Date posted: 8th Mar 2024
In a significant development aimed at streamlining financial reporting for businesses, HM Revenue & Customs (HMRC) has announced a new basis of accounting for sole traders and partnerships.
Effective from 6 April 2024, these businesses will have the option to report their profits based on cash and bank transactions, moving away from the traditional accrual basis of accounting. This change comes as part of the preparations for the Making Tax Digital initiative, set to be introduced in April 2026.
Lee Watson, tax partner at Clive Owen LLP, a leading firm of chartered accountants and business advisers with offices in Darlington, Middlesbrough, Durham, and York, sheds light on the current practice and the implications of the new system.
“Currently, the majority of businesses are required to prepare their accounts on an accruals basis, declaring income billed but not received by the year-end, and claiming expenditures not yet paid but due. This can be cumbersome and not reflective of a business’s actual cash flow.”
The shift to a cash-based accounting system will become the default for sole traders and normal partnerships, although they can opt to continue with the accruals basis if they prefer. This move is expected to simplify financial reporting significantly, aligning profit declaration with the tax year following the basis period reform.
“Moving from accruals to a cash basis will necessitate adjustments in the transition year, particularly concerning previously taxed income and accrued expenses,” Lee adds, highlighting the practical considerations businesses must address.
However, not all entities will benefit from this change says Lee: “Limited liability partnerships (LLPs) and limited companies will continue to report on an accruals basis. Those operating within these structures may consider converting to a different business medium, though this requires careful consideration of the commercial and taxation implications.”
The introduction of cash basis accounting could however have broader implications for business owners, particularly in how lenders perceive profits and indeed HMRC. “Cash basis profits could significantly fluctuate, affecting mortgage applications or resulting in higher tax charges if profits fall into different tax thresholds,” Lee cautions, pointing out the potential for increased financial volatility.
Ian Jarvis, managed services partner added: “While cash-based accounting may simplify taxes, it doesn’t give a clear picture of business performance, which is crucial for larger sole traders and partnerships. Accrual accounting, almost universally used in business reporting, provides this essential performance insight. This means that businesses will need to carefully consider their position and what will work best for them.
If you have any questions regarding any of the implications of these announcements, get in touch with a member of our team here.
