Your self-employed profits are typically prepared on an ‘accruals’ basis – you include the income for work performed in an accounting year and not just the cash you received.
However, if your income is less than £150,000, you can use the more straightforward cash basis to work out your profits. The cash basis option is only available for the self-employed and partnerships. You can stay in the scheme until business turnover exceeds £300,000.
Cash basis probably won’t suit you if you:
- want to claim interest or bank charges of more than £500 as an expense
- run a more complex business, e.g. you have high levels of stock
- need to get finance for your business – a bank could ask to see accounts drawn up using traditional accounting to see what you owe and are due before agreeing on a loan
- have losses that you want to offset against other taxable income (‘sideways loss relief’)
Cash basis probably will suit you if you:
- Pay interest on personal borrowings. The borrowing doesn’t need to be for business reasons – so if you pay any interest, including a mortgage on your home, you can claim up to £500 as a business expense.
- want more straightforward accounts without the need to account for yearend stocks, debtors and creditors
- want to delay tax payments if you get paid for your work the month after you carry out the work
- have more straightforward tax affairs as there is no need to make adjustments for capital allowances for things like computers and dental equipment, as capital expenditure (apart from cars) will be offset against tax when it is incurred, just like any other expense
Example of a self-employed associate dentist using cash accounting
Darren started as a self-employed associate dentist in 2017-2018. He prepares accrual accounts and has profits of £60,000. He has no other income and calculates total Income Tax and National Insurance contributions of £16,460.
Darren decides to use the cash basis accounting scheme. He can exclude the £5,000 he was paid for services he performed before his yearend that was paid to him after his year-end. He has no year-end creditors to exclude. He has an overdraft on his bank account, and he can include the first £500 interest he has paid on this overdraft in the tax year as a tax-deductible expenditure.
Darren has profits of £54,500 using the cash basis accounting scheme and has Income Tax and National Insurance contributions due to £14,150. He saves £2,310 in tax payments by using the cash basis scheme.
Darren’s payments for January 2019 and July 2019 now fall from £8,157 using the accrual scheme to £7,002 using the cash basis scheme. This allows Darren to pay less to HMRC and keep more of his income.
A further benefit to Darren is as a parent. As Darren and his partner now both have incomes of less than £60,000. This reduces Darren’s “High Income Child Benefit Charge” from 100% of child benefits withdrawn to 45% of child benefits withdrawn.
Using the cash accounting scheme, Darren pays less tax to HMRC, and his family keeps more of their Child Benefit.