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HMRC internal manual

Business Income Manual

HM Revenue & Customs
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Cash basis: transitional adjustments: leaving the cash basis: overview

Chapter 17 of Part 2 ITTOIA 2005

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

When not in the cash basis, a business must calculate its profits for tax purposes on the accruals basis. Except for those small businesses that opt to use the cash basis, all businesses, whatever their size, must calculate their profits on this basis as a starting point for their tax calculations.

In the first tax year after leaving the cash basis, correctly prepared accruals basis profit and loss accounts should include only income earned from work done in the tax year. This means that any money received from customers in this new tax year for work done in the previous (cash basis) tax year, would not be included in the accruals basis accounts income figure. Because the money was not received in the cash basis tax year, it will not have been taxed.

So unless adjustments are made as described below, income would not be taxed correctly. Similar considerations apply to expenses (in respect of the period in which a business gets tax deductions).

The adjustments have to be calculated in a specified way, in accordance with the legislation, to give an overall positive or negative adjustment. The way the adjustment is treated for tax depends on whether it is positive or negative. The method of calculating the adjustment, and the tax treatment, are described at BIM70071.

If any prepayments were made while in the cash basis (that is, up front payments for goods or services that would be supplied in periods after leaving the cash basis - so there was a tax deduction for the full amount paid, in the cash basis), no adjustment has to be made in the first tax period after the business leaves the cash basis. However, any subsequent expense in the accruals accounts that relate to the prepayment must be disallowed for tax. This is explained at BIM70072.

There are specific considerations for equipment. In the cash basis, a business deducts the amounts paid for equipment. When not in the cash basis, the amounts paid for equipment are not deducted in calculating accruals basis profits. Instead, capital allowances are claimed on the cost of the equipment.