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HMRC internal manual

Business Income Manual

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

S231 ITTOIA 2005

There are 2 steps to the transitional adjustment calculation:

Step 1

  1. Add together amounts that customers had owed to the business at the end of the last cash basis period, and add to this the amounts paid for any stock of goods held at the end of the last cash basis period;

  2. Add together amounts that the business had owed to suppliers at the end of the last cash basis period. Add to this any amounts of income that the business received, in the last cash basis period, where the work for the customer had not been done as at the end of that period.

Step 2

Deduct the total of 2 from the total of 1.

If the result is a positive amount, that is adjustment income. This adjustment income is spread for tax over 6 tax years. One sixth of the adjustment income is charged to tax, starting in the first period after leaving the cash basis. An election can be made to accelerate the tax charge on this adjustment income.

If the result is a negative amount, that is an adjustment expense. This is deducted from the taxable profits of that first period after leaving the cash basis. There is no spreading.

Why are transitional adjustments required on leaving the cash basis?

If a business did work for certain customers in its last cash basis period but those customers did not pay them in the cash basis period, the business will not have been taxed on the amounts owed to them, under the cash basis rules.

In the new period, an accruals basis profits figure must be calculated, and this will include only income from work done in that period, whether or not a customer has paid. So the income for work done in the last cash basis period would not be brought into the turnover figure for the new period.

This means that the amounts that were owed at the end of the last cash basis period would not be taxed in either period, and that is why an adjustment might be needed in the first period after leaving the cash basis.

Similarly, if a business bought goods from certain suppliers in its last cash basis period but did not pay those suppliers in the cash basis period, the business will not have had tax relief for the cost of those goods, under the cash basis rules.

In the new period, an accruals basis profits figure must be calculated, and this will include only expenses for goods purchased in that period, whether or not the supplier was paid. So the cost of the goods purchased in the last cash basis period would not have been deducted for tax in the new period.

This means that the amounts that were owed at the end of the last cash basis period would not be deducted for tax in either period, and that is why an adjustment might be needed in the first period after leaving the cash basis.

Example

In its last cash basis period, X did work for a customer and billed them for £400. The customer paid after the end of the last cash basis period, so that £400 was not taxed in the cash basis period.

Also in the cash basis period, X received £220 of goods from a supplier which X had not paid for by the end of the period. None of those goods were in stock at the period end.

X did have £60 of goods in stock at the end of the cash basis period, which had been paid for.

X had received £1,000 just before the end of the cash basis period for work to be done in the following period. This was taxed in the cash basis period.

Step 1:

  1. Add together the amounts owed by customers, £400, and the amount in stock, £60 = £460

  2. Add together amounts owed to suppliers, £220, and the amount of income received in advance, £1,000 = £1,220

Step 2:

  Total 1   £ 460  
         
Less: Total 2   £1,220  
NEGATIVE     £ 760  

As this is a negative amount, it is an adjustment expense, and it is all deducted from taxable profits in the first period after leaving the cash basis.