Overview of cash accounting scheme

Produced by Tolley

This guidance note provides an overview of the main principles concerning the cash accounting scheme. This note should be read in conjunction with the Operating the cash accounting scheme guidance note.

SI 1995/2518, regs 56 - 65

VATA 1994, s 25

VATA 1994, Sch 11, para 2

What is cash accounting?

Businesses using the cash accounting scheme are able to account for VAT due on sales when they have been paid by the customer. Businesses using the cash accounting scheme also need to bear in mind that input tax can only be recovered when they have paid the supplier. This differs from the normal rules where businesses use invoices as the basis for paying VAT to HMRC and recovering VAT from HMRC.

Using cash accounting can be beneficial to a business in terms of cash flow as it will not be required to pay VAT to HMRC on sales until the customer has actually paid for the goods / services supplied. Using the scheme will be most beneficial for businesses that offer customers extended payment terms or suffer significant bad debts.

The scheme will not benefit businesses in the following circumstances:

 • if the customers normally pay at the time that the goods / services are supplied (ie retailers, etc)

 • where the business is normally in a VAT repayment situation so VAT is reclaimed from HMRC each quarter

 • where continuous supplies of services are provided

If a business has opted to use the scheme and discovers that it is not beneficial, it can elect to go back to normal VAT accounting, based on invoices issued and received, at the end of a VAT return period.

Conditions

All of the following conditions must be satisfied:

 • the total value of taxable supplies is expected to be £1,350,000 or less for the next 12 months

 • all VAT return submissions are up to date

 • no VAT offences have been committed in the last 12 months

 • no offer to compound proceedings has been accepted in the last 12 months in connection with a VAT offence

 • no VAT penalties have been received for evading VAT where the business has been accused of dishonest conduct in the last 12 months

 • no outstanding VAT is due to HMRC. If the business owes HMRC VAT then it must have made satisfactory arrangements to remit the outstanding VAT, etc with HMRC. Please note that HMRC will normally withdraw permission if situations where the business has defaulted on two time to pay arrangements.

 • HMRC has not withdrawn permission to use the scheme within the last 12 months

 • HMRC has not denied access to the scheme

Calculating value of taxable turnover

Taxable supplies include all of the following:

 • standard-rated

 • reduced-rated

 • zero-rated

The value of any exempt supplies or sales of capital assets should be excluded from the calculation when determining the anticipated value of taxable supplies in the next 12 months.

If the business has been VAT registered for more than 12 months, then it should use the total value of taxable supplies made in the last year in order to estimate the value of supplies it expects to make over the last 12 months. If the business has been VAT registered for less than 12 months, the business should use the calculation it prepared when it estimated its turnover on the VAT registration form in order to determine the likely value of supplies over the next 12 months.

If the business, or its adviser, considers that an alternative method needs to be adopted in order to obtain an accurate assessment of the value of taxable supplies for the next 12 months then it should consider using:

• business plans

 • pre-registration business activity information

 • information provided by the previous owner

If the business has determined that the value of taxable supplies will be less than £1.35m and it later discovers that the taxable turnover has actually exceeded the threshold, HMRC will not penalise the business providing it had reasonable grounds to believe that the estimate was accurate. HMRC will remove the business from the scheme immediately. It is advisable for the business, or its adviser, to keep detailed records supporting the calculation used to estimate the anticipated turnover for the next 12 months in case there is a problem.

Exceeding the turnover limit

A business is entitled to use the scheme until the annual value of total taxable supplies, including the disposal of any stock and capital assets, reaches £1.6m (excluding VAT).

Businesses who reach the £1.6m threshold are required to leave the cash accounting scheme at the end of the VAT return period covering the period in which the limit was reached. The business will need to use the normal VAT accounting method going forward.

Businesses will need to ensure that it monitors the total taxable turnover regularly so it can ensure that it leaves the scheme if it exceeds the £1.6m threshold.

One-off transactions

If the £1.6m threshold is breached due to a one-off increase in sales, it may be possible for the business to remain in the cash accounting scheme. All of the following must be satisfied:

• the limit was exceeded due to a genuine one-off transaction that has never occurred before and is not expected to occur again

 • the transaction was the result of genuine commercial business activities

 • the business reasonably expects the level of taxable turnover will be £1.35m or less in the next 12 months

Businesses should ensure that they keep acceptable documentation that can be used to support the decision to remain in the scheme if the turnover limit is breached due to a one-off transaction.

If the business has exceeded the threshold and cannot provide adequate supporting documentation that it was a one-off transaction that met all of the conditions outlined above, HMRC may decide to remove the business from the date it considers that it was no longer eligible to use the scheme.

Excluded transactions

Cash accounting cannot be used for the following types of transactions:

 • goods purchased under one of the following:

 ◦ hire purchase

 ◦ lease purchase

 ◦ conditional sale agreement

 ◦ credit sale agreement

 • goods imported into the UK from a country outside of the EU

 • goods acquired from a vendor located in another EU country

 • goods where the purchaser is required to self-account for VAT on the purchaser of the goods from the seller (ie certain supplies of gold, etc)

 • supplies where the business issues a VAT invoice and has agreed with the customer that payment does not need to be remitted within 6 months

 • supplies of goods / services where the business issues a VAT invoice in advance before any supply has actually been made

VAT must be accounted for under the normal VAT accounting methods for these types of transactions.

Using other accounting schemes

Businesses using cash accounting may also be entitled to use the annual accounting scheme as well. The annual accounting scheme enables businesses to pay a fixed amount of VAT each month or quarter via instalments based on an estimate of the annual VAT liability. At the end of the year, a single annual VAT return is prepared and submitted to HMRC together with any VAT due. See the Overview of the annual accounting scheme guidance note for more information.

Businesses cannot use the flat rate scheme with cash accounting. However, the flat rate scheme does have a cash based method that can be used. See the Overview of the VAT flat rate scheme for small businesses guidance note for more information.

VAT groups

The turnover limit for the cash accounting scheme applies to the VAT group as a whole. Therefore if the total taxable turnover of the whole group exceeds £1.35m then the group cannot use cash accounting.

VATA 1994, s 43(1)

HMRC do not allow one or more companies in a VAT group to operate cash accounting while other members use the normal invoice-based requirements.

The following action is required when a new member enters a VAT group:

 • the new member must deregister (whether or not using the cash accounting scheme)

 • if the existing group is not using the cash accounting scheme but the new member is, the new member must return to the normal method of accounting and account for outstanding VAT whilst using the scheme on its final VAT return

 • if the existing group is using the cash accounting scheme, and the turnover of the enlarged group remains within the turnover limits for using the scheme, the new member must use the cash accounting scheme from the date of joining the group. After joining the group, if the new member makes or receives payments for sales or purchases made whilst separately registered, the associated VAT must be accounted for on its final return and should be excluded from the group’s VAT account.

 If the existing group is using the cash accounting scheme, but the new member pushes the group turnover over the scheme limits, the whole group must leave the scheme at the end of the VAT period in which the new member joins the group.

 ( SI 1995/2518, Reg 58 )

Leaving the scheme

SI 1995/2518, Reg 60

A business can only leave the scheme at the end of a VAT return period. The normal VAT accounting rules must be used from the start of the next VAT return period.

The business will need to undertake the following steps in order to bring its VAT accounting up to date and the reflect the change in accounting procedures.

When is a business required to stop using the scheme?

Businesses must cease using the cash accounting scheme in the following circumstances:

 • it fails to comply with the requirements of the scheme

 • the value of taxable supplies for the last 12 months, ending on the last day of the latest VAT return period, have exceeded £1.6m (including disposal of stock and capital assets)

 • HMRC has notified the business that it is no longer eligible to use the scheme

 • the business is convicted of a VAT offence

 • the business accepts an offer to compound proceedings connected to a VAT offence

 • a penalty is imposed for VAT evasion involving dishonest conduct. See the Conduct involving dishonesty guidance note for more information

If a business leaves the scheme voluntarily or because the total value of taxable supplies exceeds £1.6m, it can rejoin the scheme at the start of a new tax year. The business must meet the eligibility criteria outlined at the start of this guidance note.

Accounting issues

SI 1995/2518, reg 61

It is likely that the business will have made taxable supplies for which it has not been paid. As a result VAT has not been accounted for on the unpaid supplies. The business will be required to account for output VAT on the total value of the taxable supplies made, where no VAT has currently been accounted for to HMRC.

The business will also now be entitled to recover input VAT on invoices received from suppliers where it has not yet paid for the goods / services received.

The business can opt to use one of the following methods to account for any VAT due:

 • account for any outstanding VAT due on the VAT return covering the period in which the business stopped using the scheme. This is the simplest method to use but can have potentially serious cash flow implications for the business if it has a significant number of unpaid invoices, or

 • the business can opt to take a further 6 months to account for the outstanding VAT due. Businesses using this option will be required to keep the normal cash accounting records for the supplies made and received whilst using cash accounting. It will need to ensure that it keeps a record of payments made and received during the 6 month period. In addition it will need to keep separate records of the supplies made since it ceased using cash accounting in order to ensure that it accounts for the correct amount of VAT. Any outstanding VAT still due under the cash accounting scheme must be included on the final VAT return due for the six month transitional period. In exceptional circumstances HMRC can give permission to extend the transitional provisions in cases of 'financial hardship'. Please see HMRC guidance ARTG3340 for more information on hardship.

 Please note that a business cannot use this option in the following circumstances:

 ◦ HMRC has withdrawn permission for the business to use cash accounting, or

 ◦ the total value of taxable supplies has exceeded £1.6m and the value of the supplies made in the last 3 months totalled more than £1.35m

Businesses are not required to advise HMRC regarding the method that have elected to use to account for any outstanding VAT.

Bad debts

On of the major advantages of cash accounting is the fact that VAT is only payable to HMRC when the customer has paid so there are no VAT bad debt issues to consider. However, once a business stops using the scheme it will need to account for VAT on an invoice, rather than cash, basis so it may start to suffer from bad debts. See the Claiming VAT bad debt relief (BDR) guidance note for more information on how to recover VAT incurred on debts that have remained outstanding for more than 6 months.

SI 1995/2518, reg 64A

VATA 1994, s36(1)(a)

If the business elects to use the 6 month transitional period when they leave the scheme to delay accounting for VAT, they can reclaim VAT bad debt relief on the next VAT return due after the six month transitional period has elapsed, if the relevant conditions have been satisfied.

Ceasing to trade

If a business ceases to trade, it can continue to use cash accounting whilst it disposes of any remaining stock and other assets, until it cancels its VAT registration number.

SI 1995/2518, Reg 63

Insolvency

If the business becomes insolvent it will be necessary to account for any outstanding VAT due on supplies made and received before the business became insolvent on the pre-insolvency VAT return.

SI 1995/2518, reg 62

If the business continues to trade after it is declared insolvent, the insolvency practitioner may continue to operate the scheme if it meets the relevant conditions. The insolvency practitioner will need to ensure that any books and records maintained during the insolvency procedure take into consideration the fact that the business declared any outstanding VAT on supplies made / received up to the point that it became insolvent on the pre-insolvency VAT return, in order to ensure that the VAT is not declared twice.

Cancelling the VAT registration

A business will need to complete and submit a final VAT return once a decision is made to cancel the VAT number. The business will be required to include all outstanding VAT due on supplies made and received prior to the date of deregistration. The business will need to ensure that it accounts for VAT on all supplies where it has not been paid. It can also recover VAT incurred on costs and expenses where it has not paid the supplier, providing it has a valid tax invoice.

The business may need to account for output tax on the value of goods on hand at the time the number is cancelled.

For more information on deregistration, see the Cancelling a VAT registration number and Cancelling a VAT registration - points to consider guidance notes.

Transfer of a business as a going concern

Please see the Overview of a transfer of a business as a going concern guidance note for more information on the impact of cash accounting on businesses transferred as part of a TOGC.

HMRC withdraws permission

If HMRC make the decision to withdraw use of the scheme or deny access to a business, the business will be notified in writing of that decision. If the business is currently using the scheme, then HMRC will specify the date when the business is required to stop using the scheme and how to account for any outstanding VAT due. HMRC cannot withdraw approval retrospectively.

SI 1995/2518, Reg 64

SI 1995/2518, reg 58(4)

SI 1995/2518, reg 58(1)(c)(iv)

HMRC will normally withdraw permission to use the scheme for a minimum period of 12 months.

If the business wishes to challenge HMRCs decision then it can ask for a local reconsideration. The business must request the reconsideration within 30 days of receiving the decision, providing facts and further information to support the request. If HMRC still refuses to allow the business to use cash accounting, the business has the right to appeal to a VAT tribunal.

If a business has appealed to the VAT tribunal it will not be able to continue to use the scheme in the following circumstances:

• HMRC has denied access to the scheme

 • HMRC has withdrawn permission to use the scheme in order to 'protect the revenue', or

 • the business has exceeded the tolerance threshold

If the appeal is on other grounds, then it should be possible for the business to continue to operate cash accounting, until the outcome of the appeal has been decided.