Katie Paxton-Doggett looks at changes to the VAT cash-accounting scheme and how they will affect law firms


From 1 April 2007, changes to the VAT cash-accounting scheme will help small-to-medium sized businesses cope with cash-flow difficulties. Not only could this benefit client businesses, but also law firms which fulfil the requirements.



The threshold under which businesses may elect to use the scheme is to be doubled. It is currently available for businesses with annual taxable turnover of up to £600,000. This will increase to £1.35 million.



There is a tolerance built into the scheme, which means that, once within the scheme, businesses can continue to use cash accounting until they reach the annual turnover limit. On 1 April 2007, this will increase from £825,000 to £1.6 million. This refers to the value of taxable supplies, including disposal of stock and capital assets but excluding VAT, during a period of one year ending at the end of a tax period. If the limit is exceeded, the business must leave the scheme immediately, unless Revenue & Customs allows or directs otherwise.



The scheme allows eligible businesses to account for VAT on sales, or output tax, on the basis of payments received from customers, rather than on tax invoices issued. This means that if the business does not get paid, it does not pay the VAT. Conversely, VAT cannot be reclaimed on purchases, or input tax, until suppliers have been paid.



Under the normal rules, VAT on sales must be accounted for as they take place or as soon as a VAT invoice is issued, and VAT on purchases can be reclaimed as soon as a VAT invoice is received, even if payment has not been made.



It is possible to use the scheme from the first date of VAT registration. However, businesses should consider whether using the cash-accounting scheme would be of benefit to them. It may be more beneficial to account normally at a time when the business wishes to reclaim tax on initial stocks, tools, machinery, office furniture or other capital equipment on the date invoiced rather than when it has been paid.



By contrast, it is necessary for businesses to have been trading for at least 12 months before joining the annual accounting scheme. Under this alternative VAT scheme, a single annual return is completed with estimated instalments paid monthly or quarterly, and any balance due at the end of the year. Provided that they satisfy the conditions of both schemes, it is possible for businesses to join both schemes at the same time.



Provided that a business fulfils the eligibility requirements, it may start to use cash accounting at the beginning of a tax period. There is no need to apply to use the scheme or a requirement to notify Revenue & Customs. The cash-accounting scheme cannot be applied retrospectively.



The conditions that must be fulfilled in order for a business to use the scheme are:

l The value of taxable supplies (excluding VAT) is expected to be £1.35 million (from 1 April 2007) or less during the next year beginning at the start of a tax period;

l At the time the business starts to use the scheme, all VAT returns due have been sent in;

l The business has not been convicted of a VAT offence in the last year;

l The business has not accepted an offer to compound proceedings in connection with a VAT offence in the last year;

l The business has not been assessed to a penalty for VAT evasion involving dishonest conduct in the last year;

l No money is owed to Revenue & Customs, or arrangements been made to clear the total amount of outstanding VAT payments including surcharges and/or penalties;

l Revenue & Customs has not written to the business withdrawing the use of the cash accounting scheme during the last year; and

l Revenue & Customs has not written and denied access to the scheme.



The scheme cannot be used for goods imported, acquired from a business registered in another EU member state, or removed from a Customs warehouse or free zone. VAT on such purchases must be accounted for under the normal VAT rules. Nevertheless, the cash-accounting scheme can be used to account for VAT on the outward supply of goods.



Where a business has elected to use cash accounting, the scheme must be used for the whole of the VAT-registered business, subject to a number of exceptions. To simplify the scheme and assist the cash flow of small businesses, the following transactions are excluded: goods bought or sold under lease purchase, hire purchase, conditional sale or credit sale agreements.



To prevent abuse of the scheme, the following are also excluded: supplies where a VAT invoice is issued and payment of that invoice is not due in full within six months of the date it was issued; and supplies of goods or services where a VAT invoice is issued in advance of making the supply or providing the goods.



In any of these circumstances, transactions must be accounted for under the normal VAT accounting rules.



The business must keep a cashbook summarising all payments made and received, with a separate column for the relevant VAT. The payments need to be clearly cross-referenced to the appropriate purchase/sales invoice.



Whether the cash-accounting scheme is appropriate for a business will depend on the period of time between the issuing of sales invoices and receiving payment from customers. The longer the time lag, the more benefit cash accounting is likely to be, so it is ideal for businesses which have customers that pay late or are given extended credit. It is also an easy alternative for businesses with bad debts. They can avoid the need to apply for bad debt relief, which requires the debt to be at least six months old.



The scheme is unlikely to benefit businesses that usually receive payment at the point of sale, for example in a retail environment, or businesses which regularly receive repayments of VAT.



The changes taking effect in April 2007 will double the annual taxable turnover threshold for eligibility to the scheme. It is anticipated that this will permit more than 50,000 businesses to join the cash-accounting scheme and receive the cash-flow benefits. John Healey, Financial Secretary to the Treasury, speaking about the extension to the scheme, said: 'We know that small businesses are the engine for the UK's economy, so it is only right that we look to improve the climate for them.'



Katie Paxton-Doggett is a solicitor and producer at the Law Channel, Einstein Network