What are the basis of assessment under cash basis of accounting for small business formation UK, cessation of trades and basis periods of tax?


04 Jan

The basis of assessment under the cash basis of accounting (mainly the accruals accounting that involves dealing and income on accruals basis) for small businesses, losses fixed rate expenses, cessation of trades (post cessation expenses and receipts, and valuation of trading stock on cessation) and basis periods including the first year of tax will be a part of discussion in this blog. The blog remains important for all the readers who are interested in starting a company UK and pondering upon the question: how to set up a business UK within your limitations and resources.

Cash Basis of Accounting for the Small Businesses

An individual performing the trade may make an election for the calculation of the trade profits on the cash basis (rather than in accordance with generally accepted practice of accounting) in particular scenarios.

For a person wondering upon how to set up a business UK should note that as a usual practice, the businesses are involved in the preparation of accounts making use of the generally accepted practice of accounting for the purposes of tax. Particularly, this means that the dealing of income and expenses is done on an accruals basis after starting a company UK. This is known as the accruals accounting.

Some specific small unincorporated businesses may make an election to make use of the cash accounting, known as the cash basis, instead to referring to it as accruals accounting for the purpose of the calculation of their taxable income from trade.

Basis of Assessment

A trader like any other trader, making use of the cash basis can opt for the preparation of his accounts to any date that year.

The basis of rules of assessment that are involved in the determination of the tax year in which the accounting period’s profits are taxed are applicable in a similar manner for accruals accounting and cash basis traders.

Cash Deficit

A loss or a net cash deficit can only be relieved normally against surplus of future cash (future profits of trade). The traders on cash basis cannot offset a loss against other gains or income. The losses if trade for the accruals accounting traders are discussed in this article.

Expenses at Fixed rate

The utilization of the expenses at fixed rate can be done in relation to expense on motor cars and premises of business partly used as the home of trader.

In the case where a business makes an election to use the cash basis, an assumption should be made that the expenses at fixed rate should be used instead om making deductions on the usual basis of expense actually suffered.

The expenses at fixed rate relate to expense on motor cars and premises of business partly used as the home of trader. The claim of fixed rate mileage (FRM) can be made in respect of the motor cars that are leased or owned by the business and which are used for the purposes of business by the sole partner or trader or an employee of the business. The calculation of the FRM expense is done in the form of business mileage times the appropriate rate per mile. The rates for appropriate mileage for motor cars are 45p per mile for the starting 10,000 miles and then 25p per mile later.

In the case where a sole trader or partner makes use of the part of business premises as his home such as where a sole trader operates a small guesthouse or hotel and is also a resident of it, then a monthly adjustment at a fixed rate should be made. The deduction of the adjustment is done from the actual allowable premises of business costs for the reflection of private portion of household costs involving food and utilities such as heat and light. It does not involve rent, mortgage interest, rates or council tax: the division of these expenses should be made based on the private occupation’s extent of the premises.

The fixed rate amount to be deducted is dependent on the fact that how many people make use of the premises of business each month as a private home.

Consider an example in which Larry started trading as an interior designer on April 6, 2013. The relevant information for the year to April 5, 2014 is mentioned below:

  • Revenue was £65,000 of which £8000 was owed in the form of receivables at April 5, 2014
  • The acquisition of a motor car was done on April 6, 2013 for an amount of £15,000. Larry drove for 10,000 miles in the car throughout the year to April 5, 2014 of which 3000 miles were for private journeys. The car makes a qualification for the capital allowance of an amount of £1890, after considering the private usage. The costs for motoring were £2000. The mileage expense at fixed rate for motoring is 45p per mile for the first 10,000 miles, then 25p per mile thereafter.
  • The acquisition of the machinery was done on May 1st, 2013 for an amount of £4000. The qualification is done by the machinery for a capital allowance of an amount equal to £4000.
  • Other allowable expenses were equal to an amount of £12000 out of which an amount of £1000 was owed as payables at April 5th 2014.

If Larry makes use of the accruals accounting basis and does not make use of the expenses at fixed rate, the calculation of his trading profit will be done in the following way:

The taxable trading profit will be achieved by subtracting the capital allowance on motor car, business motoring expenses (£2000 * 7/10), capital allowance on machinery and other allowable expenses (accruals) from the revenue (accruals).

If Larry makes use of the cash basis of accounting and expenses at fixed rate, the calculation of his trade profit will be done as follows:

The taxable trading profit is calculated by subtracting FRM on car (7000 * 45p). cost of machinery and other allowable expenses (cash paid £12000 - £1000) from the revenue (cash received £65000 - £8000).

Ceasing the Trades

Post Cessation Expenses and Receipts

The receipts after ceasing the trade (any releases of debts suffered by the trader inclusive) are chargeable to income tax in the form of miscellaneous income.

If their acquisition is done in the year of tax of cessation or the next six years of tax, the trader can make an election that their treatment should be done as received on the cessation day. 

The time limit for making an election is the 31st January that is 22 months after the termination of the year of tax of receipt.

Some specific post cessation expenses paid within seven years of discontinuance may be relieved against some other income. The expense should be related to costs of remedying the defective work or goods, or legal expenses of or insurance against claims of defective work. The availability of relief is also found for the receivable trade that subsequently prove to be impaired.

Valuation of Trading Stock on Cessation

Whenever the cessation of a trade occurs, the valuation of the closing stock should be done. The higher the value, the greater the profit for the trading’s final period. If the sake of a stock is made to a trader in UK who will subtract its cost in the computation of their taxable profits, its valuation is done according to the following rules:

  • If the buyer and seller are not in connection, the actual price is taken
  • If the buyer and seller are in connection, take what would have been the price in a sale of arm’s length.
  • However, if the buyer and seller are in connection, the arm’s length price is more than the original cost of the stock and the actual price of transfer, and both the buyer and seller make an election, then greater of the original cost of stock and transfer price is to be taken. The time limit for election for the unincorporated business is the January 31st which is 22 months after the termination of the tax year of cessation (for companies, it is two years after the termination of the cessation’s accounting period).

In all of the cases mentioned above, the used value for the calculation of profit of seller is also used as the cost of the buyer.

An individual is in connection with their spouse or civil partner, with the relatives such as siblings, ancestors and lineal descendants of themselves and their civil partner or spouse, and with the civil partners or spouses of those relatives. It includes the in-laws and step family but the aunts, uncles, nieces, nephews and cousins are excluded. He is also in connection with their business partners (except in relation to bona fide commercial arrangements for the partnership assets’ disposal, and with their civil partners or spouses and relatives. An individual is also in connection with an ltd formation UK if he has control of that company (or if he and persons in connection with him together have control of that ltd formation UK). An individual is also in connection with a trust’s trustees of which that individual is the settlor.

If the transfer of a stock is not done to a trader in UK who will be able to subtract its cost in the calculation of their profits, then its valuation is done as its open market value as in the case of cessation of trade.

Basis Periods

The basis periods are used for linking the periods of account to the years of tax. The duration of a year of tax is from April 6 to April 5, but majority of the businesses do not contain periods of account being terminated on April 5. Hence, there should be a link between a period of account of a business and a year of tax. The process is to determine a period to act in the form of basis period for a year of tax. The taxation of the profits for a basis period is done in the corresponding year of tax. In the case if the basis period is not found identical to a period of account, the time-apportionment of profits of period of account is done as required on the assumption that the profits accrue evenly over an accounting period.

There is a requirement for some special rules when there is a change in the accounting date by the reader. The first year of tax is the year during which the trade is started. For example, if a starts on June 1st, 2013, the first year of tax is 2013/14.

First Year of tax

Special rules are applicable in the starting and closing years of so that the taxation of a new trader can be started quickly, and the taxation of a retiring trader need not be done long after their retirement.

The basis period for the first year of tax starts from the starting date of trade and ends on next April 5 (or to the cessation date if the trade does not last until the end of the year of tax).

So according to the example mentioned above, a trader starting business on June 1st, 2013 will be liable to tax on profits occurring from June 1st 2013 to April 5, 2014 in 2013/14, the first year of tax.

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