HMRC notices

The cash basis scheme helps sole traders and other unincorporated businesses benefit from a simpler way of managing their financial affairs. The scheme was extended to landlords from April 2017. The scheme is not open to limited companies and limited liability partnerships. The entry threshold for the cash basis scheme is £150,000 and you can stay in the scheme until your business turnover reaches £300,000.

Unlike other taxpayers that need to opt-in to use the scheme, the legislation assumes that landlords will use the cash basis as the default method of calculation. A landlord can still elect to opt out of the scheme in which case they can continue to use Generally Accepted Accounting Practice (GAAP) to calculate their taxable profits. Landlords are also required to continue using GAAP if their rental receipts are in excess of the £300,000 scheme threshold.

The cash basis scheme allows landlords to use the cash basis when recording income received and expenditure paid i.e. recording the flow of money from and to the business based on actual money flows. Traditional accounting uses the accruals basis i.e. income and expenditure is recorded when a bill is received, or a customer is invoiced.

Where an individual makes a loss in a trade or incurs a loss as a partner in a partnership trade, the tax rules allow the loss to be set against general income. Certain trade losses may be offset against general income. It may also be possible to carry trade losses back to earlier years or forward to subsequent years. However, partial claims are not allowed. This means that a loss set against income for a particular year must be set as far as possible against that income, even if this means that personal allowances available for that year are not fully utilised.

This relief against general income extends to:

1. losses in trades (including a profession or vocation), provided they are carried out on a commercial basis and with a view to the realisation of profits;
2. losses arising out of land – mines, quarries and other concerns;
3. but not to relief for losses in an employment or office; these are not trade losses.

By way of explanation, HMRC’s internal manuals provide the following example:

Mark has been carrying on a trade for a number of years and makes up his accounts annually to 30 September. He makes a loss of £20,000 in the year ended 30 September 2012; that is, for the tax year 2012-2013. He can relieve that loss against his general income in 2012-2013 or by reference to his general income in 2011-2012 or his general income in both 2011-2012 and 2012-2013. The claim must be made by 31 January 2015.

If the loss is to be the subject of claims for both years, Mark must choose which claim has priority. But partial claims cannot be made. The loss used in the priority year is an amount equal to income of that year. The remaining loss can be used in the other year.

If Mark had general income of £22,000 in 2012-2013 and £5,000 in 2011-2012, the alternative reliefs under S64 ITA 2007 would be:

• £20,000 against 2012-2013, or
• £5,000 against 2011-2012 and £15,000 against 2012-2013.

It is not possible to relieve, say, £2,000 against 2011-2012 and £18,000 in 2012-2013. The claim for each year must be the smaller of the loss available for relief and the income available to be relieved.

If you are selling your business, there are some important actions you must take in order to properly finalise your affairs. We have summarised below some of the main steps you need to take if closing your business. Please note that this is not an exhaustive list and it is important to check what else may be required.

Self-employed sole trader

• Notify any staff about when and why you are selling your business.
• Keep staff informed about redundancy terms or relocation packages and be mindful not to breach your employees’ rights.
• Notify HMRC. There is an online form that can be completed to tell HMRC you are closing your business. The form covers both Self-Assessment and National Insurance.
• Cancel your VAT registration or possibly transfer to new business owner.
• Consider your liability to Capital Gains Tax and whether you can benefit from reliefs including Entrepreneurs’ Relief.

Business partnership

• Your responsibilities when selling a partnership will depend on whether you’re selling your share of the partnership or the entire partnership.
• Keep staff informed about redundancy terms or relocation packages and be mindful not to breach your employees’ rights.
• If you will cease being self-employed, cancel your Class 2 National Insurance contributions.
• Cancel your VAT registration or possibly transfer to new business owner.
• Consider your liability to Capital Gains Tax and whether you can benefit from reliefs including Entrepreneurs’ Relief.

Limited company

• Your responsibilities when selling a limited company will depend on whether you’re selling your entire shareholding, or the company is selling part of its' business. 
• Keep staff informed about redundancy terms or relocation packages and be mindful not to breach your employees’ rights.
• If you are selling your entire shareholding you should appoint new directors before you resign as a director yourself.
• Consider your liability to Capital Gains Tax and whether you can benefit from reliefs including Entrepreneurs’ Relief.
• If there are charges against your company, for example a mortgage on your house to secure a business loan, you must let the provider know within 21 days of the sale.
• You may want to transfer your VAT registration to the new owner.

HMRC publishes a list of income streams that are excluded from a UK property business. The list includes fishing concerns, hotels and guest houses, tied premises, caravan sites, lodgers and tenants in your own home, extra services to tenants and letting surplus trade accommodation. In most cases the income from these activities will be taxed as income of a trade and not as property income.

There are also certain receipts which can arise out of the use of land and which are specifically excluded by statute from a rental business. These include yearly interest, income from the occupation of woodlands managed on a commercial basis, income from mines and quarries and income from farming and market gardening.

In addition, there is a £1,000 property income allowance that applies to income from property (including foreign property). If a taxpayer’s annual gross property income is £1,000 or less, the amount is exempt from tax and does not need to be reported on a tax return.

There is specific tax legislation that seeks to determine which charge takes priority where two different charges could potentially apply to the same income. These rules are known as the 'priority rules'.

HMRC manuals state that for Income Tax purposes, savings and investment income, and income otherwise within one of the charges on miscellaneous income, which also falls to be treated as a trade receipt is dealt with under the trading income rules. For Corporation Tax purposes, distributions from unauthorised unit trusts and income from the sale of foreign dividend coupons, which are also trade receipts, are dealt with under the trading income rules.

There are a number of exceptions to these rules. For example, a receipt or other credit item which would otherwise be treated both as a trade receipt and as a receipt of a UK property business is dealt with under the property income provisions.

The Income Tax priority rules must be considered together with other rules of law about the scope of particular provisions or the order of priority to be given to them. For example, there are particular rules which expressly require certain activities to be treated as a trade.

There are special rules, known as the miscellaneous income sweep-up provisions, that seek to charge tax on certain income. This unusual provision, which is broad in scope, catches certain income that would not otherwise be charged under specific provisions to Income Tax or Corporation Tax.

Amongst the types of income covered are:

• payment for a service where it was agreed that the service would be provided for reward;
• income received under an agreement or arrangement and which is not otherwise taxable;
• payment for the use of money that is not interest or does not fall within the loan relationships legislation.

HMRC is keen to stress that although the provisions are sweep-up provisions, this does not make all miscellaneous income taxable.

Specifically, the provisions do not tax:

• capital accretions on isolated transactions in assets;
• voluntary receipts such as gifts and gratuities;
• gambling winnings from wagers and bets;
• certain post-cessation receipts.

The holder of a scholarship is exempt from a charge to Income Tax on income from a scholarship when receiving full-time education at a university, college, school or other educational establishment.

Please note, that the provision of a scholarship to a member of the family or household (usually a son or daughter) of a director or employee by reason of the employment of that director or employee, will give rise to a taxable benefit. Fortuitous awards of scholarships are the only exception to this rule.

We have noted below the principal conditions and one exclusion, which together explain the basic position when a scholarship can be exempt from Income Tax.

Conditions

1. The employer must require that the employee be enrolled at the educational establishment for at least one academic year and must attend the course for at least twenty weeks in that academic year. Or if the course is longer, the employee must attend for at least twenty weeks on average, in an academic year over the period of the course.
2. The educational establishment must be a recognised university, technical college, or similar educational establishment and which is open to members of the public generally and offers more than one course of practical or academic instruction. For example, an employer’s internal training school or one run by an employer’s trade organisation will not satisfy the educational establishment condition for this relief.
3. The payments, including lodging, subsistence and travelling allowances but excluding any tuition fees payable by the employee to the university etc, should not exceed £15,480.

Exclusion

• This exemption does not apply to payments of earnings made for any periods spent working for the employer during vacations or otherwise. These payments would be taxable as earnings in the normal way.

If you are self-employed as a sole trader or as a partner in a business partnership, then you must keep suitable business records as well as separate personal records of your income.

For tax purposes, the business records must be held for at least 5 years from the 31 January submission deadline for the relevant tax year. For example, for the 2017-18 tax year where online filing was due by 31 January 2019 you must keep your records until at least the end of January 2024. In certain situations, such as when a return is submitted late, the records must be held for longer.

If you are self-employed you should also keep a record of:

• all sales and income
• all business expenses
• VAT records if you’re registered for VAT
• PAYE records if you employ people
• records about your personal income

You don't need to keep the vast majority of your records in their original form. If you prefer, you can keep a copy of most of them in an alternative format, as long as they can be recovered in a readable and uncorrupted format. For example, a scanned PDF document.

If your records are no longer available for any reason, you must try and recreate them letting HMRC know if the figures are estimated or provisional. There are penalties for failing to keep proper records or for keeping inaccurate records.

The cash basis scheme helps many sole traders and other unincorporated businesses benefit from a simpler way of managing their financial affairs. The scheme is not open to limited companies and limited liability partnerships. The scheme allows qualifying businesses to use the cash basis when recording income and expenditure. However, some smaller businesses are more suited to using the case basis than others.

The scheme is most suitable for straight forward businesses especially those that provide services. Firms must have a turnover of £150,000 or less to join the scheme and they can continue using the scheme until their turnover reaches £300,000.

If clients wish to use the cash basis, they must also meet the following conditions:

1. The total cash basis receipts for all trades carried on in a tax year must not exceed the amounts stated above.
2. Where a business is either an individual who controls a partnership or a member of a partnership controlled by an individual, the total cash basis receipts for all trades carried on in a tax year must not exceed the amounts stated above where the individual or partnership uses the cash basis for all those trades.
3. Clients are not specifically excluded from using the cash basis. Excluded categories include Lloyd’s underwriters, partnerships with one or more corporate partners and businesses that have claimed a research and development allowance.

Clients considering the use of the cash scheme, and who elect to use the cash basis for a tax year, must use the cash basis for each trade they carry on during that tax year.