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HMRC internal manual

Business Income Manual

Cash basis: transitional adjustments: entering the cash basis: overview

Chapters 17 and 17A of Part 2 ITTOIA 2005

The transitional adjustments described in this section are concerned with ensuring that business income is taxed once and only once, and business expense is relieved once and only once.

For new businesses where this is the first tax return to include profits of the business, no transitional adjustments will be needed.Using the cash basis to calculate trade profits or losses for a tax year means that a business will be taxed on the amount of receipts less payments in that tax year. If the business has previously been taxed on profits calculated in accordance with generally accepted accounting practice (so that income and expenses are accounted for when earned and incurred (‘accruals basis’), rather than when received and paid), receipts in the first cash basis year might include amounts received from customer debtors, that is, customers who had not settled their debts by the end of the previous tax year.

Similarly, payments the business makes to its suppliers in the cash basis period might include settlement of amounts owed for purchases it made in the previous tax year.

It is transactions like these and several others that drive the need for transitional adjustments. In the above examples if transitional adjustments were not made, a business would be taxed twice on those sales (once in the previous tax year when the amount was earned, and again in the cash basis period when the amount was actually received) and would similarly get tax relief twice on those purchases.

An existing business may have to make adjustments when preparing its first cash basis tax return if any of the following apply:

  • The business had debts owed to it by customers at the end of the previous tax year (see BIM70065)
  • The business owed money to its suppliers at the end of the previous tax year (see BIM70065)
  • The business held trading stock at the end of the previous tax year (see BIM70065)
  • The business profits in the previous tax year included other items that were not equally represented by cash payments or receipts. For example, accrued expenses, prepayments, income received in advance (see BIM70066)
  • The business had claimed capital allowances on equipment purchases, and there were allowances still to be claimed at the end of the last tax year (see BIM70067)
  • The business had been claiming capital allowances on cars (see BIM70067)
  • The business has been paying for equipment in instalments, and there were some instalments left to pay at the end of the last tax year (see BIM70067)
  • The business bought capital items and claimed full allowances before joining the cash basis, but did not pay anything until the cash basis period (see BIM70067)
  • The business is taken over by a successor, with an election under S266 CAA 2001 to treat the equipment as sold to the successor by the predecessor (see BIM70068)
  • The business is VAT registered and prepared its last tax return using VAT inclusive sales and purchases figures (see BIM70069)
  • The business used equipment under a finance lease (see BIM70069)