HMRC Consultation:
Expanding the cash basis for the self-employed

What is the Cash Basis 

The Cash basis is a way to work out income and expenses for Self-Assessment where fee income is only declared when it comes in and costs such as chambers calls are deducted when they come out of the business. At the end of the tax year, Barristers would only pay Income Tax on money received less money spent in the accounting period.

The primary drawback is that only £500 of interest can be deducted. The aim of this was to provide simplicity in saving businesses from having to draw distinctions between the business and personal elements of loan or overdraft financing. The typical costs for Barristers in this category may include loans for Cars purchased on finance, home office mortgage interest deductions, bank charges or other loans. Where these costs are over £500 the deduction is capped at the £500 and full tax relief will not be given.   HMRC are also considering an increase of up to £1,000 and are taking feedback on other limits.

In order to be eligible to enter the cash basis, fee receipts would need to be below £150k in the year of joining and individuals can remain on the scheme with receipts of up to £300k. After this point they would generally be required to use the accruals basis.

What is the Accruals Basis 

Under the accruals basis profits of a trade must be calculated in accordance with generally accepted accounting practice. Fee Income would be taxed in the year it was earned rather than when it is paid, and costs would be deductible in relation to the period they were incurred.

Fee Income can be particularly complex for barristers for several reasons, and this will vary depending on area of law and the types of clients that that the barrister works with. Cases may take years to complete, there may be uncertainty around whether payments will be received at all, and the amount may not be quantifiable. This means that judgement needs to be made on which elements of the aged debt is taxed with different treatments for private fees, private work paid on conclusion, legal aid and conditional fee cases.   The fees received in year do not always reflect the amounts earned for tax purposes and the income in the accounts can swing about year to year. This can make it very difficult to forecast the income that will be taxed in any year for the purposes of saving for the tax charge and also for making pension contributions within the annual allowance where it may be restricted.  

There are other differences between the cash basis and accruals schemes including losses and capital allowances, but these are generally not considered material in the case of most barristers.

All fee income will be taxed over the life of the barrister's trade regardless of which method is used, but the choice of method determines which tax year it falls in.

Transitional problems for members with receipts between £150k and £300k after April 2013

For many years HMRC had a practice under which businesses which count as ‘professions’ could compute their profits for tax purposes on a cash basis, rather than the accruals basis which traders and companies had to adopt.
Legislation was introduced in 1998 to ensure that professions instead used the accruals basis. The legislation allowed the use of the cash basis in the first seven years of a Barristers practice regardless of fee income moving onto the accruals basis thereafter. This was called the ‘alternative’ basis.

This was then repealed by Finance Act 2013 and phased out such that any Barristers starting independent practice from the tax year 2013-14 would no longer use this method. Instead, they could use the current cash basis that applies to all trades if they met the thresholds and requirements. These include receipts less than £150k in the tax year to join the scheme and being required to leave the scheme where receipts go beyond £300k.  Where established barristers had receipts of over £150k in the 2013-14 tax year they could not join the cash basis unless receipts dropped below this level in the future.

Currently any Barristers with receipts above £300k would be on the accruals basis and would therefore be taxed on some elements of their aged debt.  

Any pupils starting their second six at any time would be generally have had receipts less than £150k in their first year and would expect to be able to enter the cash basis immediately and remain on that basis unless their receipts exceed £300k.

However, any Barristers that had receipts of over £150k in 2013-14 were unable to join the cash basis at that time and continue to pay tax on their aged debt unless their receipts dropped below that level.  This effectively means that for those that generally have receipts between £150k and £300k each year, then their year of call could be the determining factor of which tax basis they are able to use, with those that were trading longer trapped on the accruals basis and unable to leave.  Increasing the current entry limit will remove that unintentional inconsistency.

HMRC Consultation

The consultation covers:

• Turnover restriction – including increasing the entry limit to £1.35m or removing it altogether.  We are in support of this measure.
• Interest restriction – increasing this to £1,000 or another limit.  We are in support of this measure and would propose to increase it further.

There are also other considerations including setting the Cash basis as the default method, Loss restrictions and interactions and other improvements to the Cash basis. We have some suggestions on these matters but feel the points above are the priority in relation to our clients. 

Responses need to be sent by 7 June 2023 and representative bodies are able to note the number of members that they are responding on behalf of.

Chambers Accountants has prepared a template response which can be provided at no cost to Chambers.  Complete the form below to request a copy.