Consultation outcome

Expanding the cash basis - summary of responses

Updated 22 November 2023

1. Introduction

Background to the consultation

The government intends to improve the experience of reporting in Income Tax Self Assessment (ITSA) for small businesses by simplifying the rules and extending eligibility for the cash basis.

Tax simplification is a priority for the government, and in particular for small businesses; simplifying the tax system helps to boost productivity, increases business confidence, and reduces the amount of time and money businesses spend on tax administration. The cash basis is an example of a successful tax simplification which has made the tax affairs of many small businesses more straightforward since its introduction in 2013, cutting down on the number of tax and accounting adjustments that small businesses are required to make, and making a business’s tax position easier to understand.

To continue to simplify the tax system further, the government launched a consultation on expanding and simplifying the cash basis. The government recognises the benefits that the cash basis offers to small businesses, and views the regime as a valuable simplification. More than two-thirds of eligible businesses do not currently officially use the cash basis, even though many may benefit from its simplicity.

The cash basis is a simplified regime for calculating taxable profits for businesses with straightforward tax affairs. The regime allows businesses to calculate their taxable profit as the difference between income and expenditure when money is actually received or paid out. This eliminates accounting and tax complexities such as accruals and most capital allowances, and simplifies reporting.

The government identified a series of options to improve the experience for small businesses of using the cash basis:

• increasing the turnover threshold for businesses to use the cash basis,
• setting the cash basis as the default basis, with an opt-out for accruals
• increasing the £500 interest restriction for businesses in the cash basis
• relaxing restrictions on loss relief for losses that are generated in the cash basis

On 15 March 2023, the government issued a consultation document asking for views on the proposals to expand and simplify the cash basis, and also asking for views more generally on how the cash basis could be improved to give more businesses the opportunity to use it.

Summary of responses

This document sets out a summary of responses received in respect of the consultation, and the government’s next steps.

The government held 4 meetings and received 23 written responses from businesses, individuals, and representative agents and bodies. Alongside the consultation itself, the government also held 2 meetings with groups of self-employed people to better understand the views of small businesses likely to be affected by these changes.

The general tone of the consultation was supportive of the cash basis as a useful simplification for the smallest businesses and for those with the simplest affairs. Respondents generally agreed with encouraging more of these types of business to use the cash basis where appropriate. However, most respondents from the accounting profession also noted that accruals would be the most appropriate method of accounting for many businesses with slightly more complex affairs, such as those with a lot of stock, and that businesses often needed full accruals accounts for commercial or other reasons.

Turnover restriction

On the level of the cash basis threshold, responses were generally neutral. Respondents to the consultation mostly expected businesses with turnover of more than £150,000 to be using accruals accounts as a matter of course due to their size. Respondents also set out that they expected very few businesses to move to the cash basis as a result of changing the threshold. Feedback suggested that the existence of a threshold may discourage some start-up businesses from choosing the cash basis, and that removing the threshold would, in principle, simplify the cash basis.

Cash basis default

On the cash basis default, feedback was mixed. Self-employed people and some of their representatives saw significant value in setting the cash basis as the default. In particular, this was seen as helpful formalisation of the use of the cash basis by many businesses that use it without electing to. The default was also seen as a useful way to avoid businesses getting confused or worried about making a specific election to use the simpler regime; respondents thought that electing into a regime that was not the ‘standard’ approach discouraged people from using it.

However, most responses from representatives of the accounting sector stressed the value of accruals for businesses, particularly for reasons other than tax. These accountancy respondents thought that the cash basis default would have little effect on the number of people actually using the cash basis, as they expected that current accruals users would almost always opt out, or be advised to opt out. Most of these accountancy respondents set out that they would only support the cash basis default if the interest and loss relief restrictions were removed at the same time.

Interest restriction

Responses about the £500 limit on interest deductions in the cash basis were more consistent; almost all responses called for the cap to be significantly increased or preferably removed entirely. Respondents thought that removal would align the rules with accruals and encourage more businesses to use the cash basis. This restriction, alongside the restriction on loss relief, was most commonly cited as the reason businesses did not choose to use the cash basis, and respondents were unclear about the original policy intent behind the restrictions.

Loss Restriction

Similarly, almost all responses covering restrictions on loss relief under the cash basis were also in favour of removing the restrictions and aligning the rules for losses with accruals, as a way to encourage use of the cash basis. In particular, respondents thought that removing the loss relief restriction could encourage more start-up businesses to use the cash basis in their early years of trade.

Guidance and education

A point that was raised by all stakeholders throughout the consultation responses was the need for further guidance and education about the cash basis for self-employed people. When discussing the proposals with self-employed people, many did not realise that the cash basis had to be elected into, and the majority of them did not realise that there was a restriction on interest costs in the cash basis. Most self-employed people that HMRC spoke to did not realise that loss relief was available under cash or accruals, and therefore also did not understand the current difference in treatment between the two regimes.

Respondents thought that this lack of awareness and understanding could be contributing to a large number of people officially appearing to use accruals, while actually using the cash basis or some hybrid of the cash and accruals basis. A common view was that even in the absence of changes to the cash basis rules, HMRC should significantly improve the GOV.UK guidance on the cash basis.

We are grateful to all those with whom we discussed the proposals and those that submitted responses, recognising the time and effort that went into them. The responses and external discussions have helped HMRC to understand respondents’ views and concerns, as well as the potential impacts of the options.

The following chapters set out the responses received to the specific questions asked in the consultation, and outlines how the government proposes to take forward the options for change. Annex A provides a list of respondents.

2. Responses

This chapter summarises the responses to the questions asked in the consultation.

Turnover restriction

Question 1a: Under either of the options, would businesses within the newly-eligible population consider moving to the cash basis?

There were 14 responses to question 1a.

The consensus amongst responses was that businesses with a turnover of more than £150,000 would very likely be drawing up accruals accounts for other commercial reasons, or would want to use accruals accounts to be able to make stock or work in progress adjustments.

However, a small number of respondents suggested that specific sectors, such as barristers and consultants, may choose to use the cash basis at higher turnover levels as it is more appropriate for their specific trades. A small number of respondents suggested that larger self-employed businesses may consider using the cash basis if it is financially beneficial.

Some accountancy responses also pointed out that the main barriers, in their eyes, to businesses using the cash basis were the interest restriction and loss relief restriction, rather than the turnover threshold.

Question 1b: What are the benefits/disbenefits of aligning the threshold to the VAT cash accounting scheme, and what are the benefits/disbenefits of removing the threshold entirely?

There were 12 responses to question 1b.

The majority of responses to this question considered alignment with the VAT cash accounting scheme threshold to be a simplification and helpful alignment, as long as the two thresholds remained linked going forward.

However, most responses suggested that because there are likely only a very small number of self-employed businesses above the VAT cash accounting threshold, it may be simpler to remove the turnover threshold for the cash basis entirely. Feedback from accountants and self-employed representatives suggested that this may simplify the rules further, and would completely remove the prospect of a business being forced out of the cash basis due to turnover.

Question 1c: Would increasing the cash basis threshold encourage businesses currently below the threshold to move into the cash basis, knowing that they would be able to stay in it for longer if their business grew? Would this have a significant or minor effect on businesses?

There were 13 responses to question 1c.

Responses to this question were mixed, across both accounting and self-employed representatives. Some respondents agreed that businesses would be more likely to choose the cash basis, particularly when they were starting up, if the turnover threshold were higher and the cash basis were available for longer. However, a similar number of respondents thought that changing the threshold would not have a significant effect on businesses that were currently under the threshold and using accruals.

Question 1d: Are there any alternative changes to the entry or exit thresholds that would also increase the eligible population and encourage businesses to join the cash basis?

There were 9 responses to question 1d.

Broadly, responses to this question set out that changes to the turnover threshold are unlikely to significantly impact the number of cash basis users compared to changing the interest and loss relief restrictions. However, respondents said that allowing businesses of all sizes to use the cash basis would at least allow businesses to make their own decision on whether it is appropriate for them, and whether to use it, rather than being forced out due to turnover limits.

Specific suggestions put forward in responses to this question included:

• increasing the ‘grace period’ for peaks in turnover from 1 to 3 years
• if the general turnover threshold remains unchanged, allowing all barristers to use the cash basis
• carrying out further research to identify how many Universal Credit (UC) claimants use the enhanced UC cash basis threshold

Cash basis default

Question 2a: Many businesses that would benefit from the cash basis currently do not use it, and many use it without electing to do so. Do you have any insight into why many businesses in the eligible population do not use the cash basis?

There were 16 responses to question 2a.

Some representatives of self-employed businesses, and the self-employed businesses that HMRC spoke to, suggested that many businesses do not understand the term ‘cash basis’ and how the cash basis may apply to them. Few of the self-employed people that HMRC spoke to about the cash basis understood that the ‘cash basis’ as a separate regime existed; many simply used it without ticking the box to elect into the regime on their tax return. Accounting and self-employed respondents suggested that this could mean that there may be a large number of businesses, concentrated in the unrepresented population, using the cash basis without formally telling HMRC that they are doing so.

Many accountancy respondents suggested that many of the businesses in the eligible population prefer to have accruals accounts drawn up. These respondents suggested accounts may be used for reasons beside reporting to HMRC, such as management of the business, supporting evidence for loan or mortgage applications, or reporting to other external stakeholders. Most of these accounting respondents thought that for these businesses, the benefits of accruals accounts outweighed the simplification offered by the cash basis.

Some accounting respondents also highlighted the deterrent effect that the restrictions on turnover, interest, and losses have on businesses joining the cash basis; either because they would be directly affected by them, or that they are worried about the restrictions potentially applying in future.

In particular, different types of business were identified as less likely to use the cash basis, or specifically restricted from using the cash basis, such as:

• businesses holding large amounts of stock
• businesses operating in the construction industry under the construction industry scheme
• partnerships, that preferred to use the accruals basis to calculate profit shares
• businesses that provided staff bonuses based on profits
• farming businesses that are specifically prevented from using the cash basis because they use the herd basis or profit averaging

Some respondents, both accountants and self-employed representatives, suggested that some small businesses may not be electing to use the cash basis but are using a ‘hybrid’ basis instead. These businesses may be confusing some rules from the accruals basis with others from the cash basis, creating a mixed or ‘hybrid’ set of tax rules that they apply to their end of year position to reach taxable profits. For example, respondents suggested that some small businesses are using the cash basis rules but claiming capital allowances on their plant and machinery, or that some are using the cash basis and incorrectly claiming sideways loss relief.

Question 2b: Would changing the cash basis to the default for trading income have an impact on whether businesses use the cash basis or accruals basis? What are the benefits or drawbacks of setting the cash basis as the default?

There were 14 responses to question 2b.

Most respondents from the accounting profession were doubtful of the impact that setting the cash basis as the default would have. They were keen to stress the importance keeping accruals accounts as the default and thought that the current position should remain unchanged.

Other respondents thought that there was a significant number of businesses that were already using the cash basis without electing to do so. These responses outside of the accounting representative bodies thought that the cash basis default would formalise what these businesses were already doing, increasing the official number of cash basis users and reducing errors that are currently made in returns where the election to use the cash basis is not made.

Some feedback from a small number of accountants suggested making neither basis the default, instead requiring businesses to make an active choice between cash and accruals. Other feedback from small businesses suggested that the need to make an election to opt-in to the cash basis can be confusing and intimidating for many unrepresented businesses, discouraging them from electing into the regime as they saw it as not the ‘standard’ or ‘not the normal way of doing things’.

Some accountancy respondents noted that the cash basis is often not chosen because of the interest and loss relief restrictions, and that defaulting businesses into a regime with these restrictions would be inappropriate. Most of these accounting respondents said that these restrictions should be removed if the cash basis were set as the default.

All respondents said that HMRC should launch a significant communications and education campaign about the cash basis; this was suggested both as an alternative to the cash basis default and as an accompaniment to making the change.

Question 2c: Under a cash basis default, what proportion of businesses would you expect to opt-out and use the accruals basis?

There were 10 responses to question 2c.

Common feedback from accountancy representative bodies was that they would advise many businesses to opt-out of a cash basis default because the accruals basis would be more suitable for them, as suggested in the answers to question 2a. The businesses choosing to opt-out of a default would more likely be represented, already using accruals, or larger self-employed businesses.

However, respondents also expected that many unrepresented businesses, that were already using the cash basis on an informal basis, would be formally brought into the cash basis if it were made the default.

The majority of respondents were unable to, or did not have sufficient information to, estimate the number of businesses that may start to use the cash basis if it were made the default.

Question 2d: Would you expect there to be a transition administrative burden for businesses brought into the cash basis by the default, and are there any changes to the transition process for entering the cash basis that could help to smooth any burdens?

There were 11 responses to question 2d.

Most accountancy respondents said that changes to the transition process would not be needed, as the transition rules already work well to convert from cash to accruals, and they thought that many businesses would avoid any transition adjustments by opting into the accruals basis. However, for those businesses that did change from accruals to cash, feedback suggested that there would be a transitional administrative burden.

In particular, concerns were raised around unrepresented customers being able to make transitional adjustments to move from accruals to the cash basis. Further education and guidance were suggested to mitigate this concern.

Respondents representing the self-employed also suggested that following the change, HMRC should not automatically conclude that a business that is appearing to move into the cash basis needs to make transition adjustments; as they may have been informally using the basis beforehand.

Question 2e: To what extent would businesses need help and support with understanding the change from the default accruals basis to the cash basis?

There were 13 responses to question 2e.

The majority of responses to this question suggested a significant education and communications campaign to clearly explain the cash basis to businesses and to allow them to make an informed choice of cash or accruals. Respondents called for HMRC to ensure that enough staff were available to handle any additional queries as a result of the changes.

Most responses from the accountancy sector thought that businesses with accountants would be less likely to make errors if they moved to a different basis if the changes were introduced, but feedback suggested two groups in particular that may need extra support or targeted communications:

• accounting stakeholders were particularly concerned about businesses that previously had an accountant, drawing up accruals accounts, that choose to move to the cash basis and prepare their tax return without support for the first time, possibly including transition adjustments in that return
• generally, respondents were also concerned about unrepresented businesses, specifically those that have previously been informally using the cash basis, and who may think that they need to make transition adjustments if any changes are introduced

Interest restriction

Question 3a: What would be an appropriate level to set the interest restriction to? Are any of the 3 options proposed an appropriate level, considering the balance between allowing up-to-date costs of financing and the distortive effects of allowing private borrowing costs as deductions?

There were 13 responses to question 3a.

Respondents frequently made the point that the £500 restriction was set in 2013, when the Bank of England base rate was 0.5%; they commented that this rate, and the interest rates that small businesses are likely to be paying on finance, have significantly increased in recent years. Feedback called for the £500 limit to be updated to reflect these changes in the costs of borrowing since 2013.

A common view amongst accountancy respondents was that increasing the restriction to the highest level proposed in the consultation document, £1,000, would still be too low. Some respondents suggested restrictions above this, including £5,000 and £10,000. Most other respondents suggested that their preferred course of action would be to remove the restriction entirely, in order to incentivise more businesses to use the cash basis. The self-employed businesses that HMRC spoke to were generally unaware of the £500 restriction, and did not have any business loans that they were paying interest on.

Questions were raised around the rationale for the interest restriction, and the reasons for its inclusion as part of the cash basis. In particular, some respondents questioned why non-business borrowing costs could be allowed under the £500 deduction.

Question 3b: To what extent would increasing the interest restriction in the cash basis have an effect on whether businesses choose to use the cash basis or not? Does the interest restriction influence decisions to join the cash basis where a business has interest costs below the £500 limit?

There were 11 responses to question 3b.

The general consensus, particularly amongst accounting representative bodies, in response to this question was that the current level of the restriction is disincentivising some businesses from joining the cash basis.

However, it was also noted that increasing the restriction by amounts similar to those listed in the consultation would likely only have a small effect on the number of businesses that would choose to use the cash basis. Respondents thought that a larger increase, or removal of the restriction, would be needed to encourage more businesses to think about using the cash basis.

Some respondents said that removing the interest restriction would actively encourage businesses currently using accruals to consider switching to the cash basis, particularly if the cash basis benefitted them overall.

Question 3c: To what extent would you expect businesses currently using the cash basis to increase their interest deductions, either through further borrowing or not being limited by the current £500 maximum?

There were 10 responses to question 3c.

All respondents to this question said that business borrowing is driven by commercial necessity rather than tax reasons, meaning that businesses would not be expected to increase their borrowings in response to greater relief becoming available. Businesses that wanted to borrow and either needed or wanted to get full deductions for their interest costs were expected to already be using, or move to, the accruals basis.

Question 3d: Is the form of the current interest restriction appropriate for the cash basis? Are there any changes to the interest restriction rule itself, aside from changes to the limit, that would help to increase the number of businesses that are able to use the cash basis while allowing appropriate deductions for interest costs?

There were 10 responses to question 3d.

A series of respondents set out that they were unclear about the original policy intentions of the interest restriction, and that they did not think there was a good reason for it to remain part of the cash basis. Feedback from the accounting profession suggested that removing the interest restriction entirely would remove a significant disincentive for businesses to join the regime, for businesses that currently borrow money and for those that thought they might need to borrow money in the future.

One response also highlighted the need for education on splitting out private and business finance costs if the restriction were to be removed, as the current rules do not require a user of the cash basis to distinguish between private and business interest costs. However, another response pointed out that apportioning personal interest was less of an issue compared to the more fundamental misunderstanding of whether the individual capital and interest elements of a loan repayment can be deducted.

Loss restrictions

Question 4a: Would removing or relaxing the cash basis trade loss relief restrictions have an effect on whether businesses with losses choose to use the cash basis?

There were 16 responses to question 4a.

Most respondents agreed that removing or relaxing the restrictions on loss relief for losses generated in the cash basis would encourage more businesses to use the regime. This restriction was seen, in particular by accountants, as a direct deterrent to using the cash basis and one of the main reasons why businesses did not currently use the cash basis.

In particular, respondents highlighted that removing restrictions on loss relief would encourage new businesses to use the cash basis, and support those businesses during their early years of trade. Currently, respondents from the accounting sector noted that these businesses would likely start on the accruals basis in order to access, or to have the option of accessing, loss relief, and then would remain on the accruals basis after their lossmaking period.

Some respondents pointed out that small businesses may not know that they are able to take advantage of loss relief after experiencing losses. When HMRC discussed the cash basis with self-employed people, most did not realise that loss relief was available in some circumstances.

Question 4b: Is the burden of moving out of, and then back into, the cash basis to claim sideways loss relief currently having an effect on businesses’ decisions to use the cash basis?

There were 10 responses to question 4b.

Feedback, mostly from the accounting sector, to this question suggested that it was unlikely for businesses to switch between the cash and accruals basis purely to access loss relief available under the accruals basis. The complexity of moving between cash and accruals was noted, which some respondents thought would mean that businesses expecting to make losses would use the accruals basis, and stay in the accruals basis, to ensure that they could use loss relief if needed. Respondents thought that only businesses with an advisor would be able to make regular judgements on moving between the cash and accruals basis to make the most of loss relief when needed.

Question 4c: Are the restrictions on loss relief under the cash basis dissuading new businesses, that may be making losses in their early years of trade, from using the cash basis?

There were 10 responses to question 4c.

Responses highlighted the value of sideways loss relief for new businesses, particularly where an individual is transitioning from employment to self-employment or has other income streams. Therefore, most respondents, representing both self-employed people and accountants, thought that a significant number of loss-making new businesses did not use the cash basis because they are not currently able to take advantage of loss relief.

Question 4d: What changes of the loss relief restrictions for the cash basis do you think would have the greatest effect on the number of businesses that would be eligible for, and use, the cash basis?

There were 11 responses to question 4d.

The most common suggestion put forwards in most of the responses to this question was to remove the loss relief restrictions entirely and align the loss relief rules in the cash basis with those in the accruals basis.

Accounting respondents felt that the policy rationale behind the current restrictions on loss relief in the cash basis was unclear, and they were uncertain as to why the restrictions were needed. Most respondents thought that removing the cash basis-specific restrictions on losses would help to improve consistency across cash and accruals and simplify the cash basis. Respondents noted that if the cash basis rules were aligned with accruals, the general cap on sideways loss relief would apply, preventing significant abuse of relief.

Some respondents from the accounting sector said that the current loss relief restrictions act to penalise businesses using the cash basis, as they cannot use the same loss reliefs as accruals. Some also suggested that this change would make the biggest impact in simplifying the cash basis and making it available to the widest group of businesses.

Interactions and other improvements to the cash basis

Question 5: Are there any specific interactions, benefits, or issues that could arise from a combination of some or all of the options outlined in this consultation document?

There were 13 responses to question 5.

Most accountancy respondents stressed the importance of changing the restrictions on interest deductions and loss relief as a prerequisite to making any other changes to expand the cash basis. Most respondents also thought that increasing the turnover threshold or setting the cash basis as the default would have little effect without changing these two restrictions at the same time. A key driver for this was the idea that businesses should have more of a financial incentive, through changing the interest and loss relief restrictions, to use the cash basis compared to accruals.

Many respondents representing the accounting sector specifically recommend against setting the cash basis as the default without changing the rules on interest and loss relief restrictions as well.

A small number of respondents pointed out that too many changes could have the opposite effect to simplification, by adding in new rules and guidance to already complicated systems for businesses to deal with. Some other respondents also noted that regimes that changed the level of profits or losses declared could have knock-on impacts on other systems that use income to determine eligibility.

Question 6: Are there any other areas of the cash basis that could be modified or improved to increase eligibility, take up, or simplicity?

There were 8 responses to question 6.

One response set out that it is difficult to get an understanding of the number of businesses using the cash basis but that are not officially electing to do so.

One response commented that simplification has tended to look at digitisation or removing the need for accountancy support, rather than addressing inherent complexity in the tax rules. The response noted that there does not appear to be a consistent view of what ‘simplification’ means across tax reforms proposed by the government.

Question 7: Would allowing an optional end of year adjustment for stock in the cash basis be a feasible or helpful addition, and would it encourage more businesses to use the cash basis?

There were 11 responses to question 7.

The general response to this proposal was that this option would introduce complexity to the cash basis with limited benefit for small businesses, distracting from the wider simplification that the cash basis offers by introducing an aspect of accruals into the regime.

Accountancy respondents suggested that this could increase the likelihood of errors for businesses due to its complexity, and that stock-based businesses would generally be better suited to the accruals basis.

A very small number of respondents suggested that this option may encourage some small businesses to use the cash basis that would not otherwise have considered it.

Question 8: Are there any opportunities to more closely align the rules for measuring self-employment income under Universal Credit with the self-employed cash basis? Would closer alignment encourage more people to use the cash basis, or provide simplification benefits for people already using the cash basis?

There were 9 responses to question 8.

The consensus among respondents was that greater alignment between the cash basis rules and UC rules would be helpful for small businesses. Some respondents pointed out that taxpayers in the UC system are likely to be existing users of the cash basis.

Some respondents to this question, particularly those representing the self-employed, raised the potential benefits of procedural alignment between Self Assessment, UC, and Making Tax Digital (MTD) for ITSA. For example, they suggested aligning the format of the UC monthly assessment forms with the boxes of the self-employment page of the Self Assessment return. Feedback suggested that any changes in this area would likely simplify administration for UC claimants, rather than encourage more people to use the cash basis.

Question 9: Are there any non-legislative changes that could be made to improve understanding and use of the cash basis for eligible businesses? Would an education campaign to inform small businesses of the cash basis encourage more to use it, even without changes to the cash basis itself?

There were 15 responses to question 9.

Most responses called for the guidance for the cash basis to be expanded and improved upon. This feedback focused on asking to improve the GOV.UK guidance, rather than the Business Income Manual technical guidance, to ensure that guidance was accessible, easy to find, and something that could be understood by the average small business. The current guidance available on GOV.UK was viewed as inadequate compared to the number of businesses using the cash basis.

In particular, respondents asked for more guidance to help explain the differences between the cash basis and accruals basis, and guidance to help small businesses decide whether the cash basis would be suitable for them or not, including a lot of real-world simple examples. Specific areas for new guidance that some respondents identified included changes to guidance on net receipts and timing of payments from platforms, and improving the Business Profits Toolkit to include the cash basis.

Most responses to this question strongly encouraged HMRC to carry out a wider education campaign around the cash basis targeted at small businesses, which they thought would help raise awareness of the cash basis. Some respondents offered to help HMRC with such an education campaign.

Question 10: Could any of the proposals or ideas in this consultation document for reforming the cash basis be applied to income from property businesses? Would increasing or maintaining alignment between the trading income cash basis and property income cash basis have an effect on simplicity or take up?

There were 11 responses to question 10.

Feedback from most respondents on this question called for the property income cash basis and trading income cash basis to be kept separate. Responses, particularly from the accounting sector, suggested that there would be little practical advantage in aligning the cash basis for the two types of income, and that the different sets of rules represented fundamentally different types of income and expenses.

Some respondents said that changes to align the property income cash basis with the trading income cash basis would be very large and significant, and so would require a separate consultation.

Some respondents, however, suggested that aligning the rules for the cash basis across types of income made sense from a simplification perspective. These respondents encouraged alignment, particularly in the availability of sideways loss relief.

Question 11: Any changes to the trading income cash basis would automatically apply to partners in partnerships that use the cash basis; are there any particular issues that should be taken into account when considering the impact of these changes on partnerships, and should any of these proposed changes not apply to partnerships?

There were 9 responses to question 11.

The vast majority responses shared a common view that in principle, any changes to the cash basis rules should apply equally to partnerships as they do to self-employed businesses. Applying the same rules for the cash basis across both groups was seen as a way to avoid complicating the system by using slightly different rules for different types of business.

Most respondents from the accounting sector also thought that most partnerships would have other reasons for drawing up accruals accounts, such as for business purposes or to manage the partnership. The number of partnerships that would join the cash basis as a result of changes to the rules was, therefore, thought to be very limited.

Question 12: What other interactions between reforms to the cash basis and MTD for ITSA should the government take into consideration?

Question 13: What is your view on whether encouraging/expanding the cash basis will improve sole traders’ experience of MTD for ITSA, particularly for very small businesses, and why?

There were 13 responses to questions 12 and 13.

Many responses set out that businesses using the cash basis may find it simpler to finalise their annual position, as small businesses using the cash basis may need to make fewer end-of-year adjustments to move from their quarterly updates to final figures. Additionally, some respondents noted that in-year estimates based on quarterly updates may better reflect a business’s end-of-year position if it uses the cash basis. This closer link between in-year and end-of-year position could therefore help to improve some small businesses’ experience of MTD ITSA.

However, many responses also noted that use of the cash basis would not outweigh or resolve wider concerns with the potential administrative burdens that are associated with quarterly updates under MTD. Respondents stressed the importance of ensuring that MTD ITSA is designed to support the most appropriate choice of accounts for any business, whether that is the cash basis or accruals.

3. Next steps

Since the consultation closed on 7 June 2023, the government has been considering the evidence submitted in response to the consultation and exploring ideas to inform the further design of the policy. The government has listened carefully to the views expressed in response to the consultation, and has decided on its next steps for the cash basis.

Guidance and education

Guidance about the cash basis was one of the most frequently raised points in response to the consultation. Feedback suggested many improvements to guidance, particularly on GOV.UK, that would help to increase small business understanding of the cash basis and encourage its use. The government recognises the need to update this guidance on the cash basis targeted at small businesses, taking into specific consideration the needs of unrepresented taxpayers and those who may be moving from accruals into the cash basis.

Therefore, to quickly improve the amount and usefulness of the guidance available for businesses about the cash basis, HMRC will be prioritising a review and update of the cash basis guidance as part of the Small Business Guidance Review announced at Spring Budget 2023. Alongside this, as part of the implementation of any changes to the cash basis, HMRC will consider the feasibility of launching a wider communications campaign about the cash basis.

Changes to the cash basis

Consultation responses provided useful feedback on the options for changes to the cash basis, and in particular on the interaction between the options proposed in the consultation document. The government has taken a detailed look at this feedback, as well as exploring the policy rationale behind the restrictions and thresholds that the cash basis features.

To simplify the rules of the cash basis, to introduce more consistency with accruals, and to encourage more small businesses to use the cash basis where appropriate, the government has decided to go further on some of the options than originally proposed in the consultation document as detailed below.

Turnover restriction

Rather than increasing the turnover threshold, as initially suggested in the consultation document, the government will entirely remove the turnover threshold for businesses to be able to use the cash basis. Removing the complexity of the entry and exit thresholds will simplify the rules for the cash basis, and potentially encourage smaller, start-up businesses to use the cash basis if they expect to grow in the future.

This will provide a further simplification of the rules and reduce the number of cash basis-specific rules that a business has to consider before choosing to use it. However based on the feedback provided in the consultation responses, most, if not all, self-employed businesses at higher turnover levels are expected to use accruals accounts for commercial reasons regardless.

Cash basis default

After considering the consultation feedback, on balance the government has decided to set the cash basis as the default method of calculating trading income for new and existing eligible businesses. Businesses will still have the option of using accruals, if they prefer, by electing to do so, in the same way as businesses elect to use the cash basis now. Businesses that are not eligible to use the cash basis will default into using accruals.

However, the government understands the concerns that have been raised in some responses from accountancy stakeholders about introducing a cash basis default, particularly without any changes to the loss and interest restrictions.

Interest restriction

The original suggestion in the consultation document was to increase the interest restriction to either £625, £750, or £1,000. However, the government has taken onboard the suggestions from respondents on what an appropriate level of the restriction might be, and the common feedback that the restriction should be removed. The government will therefore remove the restriction on interest deductions in the cash basis, and instead align the rules with those in accruals.

Loss restriction

Similar to feedback on the interest restriction, the government received strong feedback on the restrictions on loss relief in the cash basis. Taking these responses onboard, the government has decided to remove the restrictions on loss relief for losses generated in the cash basis, aligning the rules for losses with the rules under the accruals basis.

The restrictions on interest and losses were commonly cited as two of the most significant barriers for businesses to using the cash basis; by removing these restrictions the government is hoping to remove the perceived financial penalties to some businesses of joining the cash basis.

Summary

Therefore overall, the changes that the government will introduce are to:

• set the cash basis as the default, with an opt-out for accruals
• remove the turnover threshold for businesses to use the cash basis
• remove the £500 limit on interest deductions in the cash basis
• remove restrictions on using relief for losses made in the cash basis

Following consultation responses, the government has also decided to apply these changes to the rules for the trading income cash basis for partners in partnerships. As most respondents clearly set out the differences between trading and property income in their feedback, these changes will not apply to the property income cash basis.

These changes will help to expand and simplify the cash basis, allowing and encouraging more businesses to use the simpler method of calculating their taxable profits.

Removing some of the restrictions on the cash basis will help to simplify the core cash basis rules and remove the perceived disadvantages to using the cash basis. Setting the cash basis as the default removes the hurdle that many businesses face in understanding and applying the cash basis election under the current system, giving more businesses the ability and confidence to officially use the regime.

These changes come together to create a system where the simpler method is the standard, making it simpler and easier for businesses to comply with their tax obligations. The changes make it easier for businesses to understand the starting point of taxable profits, reducing error, but they also give businesses the option to move into the accruals method as they grow and develop a better understanding of tax.

These changes will apply starting in the tax year 2024 to 2025 and onwards. The detailed legislation for the changes will be introduced in a Finance Bill in Spring 2024.

Annex A: List of stakeholders consulted

Association of Accounting Technicians (AAT)

The Association of Independent Professionals and the Self-Employed (IPSE)

Association of Taxation Technicians (ATT)

Azets

The Bar of Northern Ireland

Bennet Kirkhope Smith Ltd

Bernard Rogers & Co

Chartered Accountants Ireland

Chartered Institute of Taxation (CIOT)

Chambers Accountants

The Country Land and Business Association (CLA)

Deloitte LLP

Institute of Chartered Accountants in England and Wales (ICAEW)

Institute of Chartered Accountants of Scotland (ICAS)

London Society of Chartered Accountants (LSCA)

Low Incomes Tax Reform Group (LITRG)

Middlesex University

Moore Kingston Smith LLP

National Farmers’ Union

Untied Tax Ltd

Xero UK

HMRC also received responses from 4 individuals.