Cash Basis for the self-employed

We con­sid­er the rules for unin­cor­po­rat­ed busi­ness­es which, from 2024/25, require them to cal­cu­late their prof­its for tax pur­pos­es on a cash basis rather than the accru­als basis.

How­ev­er, it is impor­tant to note that, although cash basis is the default posi­tion for all self-employed busi­ness­es, they can make a one-off elec­tion to use the accru­als basis.

Cer­tain busi­ness­es, includ­ing Lim­it­ed Lia­bil­i­ty Part­ner­ships, those involv­ing a cor­po­rate part­ner, Lloy­d’s under­writ­ers and those eli­gi­ble indi­vid­u­als who wish to con­tin­ue to claim aver­ag­ing of prof­its e.g. farm­ers can­not use the cash basis.

Accruals basis and cash basis

One exam­ple which illus­trates the dif­fer­ence between the accru­als basis and cash basis is that cred­it sales are includ­ed in the accru­als basis accounts income despite the fact that the cus­tomer may not have paid for the goods or ser­vices by the end of the account­ing peri­od. Under the cash basis the busi­ness is taxed on its cash receipts less allow­able cash pay­ments made dur­ing the account­ing peri­od. Under the cash basis, cred­it sales are account­ed for and taxed in the year in which they are paid for by the cus­tomer.

Key tax points

Cash receipts

Cash receipts lit­er­al­ly mean all cash receipts that the busi­ness receives dur­ing the account­ing peri­od. As well as trad­ing income this will also include the pro­ceeds from the sale of any plant and machin­ery. If a cus­tomer does not pay what is owed by the account­ing year end then it will not be tax­able until the next year when it is actu­al­ly received by the busi­ness.

What deductions are allowable?

In terms of what deduc­tions can be claimed the main rules are that the expens­es must have been actu­al­ly paid in the account­ing peri­od as well as being incurred whol­ly and exclu­sive­ly for the pur­pos­es of the trade.

As is the case with cal­cu­lat­ing tax­able prof­its gen­er­al­ly for a busi­ness no deduc­tions are allowed for items which are of a cap­i­tal nature such as the pur­chase of prop­er­ty. How­ev­er, under the cash basis the costs of most plant and machin­ery can be includ­ed as a deduc­tion. One key excep­tion is the pur­chase of cars but cap­i­tal allowances would remain avail­able.

Relief for interest payments

Gen­er­al­ly, inter­est costs will be deductible but no relief is avail­able for a tax year for inter­est paid by a per­son on a rel­e­vant loan if the part­ner­ship to which the loan relates uses the cash basis for its prop­er­ty busi­ness.

A ‘rel­e­vant loan’ is a loan to buy plant or machin­ery for part­ner­ship use or to invest in a part­ner­ship unless it is used for pur­chas­ing a share in a part­ner­ship.

The use of losses

If the busi­ness incurs a loss then under the cash basis this can be used in the same man­ner as busi­ness­es using the accru­als basis.

Joining and leaving cash basis

In order to ensure that income is taxed and expens­es are relieved ‘once and once only’ spe­cial cal­cu­la­tions are need­ed on enter­ing or leav­ing the cash basis. There are also spe­cial cap­i­tal allowances rules for such sit­u­a­tions.