Policy paper

Expanding the cash basis

Published 22 November 2023

Who is likely to be affected

The measure will affect self-employed businesses and partners with trading income. These affected groups are collectively referred to as ‘businesses’ in this document.

The measure will not affect companies or property businesses, or businesses that are otherwise excluded from using the trading income cash basis, such as partnerships with a corporate member, limited liability partnerships, or businesses that have made a claim for farmers’ or artists’ averaging.

General description of the measure

This measure removes restrictions on the use of the cash basis, reducing the complexity of tax returns and making tax simpler for small businesses.

The cash basis is a method that businesses can use to calculate trading profits for income tax purposes, as an alternative to using traditional ‘accruals’ accounting. The cash basis is a simplified regime that reduces the complexity of reporting income to HMRC while still providing an appropriate measure of trading profits for many businesses.

Currently, a business has to elect to use the cash basis, usually through notifying HMRC as part of the Self Assessment tax return. The accruals basis is the default method of calculating profits, and the cash basis is an ‘opt-in’ regime.

This measure changes this to set the cash basis as the default method of calculating trading profits. An election will no longer be required to use the cash basis, and businesses will calculate their trading profits using the cash basis unless they make an election to use the accruals basis.

Currently, businesses are only able to join the cash basis if their cash basis turnover is less than £150,000, and are forced to leave in certain circumstances where their turnover exceeds £300,000. This measure removes this turnover restriction entirely. Eligible businesses, such as self-employed people and partnerships of individuals, of any size will be able to use the cash basis, allowing them to continue using the cash basis as they grow.

Businesses that currently use the cash basis are unable to deduct more than £500 in interest costs from their taxable profits each year, a restriction that was set when the cash basis was introduced in 2013. This measure removes this interest restriction entirely, allowing businesses that use the cash basis to deduct any amount of interest as long as it is incurred wholly and exclusively for the purposes of the trade. This aligns the cash basis and accruals basis rules on interest deductions.

Currently, cash basis users are also restricted in the loss relief that they are able to benefit from for losses that are generated in the cash basis. Also, losses generated in the cash basis can only be carried forward and set against future profits from the same trade, or used when the business stops trading. This measure removes this restriction, allowing cash basis losses to be used in the same way as accruals basis losses. This means that cash basis losses will be able to be set sideways against general income of the same period, or carried back to earlier years, subject to the same general loss relief rules as accruals losses.

Policy objective

This measure aims to improve and simplify small businesses’ experience of reporting in Self Assessment by extending eligibility for the cash basis, encouraging its use where appropriate, and making the rules for the regime easier to understand and apply.

By setting the cash basis as the default method of calculating trading profits, this measure aims to remove administrative barriers to using the simpler regime, and seeks to formalise the behaviour of many businesses that currently use the cash basis without officially electing to do so. This change also aims to calm any concerns that taxpayers may have that the cash basis is not a ‘normal’ or ‘proper’ way of calculating trading profits.

This measure goes further than was set out in the consultation document by completely removing specific restrictions on turnover, interest costs and losses in the cash basis. These changes aim to significantly expand the number of businesses that are eligible to use the cash basis, and aim to encourage businesses to use the regime if they are not using it purely because they would be affected by these restrictions.

In particular, removing the interest and loss relief restrictions complements the cash basis default. Removing these rules mean that businesses will not be defaulted into a position where they cannot use losses or deduct interest as a result of the cash basis default, providing consistency with the current accruals default.

Background to the measure

The government announced at Spring Budget 2023 that it would consult on expanding the cash basis. A formal consultation on proposals was launched on 15 March 2023 and ran until 7 June 2023. This measure was announced at Autumn Statement 2023.

Detailed proposal

Operative date

This measure will have effect from the tax year 2024 to 2025.

Current law

Current law on the trading income cash basis is primarily included in Chapter 3A of Part 2 of the Income Tax (Trading and Other Income) Act 2005.

The legislation setting generally accepted accounting practice as the standard method of calculating trading profits is at section 25 of the same act. The option to elect to use the cash basis is at section 25A, and the effect of such an election is described in section 31D and the remaining sections of Chapter 3A Part 2. The list of businesses specifically excluded from using the cash basis is at section 31C.

Section 31A sets the conditions for using the cash basis, setting the turnover restriction at section 31A(1), (2), and (3). Section 31B defines the ‘relevant maximum’ for the purposes of this turnover restriction.

Section 51A disallows deductions against profit for interest paid on loans under the cash basis, and section 57B allows a deduction of up to £500 for interest under the cash basis. Together, these form the interest restriction.

Section 74E of the Income Tax Act 2007 prevents sideways and capital gains loss relief for losses generated under the cash basis. This forms the loss relief restriction.

Proposed revisions

Legislation will be introduced in Autumn Finance Bill 2023 primarily to amend Part 2 ITTOIA05. This will set the cash basis as the default method of calculating profits for trading income.

A new election will be introduced to allow businesses to opt-out of the cash basis and switch to accruals. This election will have effect from the tax year in which it is made onwards, but can be withdrawn to allow the business to move back to the cash basis. This legislation will also stop the cash basis default applying to certain types of business that are normally excluded from using the cash basis.

This legislation provides the power for the Treasury to amend this list of excluded types of business through regulations.

The rules which set the turnover thresholds for entering and leaving the cash basis will be removed. The rules setting the specific restrictions on interest deductions, and allowing up to £500 in interest deductions under the cash basis will also be removed.

This legislation will also amend Part 4 ITA07 to remove the restrictions on loss relief available where the cash basis has been used to calculate those losses. This will disapply the specific restrictions on loss relief under the cash basis and align the rules for loss relief with the accruals basis.

These changes will have effect for the tax year 2024 to 2025 onwards.

Summary of impacts

Exchequer impact (£ million)

2023 to 2024	2024 to 2025	2025 to 2026	2026 to 2027	2027 to 2028	2028 to 2029
Nil	Nil	+115	-30	Nil	Nil

These figures are set out in Table 5.1 of Autumn Statement 2023 and have been certified by the Office for Budget Responsibility. More details can be found in the policy costings document published alongside Autumn Statement 2023.

Economic impact

This measure is not expected to have any significant macroeconomic impacts.

Impact on individuals, households and families

This measure is expected to have no impact on individuals other than the self-employed and partners with trading income (which have been detailed in the impact on business section).

There is expected to be no impact on family formation, stability, or breakdown.

Equalities impacts

It is not expected that there will be adverse effects on any groups sharing protected characteristics.

Impact on business including civil society organisations

This measure is expected to have a significant impact on 250,000 businesses that are estimated to move into using the cash basis as a result of these changes.

One-off costs could include familiarisation with the changes, and for businesses that choose to move into the cash basis as a result of the changes, transition to the cash basis. There are not expected to be any further one-off costs.

Continuing savings could include a simplified calculation and reporting process for businesses that choose to move into the cash basis as a result of the changes. Additionally, the measure creates a continuing saving for businesses using the cash basis as they will no longer have to indicate that they are using the basis on their Self Assessment tax return. Continuing costs could include businesses using the accruals basis needing to indicate that they are doing so on their Self Assessment tax return.

Estimated one-off impact on businesses (£ million)

One-off impact	£ million
Costs	Negligible
Savings	—

Estimated continuing impact on administrative burden (£ million)

Continuing average annual impact	£ million
Costs	Negligible
Savings	13
Net impact on annual administrative burden	-13

These admin burden savings are minimum estimates and may not include the full impact of the reductions in admin burdens identified above, in cases where it has not been possible to quantify the savings.

This measure would not be expected to impact civil society organisations.

This measure would be expected overall to improve businesses’ experience of dealing with HMRC as more businesses will be able to, and are expected to use, a simpler method for completing Self Assessment tax returns. It is expected that many businesses are using the cash basis without formally notifying HMRC that they are doing so on their Self Assessment tax returns. This measure will formalise this behaviour, reducing error.

Operational impact (£ million) (HMRC or other)

There will be operational impacts for HMRC to support safe implementation of this measure. HMRC will need to make changes it its IT systems. These changes are currently estimated to cost in the region of £2 million.

Other impacts

Other impacts have been considered and none have been identified.

Monitoring and evaluation

The measure will be monitored through information collected from tax returns and kept under review through communication with affected taxpayer groups.

Further advice

If you have any questions about this change, please contact T Brown on the Business Profits Team by email: [email protected]. Please include ‘Cash Basis’ in the subject line of the email.