New HMRC Rules For Small Businesses

HMRC wants more unincorporated businesses (sole traders and partnerships) to use the cash basis of accounting to simplify their reporting requirements under the Making Tax Digital (MTD) regime and they have produced a package of reform proposals to simplify the taxation of these small businesses ahead of the planned move to quarterly digital tax reporting.

The main plank of this simplification drive will be to raise the ceiling for the current cash basis mechanism that that allows businesses to calculate their tax liabilities based on amounts actually paid and received within a given period.

This scheme is currently available up to the VAT registration threshold of £83,000, but HMRC is consulting on raising it to as much as £166,000, double the existing figure. The popularity of the cash basis in its current form encouraged the MTD team to consider expansion, particularly since regular reporting updates will align more easily with the cash approach.

“Businesses who account this way will simply enter the details of their income and expenses as they actually receive payment or pay for an expense,”

the HMRC consultation paper explained.

HMRC estimate that by significantly raising the limit, it will give around 200,000 more businesses the option to use the cash basis for accounting, but the paper also comments that unincorporated businesses with higher turnovers are more likely to have complex tax affairs requiring the conventional basis of relying on the date of the invoice, not the payment as the method.

An exit threshold at around twice the entry threshold is also being considered that would allow businesses with fluctuating turnovers of up to £300,000 to continue to use cash basis accounting.

The tax simplification consultation document tackles one of the most frequently recurring questions about the quarterly reporting regime envisaged under MTD: how will capital allowances be calculated?

The consultation document talks of reforming the capital/revenue divide, explaining, “The cash basis can provide a coherent tax result by making a different distinction, between expenditure on assets which still have a value after the tax year (capital expenditure) and those which are used up in the course of conducting the business (trading expenditure).”

This will still mean that decisions will need to be made by the business owner on whether expenditure is of the capital type and qualifies for capital allowances under the existing rules; with restrictions on allowability continuing to apply to:

• Property, including integral fixtures bought with a property
• Intangible assets with indefinite lives (so buying a trademark would be disallowed, unless the purchase applied to use of the trademark for a specified length of time) and goodwill
• Financial instruments and equivalent assets; and
• Any other asset that has an unlimited effective life or is not expected to decline in value over the time.

Part of the new proposals examines the potential for cutting down requirements for those who currently produce accounts in accordance with Generally Accepted Accounting Principles (GAAP) for tax purposes. The proposal would not be to make changes to GAAP itself, HMRC said, but rather aim at a slimmed down version under which a profit calculation would be acceptable for HMRC’s needs.

The adjustments for things like asset values typically undertaken at year end could be deferred to a later period or the point at which an underlying asset or liability is sold or realised.

“There is no intention for these simplifications to lead to a reduction in the tax payable over the lifetime of a business. Any advantage or disadvantage arising from these rules will be restricted to changes in the timing of profits arising,”

The adjustments identified for this approach include:
• Adjustments to the closing stock figure
• Profits where contracts span the period end
• Provisions for bad debts; and
• Adjustments for prepayments and accruals.

I’m all for making life easier for clients and the simplification of tax, but I can see a sting in the tail with this proposal. What HMRC appear to be proposing is that if you are say, a builder and buy a concrete mixer for £1,000, at present you would get around £200 a year in tax relief, but under the new regime you’d get nothing until the mixer was eventually scrapped; not a clever idea for a government keen to increase business investment

In its reforming zeal, HMRC is considering ending the requirement for unincorporated traders to compile Annual Accounts. With the advent of flexible, user-driven tax accounts, the department argued that “the complexity and inflexibility of the basis period system is outdated”.

The basis period rules for calculating tax were drawn up to accommodate situations where business accounting periods fall into different tax years than the tax year ending on 5th April. One option on the table is to let quarterly filers define their accounting periods to match each quarterly report, doing away with the need for any annual process.

“This might suit those with relatively simple business affairs, or those who need or want to use short accounting periods for other purposes,” HMRC said. The consultation document also includes a suggestion that HMRC may allow the end of a business’s accounting year to be their tax year to minimise any adjustments.

In its assessment of the potential impacts of these changes, HMRC said individuals running small businesses will enjoy reduced complexity and administrative burdens within the tax system, but did not quantify any savings. There would also be changes needed to HMRC systems which are likely to have a price tag of around £100M.

HMRC business Tax Director General Jim Harra said:

“We have made our first public stab at an impact assessment, but we would want to do a full impact assessment when we publish the proposals and legislation and would really like people’s input on that, quite apart from the specific measures.”

If you would like more detailed information on some aspect of UK Tax, send me an e-mail and I’ll be pleased to advise further.

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