Advanced rent leads to higher net tax?

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13:45 PM, 16th October 2019, About 5 years ago 11

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I am helping a relative complete her tax return. She owns a property, run as an HMO, with a group of four tenants who have separate rooms. The rental agreements require rent one month in advance, but in August 2018, in addition to the regular monthly rent, all four paid 6 months rent in advance to cover the period 28/2/2019-30/8/2019 when they intended to vacate the property. As far as I can see, this was agreed by the letting agent without consulting my relative, but she accepted the payment, thereby, I guess, implicitly agreeing to it.

The payment, of course, straddles two tax years, and, from a previous forum thread, I think it is correct that how this is treated depends on whether one is doing “cash basis” accounting or “traditional accounting”. I don’t think any formal declaration on this has been made to HMRC, but in practice, previous tax returns have used cash basis.

My understanding of cash basis is that, since the payment was made in the 18-19 tax year, the whole amount counts as income in that tax year. This would increase her income by over 40% and push her into the higher rate 40% tax band with a consequent significant increase in total net tax paid.

This is clearly inequitable since, if the income was spread evenly over the two tax years, no extra tax at 40% would be payable. There are three things that occur to me that might avoid this.

1. Is it, in fact, correct that cash basis accounting requires this income to be taken in the 18-19 tax year? The “Help” screen for the TaxCalc package clearly says that rent that straddles two tax years should be apportioned, without saying “unless cash basis accounting is being used”. Possibly this is right and an exception is generally made for advance rent payments???

2. Presumably we could decide to use traditional accounting this tax year – but would we then be stuck with using it for all future years? Cash basis is much more convenient and normally gives the same results when averaged over multiple years. Clearly, however, in 19-20, the advance rent would have to be declared, but how would this be possible if we had reverted to cash basis?

3. Does HMRC have discretion to agree that we can use cash basis accounting for 2018-19, except for this advance rent payment that should be apportioned. If so, is there a preferred mechanism for asking them to agree to this?

I would be grateful for any guidance you can give me.

Ron

Editor’s Note:

Please see >> https://www.gov.uk/simpler-income-tax-cash-basis

Overview

‘Cash basis’ is a way to work out your income and expenses for your Self Assessment tax return, if you’re a sole trader or partner.

Why use cash basis

If you run a small business, cash basis accounting may suit you better than traditional accounting.

This is because you only need to declare money when it comes in and out of your business. At the end of the tax year, you won’t have to pay Income Tax on money you didn’t receive in your accounting period.

When cash basis might not suit your business

Cash basis probably won’t suit you if you:

want to claim interest or bank charges of more than £500 as an expense
run a business that’s more complex, for example you have high levels of stock
need to get finance for your business – a bank could ask to see accounts drawn up using traditional accounting to see what you owe and are due before agreeing a loan
have losses that you want to offset against other taxable income (‘sideways loss relief’)

Talk to a tax professional (such as an accountant) or legal adviser if you need help.

Find out if you’re eligible to use cash basis.

Please see >> https://www.gov.uk/government/publications/calculation-of-profits-of-property-businesses/income-tax-simplified-cash-basis-for-unincorporated-property-businesses

General description of the measure

Cash basis accounting (‘the cash basis’) is a simplified method for calculating taxable profits for those businesses with straightforward tax affairs.

Those with income from a property business (landlords) will be able to use the cash basis rather than generally accepted accounting practice (GAAP) to calculate their taxable profits. The new legislation will assume cash basis to be the default method of calculation, unless a landlord opts out or has rental receipts for the business in excess of the threshold in which case they will continue to use GAAP.

Policy objective

The measure will provide a simplification for those landlords with straightforward tax affairs and who don’t require accounts prepared under GAAP for any reason other to meet their tax obligations.

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Comments

Ron Bell

19:00 PM, 20th October 2019, About 5 years ago

Thanks for this sensible comment. It certainly is usually almost exactly the same result, accrual and cash. The trouble is - not actually exactly. For example, insurance on the property is paid yearly and changes from year to year. If it's paid, say, at the end of November 2018, we would normally account for that wholly in 2018-19. However, this is cash basis. Accrual would say that only about 1/4 of that bill should be applied to 2018-19 plus 3/4 of the bill paid at end of November 2017. Almost the same - but not quite.

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