the automatic system you’ll be enrolled into, you do have the option to elect into the current accruals accounting system - but how can you make sure you make the choice that is right for you?
This is a sizable shift from the current system outlined in the Income Tax (Trading and Other Income) Act 2005, so those impacted will need to take care to not be caught out by this change in financial regulations. Let’s explore the main takeaways from these widespread changes - and how you can balance your books accordingly.
Among these changes, the current cap of £150,000 in turnover for the self-employed and trading partnerships will be scrapped, as will the current restriction of £500 being the upper limit of bank interest that can be charged as an expense.
Similarly, ‘sideways loss relief’ will also have its current limits removed - meaning that you’ll be able to offset more taxable income against real-time cash basis losses.
What does this mean for those in the room who aren’t accountants? Basically, your turnover can be as high as you like and you’ll still qualify for cash-basis accounting - which is a simplified method of calculating the taxable profits simply from money in and out of your business. It means you can ignore any money you owe or are owed and only have to process cash you’ve already received or already spent.
However, self-employed individuals and those involved in trading partnerships will need to be careful because although it will be possible to elect for profits to be calculated in accordance with Generally Accepted Accounting Principles (GAAP), these will need to be considered each and every year.
What this means is that while you CAN elect to use traditional accruals accounting instead of cash-only (i.e. deal with all money in and out of your business including money owed and pending, not just funds that have already been received), it’s not a one-time thing.
You might miss out if you simply opt into it once and consider it done. The wording of the legislation is confusing and seems to contradict itself, which means, as I had feared when this was announced, it is therefore possible to change basis every year.
It may well be that if you want to opt for accruals accounting, you’ll need to carefully specify this each and every financial year - or risk being moved across to the new cash-only default system.
This means that self-employed people and those involved in trading partnerships must speak clearly and candidly with their accountants about their preferred accounting method going forward to avoid confusion.
If left unclarified, you could automatically default to the cash-only basis and, if your accountant has prepared your books for the accruals method, this would effectively need to be redone - doubling the workload for your accountant and ensuring frustration for yourself. Perhaps more importantly, you might be paying more tax than you need to, if your profits are very different when calculated on each basis.
So, your preferred accountancy method must be communicated with your accountants very clearly. Don't forget, this does not apply to corporate bodies (including LLPs), and only trading income for self-employed including partnerships where all partners are natural persons.
If you are a self-employed individual or operating within a trade partnership, get in touch with our team of expert accountants today to ensure you’re not caught out by these impending changes.