On 15 August 2016 HMRC published a consultation document on simplifying tax for unincorporated business.

The UK government announced at Budget 2016 that it would be looking at simplifying tax rules for businesses, with a focus on the self employed and people with straightforward tax affairs. In response to input from small businesses and their representatives a number of proposals are put forward in the consultation document.

Threshold for cash basis

Cash basis accounting requires businesses only to keep records of income and expenditure, as opposed to the accruals accounting rules that include accounting records showing how the income and expenditure figures were arrived at. Currently businesses (with some exceptions) may choose to start using the cash basis if the turnover is below the VAT threshold of GBP 83,000. Currently more than a million small businesses report to HMRC on the cash basis.

An increase in the turnover threshold for the cash basis will increase the number of businesses able to use a simpler reporting framework. An increase in the threshold for entry would also require an increase in the exit threshold which is currently set at twice the entry threshold. The modified threshold for Universal Credit claimants is also currently set at twice the entry threshold and comments are invited from interested parties on the levels of these thresholds.

Basis periods for self employed

A reform to the basis periods when sole traders commence their business or change their accounting date would provide more flexibility, permitting them to fit their accounting date to other reporting obligations and preferences.

The paper suggests that one option would be for the concept of basis periods to be removed altogether for these businesses. The business would be free to choose its own period of account but would then apportion the profits to arrive at its taxable profit for the tax year. In practice many businesses might then choose the tax year as their accounting year to avoid complication. Alternatively use of the tax year as the period of account could be made mandatory for these businesses for tax purposes.

However businesses could wish to move to shorter periods of account and the paper presents a further option based on accounting periods. Under this option the proposed accounting periods would be similar to those used for corporation tax where the period begins when the company starts to carry on business, or immediately after the end of the previous accounting period; and ends on the earliest of twelve months from the beginning of the accounting period; an accounting date of the company; or on the date the company ceases to trade. As the self-employed are not specifically required to prepare annual accounts they could choose short accounting periods if this is more suitable in their circumstances. The rule would eliminate overlap periods as these periods would not overlap and would only be taxed once.

Simplified reporting requirements

The consultation paper presents options for small businesses to reduce their reporting requirements and eliminate complex period end adjustments. Under the reduced reporting framework businesses could choose to make fewer adjustments and reduce the administrative burden of reporting taxable profits. The relaxed rules generally relate to expenditure or income that has not yet arisen in cash terms but has accrued in accounting terms. Businesses could choose to make the adjustments at every period end to be compliance with generally accepted accounting principles (GAAP) or they could make the adjustments in a later period when the underlying asset or liability is released or an underlying transaction unwinds.

The simplifications would relate to adjustments to closing stock; adjustments where contracts span the period end; bad debt provisions; and prepayments and accruals.

Reforming the capital/revenue divide under the cash basis

The profit calculation under the cash basis does not currently permit any deduction for capital expenditure unless it would qualify for plant and machinery capital allowances under the normal tax rules. The consultation paper proposes that this general disallowance on capital expenditure should be replaced by a more limited disallowance of capital expenditure on assets not used up in the business within a limited period of time. It is not appropriate to give 100% immediate relief for these assets because they depreciate slowly or do not depreciate at all.

So the paper proposes that there would still be a disallowance in relation to capital expenditure relating to real property (including fixtures bought with the property); newly constructed buildings; intangible assets other than those with a definite fixed life of twenty years of less; the purchase of another business (including goodwill); financial instruments and equivalent assets; and any other asset without a limited effective life or that is not expected to decline in value over the time of its use. Capital expenditure on cars would also be disallowed as this would be consistent with its exclusion from the Annual Investment Allowance.

Comments are invited from interested parties by 7 November 2016.