TXF6 UK
Syllabus B. Income Tax And Nic Liabilities B3. Income from self-employment

B3d. Cash basis for small businesses 4 / 11

Syllabus B3d)

Explain and compute the assessable profits using the cash basis for small businesses.

Small businesses are allowed to use the cash basis

if the business’ turnover does not exceed £150,000

This basis may result in a lower profit to be taxable, and therefore will reduce the income tax payable.

  • The business may continue to use the cash basis until the turnover exceeds £300,000.

Calculation of profit

  1. Total cash receipts of the business plus the sale of capital items are included.

    For example If the business sells trading stock worth £25,000 and sells a capital asset worth £50,000, both of these will be included to give a sales figure of £75,000.

  2. Total cash expenses of the business including purchase of capital items used for business are deducted.

    For example If the business purchases trading stock worth £25,000 and purchases a capital asset worth £50,000, both of these will be included to give a purchase figure of £75,000.

  3. There is an exception of the purchase of motor cars, these will not be included in the calculation of profit under the cash basis. (Vans purchased will be allowable).

    For example, a motor car was purchased for £40,000. Even though this is a capital item, this will not be included in the purchases of the businesses under the cash basis.

Illustration:

Sales for the period were £61,000 of which £4,000 was still owed by business customers at the end of the period.

Inventory on May 31, amounted to £1,800.

Purchases and expenses of the period (all allowable) amounted to £29,000 of which £2,000 was still owed to suppliers at the end of the period.

  • What is profit according to the normal basis and cash basis?

Solution:

Normal Basis £

Revenues 61,000

Cost of sales (29,000 – 1,800) (27,200)

33,800

Cash Basis £

Receipts (61,000 – 4,000) 57,000

Payments (29,000 – 2,000) 27,000

30,000

The above calculation of profit only includes cash items

therefore things such as: receivables, payables, opening and closing inventory will be ignored. 

The business will only pay income tax on its cash profits.

Simple proforma to use:

Cash sales received in the tax year x
Cash sales of plant and machinery in the tax year (not car) x

Less:

Cash purchase of inventories in the tax year (x)
Cash allowable expenses in the tax year   (x)
Cash purchases of plant and machinery in the tax year (x)
Motor expenses (Authorised mileage allowance) (x)
Tax adjusted trading profit

Motor expenses

The purchase capital expense of motor cars and the running expenses will not be allowed. 

Instead, under this scheme, to replace these expenses, an authorised mileage allowance will be given. 

This is:

  1. For the first 10,000 business miles – 45p/mile

  2. For any business miles after 10,000 – 25p/mile

    For example, the motor car that was purchased for £40,000, drove 15,000 business miles. 

    The allowable deduction will be (10,000 miles * 0.45) + (5,000 miles *0.25) = £5,750

Illustration:

Barry commenced a new self employment business on 06/04/2020.

The following information relates to the year ended 05/04/2021:

  1. Sales receipts of £81,000 with a further £750 owing on 05/04/2021.

  2. Purchase of inventories of £20,000.

  3. Closing inventories of £680 at 05/04/2021.

  4. On 10/06/2020 Barry purchased a car with C02 emissions of 185g at a cost of £20,000. 

    Barry drove 12,000 business miles and 4,000 private miles. 

    The total motor expenses amounted in £3,600.

  5. Computer equipment purchase cost £2,500.

  6. Other expenses (allowable) cost £17,600 with a further £400 owed as a payable at 05/04/2021.

Calculate the tax adjusted trading profit according to the accruals basis and the cash basis.

Solution:

Accruals basis

Sales  £81,750 W1
COS  (£19,320) W2
Gross profit £62,430
Capital allowances (£3,400) W5
Motor expenses (£2,700) W3
Other allowable expenses (£18,000) W4
Tax adjusted trading profit £38,330

W1

Cash and credit sales calculation:

  • £81,000 + £750 = £81,750

W2

Cost of sales calculation:

  • Opening inventory + purchases – closing inventory.

    0 + £20,000 - £680 = £19,320

W3

Motor running expense calculation:

  • The motor running expense must be adjusted for business use only, as private expenses are not allowable. 

    £3,600 * 12,000/16,000 = £2,700

W4

Other allowable expenses

  • £17,600 + £400 = £18,000

W5

Capital allowance calculation:

  • AIA £2,500 (computers)

    WDA £20,000 * 6% = £1,200 * 12,000/16,000 = £900 (car: CO2 >110g/km: special rate pool)

The Cash Basis

Tax adjusted trading profit (Cash basis)

  • Cash sales £81,000

    Cash purchases (£20,000)

    Gross profit £61,000

    Cash expenses (£17,600)

    Cash capital expenditure (£2,500)

    AMAP  (£5,000) W1

    Tax adjusted trading profit £35,900

W1

AMAP

  • 10,000 miles * 0.45 = £4,500

    2,000 miles * 0.25  = £500

  • Barry should choose to elect into the cash basis scheme as this results in a lower taxable profit for him