VAT Cash Accounting vs. Accrual Accounting | Rayner Essex

VAT – Cash Accounting Scheme 

Understanding Tax points and Accrual Accounting

In the world of VAT, tax points are a key aspect of VAT compliance. Tax points identify when output tax is paid over to HMRC or when input tax can be reclaimed.

By default, VAT returns are drafted using “accrual accounting”, that is, a sales invoice will be raised with an invoice date being either date of dispatch (if goods) or date invoice issued. When completing the VAT return, invoices dated within the VAT return period are included on the return and the business pays over output tax to HMRC. Whether or not the invoice has been paid, the taxpoint date on the invoice determines when the VAT is to be paid to HMRC.

Customers are seeking longer payment terms; certainly larger corporates can exercise pressure and demand payment terms of 90 days upwards. This then can create cash flow issues for the trader because they may have to submit a VAT return and declare output tax to HMRC before the trader has been paid by the customer. In these sorts of situations, the trader is effectively acting as a lender, paying HMRC before being paid themselves.

What is Cash Accounting & how does it work?

Cash accounting can be used by a business with turnover of less than £1.35m and once using the scheme can continue to use the scheme until turnover exceeds £1.6m.

Cash accounting simply means the date on the sales invoice is ignored and the date the invoice is paid becomes the new taxpoint for reporting on the VAT return.  

As an example, a trader raises an invoice 01 March 2024 for £1,000 + £200 VAT and customer pays in May 2024. Under accrual VAT accounting, the output tax to HMRC is declared in March 2024 Vat return period. Under VAT cash accounting, the output tax is declared on the May 2024 Vat return period.

This then gives the business an instant cash flow boost insofar as the trader does not have to pay HMRC this £200 VAT until the trader itself has been paid by the customer. Instead of financing the VAT liability to HMRC, the trader receives the VAT payment from the customer first, before then declaring it to HMRC.

More details on the cash accounting scheme can be found here

What about bad debts?

The additional benefit of VAT cash accounting is that if the invoice is never paid (bad debt), then the output tax is never due to HMRC. Yes, the trader still has a bad debt and is out of pocket by the original sale value, but at least does VAT does not have to be factored in.

Under VAT Accrual accounting basis, the business would have paid output tax to HMRC as per the date on the invoice, but where that sales invoice is unpaid/bad debt, the trader must wait 6 months from the due date before they can seek a clawback of that output tax under the bad debt relief rules.

More details on how bad debt relief works can be found here

Get in Touch

Cash accounting can seriously improve your business cashflow, if your business is not already operating VAT cash accounting scheme, then have a look at the HMRC articles linked in this article or contact us as there may be benefits for operating this scheme over accrual accounting.

If you cannot use the VAT cash accounting scheme, then it may be possible in some scenarios to consider issuing pro-forma invoices with “this is not a VAT invoice” clearly noted on the document and then upon payment by customer, issuing a formal VAT invoice and this can have the same effect as cash accounting without the threshold limitation.

Our VAT specialists are here to assist you with any VAT services you may require, so do not hesitate to get in touch today.

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