(Except clauses 1, 3, 16, 183, 184 and 200 to 212, schedules 3 and 41 and certain new clauses and new schedules) - Clause 17 - Cash basis for small businesses

Finance Bill – in a Public Bill Committee am 9:10 am ar 21 Mai 2013.

Danfonwch hysbysiad imi am ddadleuon fel hyn

Photo of Nigel Mills Nigel Mills Ceidwadwyr, Amber Valley 9:10, 21 Mai 2013

I beg to move amendment 3, in clause 17, page 7, line 24, at end add—

‘(2) The Chancellor of the Exchequer shall instruct the Office for Tax Simplification to publish a report on the effectiveness of the provisions in Schedule 4 and other tax rules on encouraging small businesses to expand and increase employment; and the Chancellor shall place a copy of the report in the House of Commons Library.’.

Photo of David Crausby David Crausby Llafur, Bolton North East

With this it will be convenient to discuss the following:

Clause stand part.

Amendment 55, in schedule 4, page 162, line 10, at end insert—

‘(8A) The Treasury shall publish an assessment of the impact that the relevant maximum set out in subsection (5) will have on the receipt of revenues by Her Majesty’s Revenue and Customs when compared with a relevant maximum set at £30,000.’.

Amendment 4, in schedule 4, page 162, line 18 , leave out ‘H’ and insert ‘I’.

Amendment 5, in schedule 4, page 163, line 3, at end insert—

‘(9A) Condition I is that at any time within the period of seven years ending immediately before the basis period for the tax year, the person was convicted of an offence relating to the evasion of tax or the fraudulent claim of one or more benefits.’.

Amendment 6, in schedule 4, page 163, line 15, at end insert—

‘(1A) For the purposes of subsection (1) an election made on or before the date of filing of the relevant tax return for tax year shall be deemed to have been made on the last day of the tax year to which the return relates.’.

That schedule 4 be the Fourth schedule to the Bill.

Photo of Nigel Mills Nigel Mills Ceidwadwyr, Amber Valley

It is a pleasure to be back here this morning. I welcome the measures in the clause. If we are trying to encourage people to start their own business and try to grow those businesses, it is right that we introduce measures to make it as simple as possible for them to do so. It is absolutely right that we try to make their experience of the tax system, perhaps for the first time as a self-employed person, as simple, straightforward and painless as we can.

We have some very welcome measures that take us in the right direction. As a qualified accountant, I say that with a heavy heart, because for many years we were told that the important thing for a business was to understand all its revenues and costs and to work out whether it was making a profit out of each individual transaction. Using a cash basis is far too simple and can give a misleading picture. Because there is more cash coming in than going out each week, the business thinks it is doing really well, until some large bills turn up at the end of the year. Conversely, the business thinks that a large piece of expenditure might be a bad thing, because it does not have the cash at that minute, but that piece of investment would provide a much larger return in future. So there is some downside to moving to a cash basis of accounting.

Over the years, accounting practice has cycled from cash to accruals to ever more complexity, and then back to the simplicity of cash. There is some attraction for very small businesses—the one-man bands—to try to get the income on which they pay tax to be as close to the increase in cash that they have earned over the year, rather than having to go through complex calculations of allowances, tax expenditure and all manner of complicated rules. What the Government are trying to do is absolutely right. The Office of Tax Simplification should get credit for the suggestion it made last year, although I am not sure we are entirely in the situation that it intended.

There has been some concern that what is proposed is perhaps not quite as simple as everyone expected. We can all picture a “Yes, Minister” sketch in which the Minister says, “I want to make a really simple system for very small businesses”, and the official says, “That’s a good idea, Minister, but have you thought about what happens if they buy an expensive car and get tax relief up front? Perhaps that is a bad idea. Perhaps we should make an adjustment for that. What about this scenario and that scenario?” Somehow, rather than paying tax on the increase in cash over the year, we end up with a rather long schedule with complicated situations, and the very small businesses that we were trying to take out of complexity then have to try to work their way through them.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

The hon. Gentleman makes a very important point about an idea that perhaps started sensibly, but then was picked up by Ministers and officials and changed in a slightly untoward way. Does he agree that quite a good parallel can be drawn, because the Exchequer Secretary has many similarities with Jim Hacker?

Photo of Nigel Mills Nigel Mills Ceidwadwyr, Amber Valley

It would probably be foolish to go that far. It is a while since I have watched any episodes. I tried to watch the new series, but it does not compare with the old one. I am sure that the Minister’s career will be as successful as Jim Hacker’s. That remark might rescue me.

Our tax regime, with our support, should encourage someone not only to start a business but, if they are successful, to try to grow it. If we could get sole traders to the stage where they could employ somebody to take the business forward, that would be a powerful way to improve the position of our economy, especially where we have youth unemployment. We should be careful  that we are not creating a big ceiling beyond which it is hard or painful to grow a business. I am thinking of a scenario in which perhaps a self-employed plumber is doing quite well and making a nice income, perhaps £30,000 to £40,000 a year, and the turnover is getting pretty close to the VAT threshold. They do not employ anyone, so there are no PAYE responsibilities. They pay no VAT, so they have no VAT duties, and they can file a relatively simple tax calculation based solely on cash in surplus that year, effectively ignoring all the complexity.

Someone might think, “I could make a bit a more money if I took somebody on and trained them. I could give that person a start in life, train them and give them a career and a skill. But, if I do that, my income will go above the VAT threshold. I will have to cope with all the PAYE reporting and now I have suddenly got myself into doing proper accounting that I have not had to do before.”

The implication is that the price goes up by 20%. That is probably a real cost, because the person is now competing with people who are not having to pay that 20% of VAT. There is all that additional complexity and the risk of employing someone. It is not unreasonable for someone in that situation to think that they are making a nice living, and have a successful business and a good reputation and to wonder whether they want all the hassle of taking on that first or second employee.

I accept that the Government have rightly come up with a policy that starts next year whereby payroll taxes will be exempted for a while. That is clearly welcome news. We need to graduate the tax system so that people start out simply and easily and get used to running their own business and making some money. Then all the complexities involved in getting bigger come in one by one on a graduated scale and do not all hit at the same point.

Someone might get their turnover up to the high £60,000s and think that that is as far as they want to go; that it is too hard to go any further. There was some merit in the OTS setting the rules at £30,000 to £40,000 turnover, rather than the VAT threshold. That would then have been graduated. Those are the reasons for tabling amendment 3, which asks the OTS to have another look at all the tax systems and where they all start, and to ensure that we do not, with the best intentions of trying to help, accidentally create a ceiling through which it is hard for businesses to grow.

The OTS could have another look at whether the regime that has been introduced is a little too complex. Some of the rules that have been introduced to meet sensible concerns have perhaps gone too far beyond the intended simplification. I have no view on when the report should be done. Perhaps we should give these rules a year or so to see what the take-up is. I accept that tax returns must be filed, which might take quite a while to achieve. If we are to get this radical change right, it is worth ensuring that we have not introduced something that is too complex to be helpful and might create a barrier that we did not intend.

There are clearly other issues with cash accounting. It lets people play games. We do not want to encourage clever accountants or people of dubious morals to play clever games, but people could clearly reduce their tax  bills by just forgetting to collect any cash from customers until the day after the tax year. Someone might delay receipt of income by only a few days, and delay the tax bill by about a year. That could be just a one-off saving, but I am not sure that it is the sort of thing that we want to encourage.

Where people have previously tried to avoid or evade tax or engage in benefit fraud, I am not sure that we want to give them the flexibility to put income on this simplified cash basis. That is the reason behind amendments 4 and 5. If there is experience of someone trying to defraud various systems, perhaps they should not be allowed this more relaxed way of preparing their tax calculations. Perhaps we ought to insist that someone keeps proper accounts on a proper basis so that it is known what is really earned.

I will next talk to amendment 6. When someone starts a business for the first time, there are many complexities to deal with when they just want to get started and find the first customers and the equipment that they need. They might not get round to all the tax compliance at the start. Someone might think that the tax year end is the time; that they need to file a tax return and find out what they need to do. The way the rules are written means that the cash basis cannot be used for the first year of trading if the deadline of the tax year end has been missed.

With amendment 6, I am saying that someone should be able to elect the cash basis when they file a tax return, rather than be required to have done so during the tax year. That would make the system a little easier for people who are starting their first business and are not used to all the compliance. I can see risks, and we do not want people to be yo-yoing between the cash basis and the accruals basis, thinking, with retrospective knowledge, “The cash basis favours me, so I will choose it.” However, people should be able to make that election for the first time in their first tax return, rather than during the year. Once they have made it, it will stick for five years, so that they cannot yo-yo each year and choose whichever basis benefits them.

I have some questions for the Minister. I would like to understand how the system will tie in with universal credit. Clearly, a lot of people who will benefit from this system will also be claiming universal credit to top up their self-employed income. When people report their income fortnightly—or whatever it is—for universal credit, that will be on a simple basis of cash in, less cash out. We want the 12-month total of what they report to be the same as their taxable income under this system, so that we do not have any strange adjustments or differences; we do not want it to be the case that when they file their tax return, their universal credit calculation is found to be wrong. I am not entirely sure whether the two sets of rules—those for universal credit and those that we are considering—will get us to similar answers.

There is one minor point: the schedule talks about someone being “entitled to universal credit”. I presume that what we mean by “entitled” is that someone is both entitled to and is claiming universal credit during the year, rather than being entitled without ever actually claiming. It could cause confusion if people were legally entitled to claim something but never actually did; would they get the extra benefits of this system? Perhaps  “entitled” means that someone has to make a claim and prove their entitlement, but will the Minister give some clarification on that issue?

This is a welcome change. It is clearly a positive thing for very small businesses, which we need to help. However, there are some issues with the change and perhaps some further tweaks would make the system the best it could possibly be.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury) 9:15, 21 Mai 2013

Good morning, Mr Crausby. It is a pleasure to be moving on to clause 17 of the Bill, although the main substance of the measures is really in schedule 4. I am sure that hon. Members, basking in the warm feeling that they will have from receiving a nice e-mail from their leader this morning saying how much he loves them, and cherishes and values their contribution, will be delighted that the hon. Member for Amber Valley has tabled amendments that are in no way, shape or form swivel-eyed. In fact, they are sensible, prudent and eminently supportable amendments. The Opposition value his hard work and diligence in keeping the Government on their toes—something a lot of his colleagues have also been doing recently, although in a perhaps less constructive way.

Looking at this issue, I agree with the hon. Gentleman. We see where the Government and the Office of Tax Simplification are coming from in trying to remove a burden from micro-businesses and sole traders, and in this case from partnerships as well. Those groups might find it easier in some circumstances to account for their income and expenditure on a cash basis and report their income for tax purposes accordingly. The trouble is that experts, having looked at these particular provisions, have been increasingly concerned about how the Government have picked up the recommendation from the Office of Tax Simplification and have turned it into something that might have a number of unintended consequences.

To dwell for a moment on what exactly it is that we are talking about, an accruals basis for accounting—for a small business or for any business—is essentially a process of recognising income and costs as they are earned or incurred, but not as the money is received or paid, so that they are dealt with in the profit and loss account for the period in which they are earned or incurred. So far, so good, and a lot of accountants—I am not one myself, so I am not versed in the details—will be familiar with that process. Indeed, it could be argued that hon. Members are quite familiar with these issues for the purposes of the Independent Parliamentary Standards Authority. We lodge our expenses for the period in which they are incurred, not necessarily for the period when we part with the money and pay the Revenue. That can often fall on either side of a financial year. But the move to the cash basis would mean that an individual could bill someone for work done in the 2013-14 tax year, for example, and does not need to account for that until the bill is paid. If the bill is not paid until after 5 April 2014, the sum of money would not need to be recognised in those accounts until the financial year 2014-15.

Let us say for the sake of argument that the Exchequer Secretary commissioned me today to do some work for him, perhaps a bit of plumbing or window cleaning around his large estate in Hertfordshire. He might well say to me, “Thank you very much for doing that work.”  Under the cash-basis arrangements I could say, “Wink, wink. Don’t pay me until after 5 April next year. That is quite a good arrangement as this year I don’t want to part with too much tax. How about I invoice you in 11 months’ time and you pay me on the other side of 5 April 2014 as I would rather not pay tax this financial year.” As a sole trader, technically I would not need to pay income tax on that until January 2015, which is quite a long way off if I were doing that window cleaning or plumbing for the Minister today. It is quite a good way of deferring my tax burden. It might be perfectly justifiable, but it is an interesting point.

Photo of Sheila Gilmore Sheila Gilmore Llafur, Edinburgh East

My hon. Friend suggests that someone might do that to relieve their tax burden, particularly when entering self-employment. There is a danger that people might see these extended tax periods as almost being over the event horizon, and fail to put aside enough money to meet their tax bill. Presumably we do not want to exacerbate that situation.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

My hon. Friend has led me neatly to the rationale behind amendment 55. Essentially, it asks the Treasury to set out what it anticipates the effect on revenues and receipts for HMRC will be from this change. After all, we know that the Chancellor has been very keen to do everything he possibly can to maximise income in the years in which his deficit figures required urgent attention, to bring in as much income as possible and, under the Budget exchange process, kick the expenditure beyond the financial year. There are all sorts of little accounting tricks that the Chancellor has been involved with so that he can try to make it appear as though the deficit is at least static at the £121 billion it was the year before last, the last financial year and is predicted to be this financial year because deficit reduction has totally stalled.

It is interesting that the Chancellor has sanctioned this move, which might mean that quite a lot of income and revenue for HMRC that might normally be accrued within this financial year can now be kicked forward into the subsequent financial year. Such is the insight of the Treasury that it has decided to increase this threshold from £30,000 of turnover to at least £79,000. In other words, it has aligned it with the VAT threshold. Of course, because of the rolling accounting processes involved with the VAT thresholds, I am told that, in reality, that will mean income projections of double that amount: £158,000. That is a large amount, which probably covers the majority of small businesses as 96% of small businesses are defined as micro businesses: those with fewer than nine employees.

It would therefore be helpful if the Minister would confirm his understanding that this provision will cover most sole traders and partnerships. He could also help the Committee by putting on the record that that is not intended to apply to incorporated companies and that the effect will be mostly on income tax. I ask that question because in schedule 4, on page 161, the drafting refers frequently to firms; for example, it states:

Condition B is that, in a case where the person is either an individual who controls a firm or a firm controlled by an individual”.

The Treasury uses “firm” a lot in the drafting, but as there is no definition of what a firm is, I am worried that many traders and partnerships who might be on the verge of incorporation could be confused into thinking that cash basis accounting would still be available to them post-incorporation. It would be helpful if the Minister would clarify that his definition of firm does not cover incorporation and explain why that is not set out in the schedule—perhaps it is, but I could not find it.

It would also be useful if the Minister would explain how this measure will work with partnerships. It is all very well if I am a window cleaner or plumber pulling my forelock as I look for work at the Minister’s Hertfordshire towers, but if I am in a partnership, there are two of us in that endeavour, so how do we decide on the basis of accounting that we will use in that partnership? For example, my hon. Friend the Member for Newcastle upon Tyne North may have a determined attachment to accrual basis accounting for our window cleaning partnership while I may say, “No, I want to go to a cash basis”. What is the mechanism for resolving which basis of accounting we would pursue? If I am quite adamant that it should be cash basis, while she likes the accrual basis, how does a partnership resolve by election—[Interruption.].

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

The Labour party, of course, is united in wanting to use the basis that is best for the taxpayer. Perhaps HMRC’s advice would be to toss a coin, but I make a flippant point to highlight a serious issue: how will a partnership resolve the question of which accounting system to use?

It was Yvette Nunn, the president of the Association of Taxation Technicians, who concluded that:

“This is a good idea gone bad.”

She has been open about how small businesses informed her organisation that the tax system is the bane of their lives, yet the offer on the table today is not much different from before. It is important that the Minister listens to what the experts say and it is incumbent on the Treasury to explain why it has overruled the Office of Tax Simplification’s suggestion that this measure should be for just £30,000 of receipts, payments and turnover, and instead went for this large figure. Various rumours are circulating that it is something to do with alignment with universal credit accounting provisions, so it would be useful if the Minister could explain why the Government have chosen that basis.

The legislation links the threshold to the VAT threshold at the end of the tax year, not at the start. VAT thresholds are linked to financial years, as I understand it, whereas the cash basis is linked to tax years. There are obviously a few days of anomaly between the two—I wonder whether the Minister has found a clever way of addressing that, because obviously some businesses run to 31 March for VAT purposes, but cash-basis accounting on a tax-year basis would run to 5 April. The Chartered Institute of Taxation has pointed out that we are left with 24 pages of legislation to effect a simple idea.

The Institute of Chartered Accountants in England and Wales has done a considerable amount of work on this subject and I pay tribute to it for highlighting these  issues. It does not think that the proposals should be implemented from 6 April 2013 in their current form, and has suggested a delay to iron out some of the anomalies. It has also pointed out that there is a danger of moving away from horizontal equity across taxpayers. All taxpayers in similar circumstances should be treated the same. There is a risk that if some are operating on a cash basis and others on an accrual basis, we could end up with unintended consequences.

It is always dangerous to resort to reading out things that are posted on the internet; I know that some Government Members have been caught out doing so in different circumstances. However, I spotted an interesting thread—I think that that is what they are called—of comments on a blog on a site called AccountingWEB. After the announcement of this £154,000 or £158,000 threshold, quite a lot of concern was expressed by a number of tax experts about what the consequences could be. I am told that the Government will allow total freedom for micro-businesses to switch between cash-basis and accrual-basis accounting, in or out, as often as they like. It is that ability to switch backwards and forwards that has caused a bit of consternation. In those circumstances in particular, will the Minister explain how HMRC will capture abuse or unintended adverse consequences that could flow from that switching process?

For example, if I decide to bill the Minister for odd jobs around his estate after 5 April next year because I have moved to cash-basis accounting, essentially I do not have to pay tax on that income accrued in this financial year. However, if I get to 4 April or 5 April and decide that I will flip it back—we know that flipping has caught people out in the past—to an accrual basis on that day, I do not have to account for work undertaken in a previous year. Are we therefore going to lose certain amounts of money that have been moved from one tax year to another? I am sure that that cannot be right, but queries have been raised about whether, if I move to an accrual basis in the next financial year, I may be receiving money in that period, but I have not done the window cleaning or the plumbing in that financial year so I do not have to account for it in my tax return for that financial year. The Minister must address the ability to flip between cash-basis and accrual-basis accounting.

Photo of John Cryer John Cryer Llafur, Leyton and Wanstead

Does this potentially imply that the flow of cash into the Treasury may rise and fall with a more exaggerated effect than previously? It may increase sharply, but it may drop sharply if the behaviour of a large number of SMEs follows the pattern that my hon. Friend has talked about.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

My hon. Friend is entirely correct. That is why we tabled amendment 55, which seeks a proper assessment of the likely effect of this choice of threshold on the revenues for HMRC. We need to know what that is not just because extra volatility may be created as a result of the threshold, but because of the possible effect on deficit reduction. Obviously, it is important for Ministers to cling to the pretence that they are reducing the deficit year on year. It might jeopardise their ability to make that claim, so I am sure the Chancellor is concerned about it as well. As I say, concerns have been raised about this arrangement.

I know this is a bit crude—I often counsel against people spending too much time on the internet—but one comment on this blog is:

“Yippy, going to have fun with that loophole...In Out In Out In Out...It will be like making love to HMRC…Pst, can we all be good now and NOT explain how that might work—I feel a gold rush of new work coming our way.”

That was from one of the accountants who made a comment—anonymously, it has to be said.

There was another set of comments. I did not want to read too much further into the outer reaches of the comments, but one was:

“legalised tax evasion. Lots of ‘loopholes’. Am going away to bang my head against a wall.”

There is another comment here:

“So, for y/e 31st March 2014 elect to use the cash based scheme. All March sales are invoiced on 31st March, cash is received in April and is therefore excluded. Purchases and stock relating to the later year are purchased in March and are therefore included. For y/e 31st March 2015, elect to use the accruals basis and this same income and expenditure is excluded. Keep swapping every year from one scheme to the other and HMRC are going to lose a large amount of dosh; even given the fact that this is for businesses below the Vat threshold.”

Another commented:

“Abuse of in-and-out is going to be rife. The advice is to buy all your stock in year 1 and prepay all your expenses under cash accounting and sell the stock in year 2 under accruals accounting. So essentially you get a double deduction for expenditure. Consultancy types who can control their income”— we know there are certain individuals in those circumstances—

“will make a huge saving by getting their clients to pay up front on the last day of year 1, pay nothing in year 2 and pay in arrears on the 1st day of year 3. The income would appear to escape taxation altogether.”

Another blogger commented on the headline of one article:

“‘Tax avoidance is now for the little people’…What a brilliant headline. I love it. I wonder if we are now going to get the protesters camping outside Fred the Plumbers or Joe the Greengrocers instead of Starbucks with the signs reading ‘Turnover £76,999—Tax nil’…Do they honestly think that taxpayers are not going to take advantage of switching every year?”

Another commenter says:

“That will be the Christmas gift that will keep on giving for years to come. A lovely new loophole to play with until the powers that be work out what’s going on and stop it in about 3 or 4 years time. I really really hope that isn’t the case as it will be grossly unfair to gain an advantage just by switching schemes.”

Those are the sorts of concerns that have been voiced on that particular issue.

I turn to the amendments from the hon. Member for Amber Valley. As I say, I think he made some important points. I like amendment 3 very much. I think a report should be published on the effectiveness of these provisions, on employment in particular. Obviously, we want to do the right thing for small firms. In most cases, I am sure the cash basis arrangement for small micro-firms can be made to work. We do not entirely rule out the benefits that that could bring, but it is important that we get some evidence that the Treasury is not rushing headlong in a dogmatic direction without thinking things through properly. Heaven knows, we know it has made that mistake before. I thought amendment 5, about not  letting those with convictions in the past seven years for tax evasion or fraud use the new arrangement, was particularly good and very sensible. I can see circumstances in which there might be abuses of the regime unless things as they stand are tidied up.

I am taken with the amendments. Important points were made in the discussion on the amendment in the name of the hon. Member for Amber Valley. Although I look forward to hearing the Minister’s assurances that I am wrong on many of the points, there are significant anxieties.

Photo of David Gauke David Gauke The Exchequer Secretary 9:45, 21 Mai 2013

It is a great pleasure to serve under your chairmanship again, Mr Crausby.

Clause 17 and schedule 4 introduce an optional, simpler income tax regime, commonly referred to as the cash basis, for the simpler small business. The cash basis will make it easier for small businesses to meet their tax obligations and give them greater certainty that their tax affairs are correct. It will not suit every business; there will be many circumstances in which formal accounts are more appropriate.

The nature of the business should determine whether the cash basis is appropriate, not tax. The cash basis will give small, unincorporated businesses the choice to be taxed based on the money that passes through their business. They do not have to apply the tax rules designed for larger or more complex businesses. Perhaps, at this point, I should confirm that, yes, it is unincorporated businesses—sole traders, partnerships and so on. As for the definition of “firm”, customarily, in legislation in this context, it applies to unincorporated businesses. That is certainly what I was taught at law school and I do not believe that it has changed.

The Government believe that the tax system should support work and be simple, predictable and fair. In 2011, the Chancellor asked the Office of Tax Simplification to identify the areas of the tax system that cause the most day-to-day complexity and uncertainty for small businesses. The final report of February 2012 identified the possibility of introducing a new approach to taxation for the smallest unincorporated businesses.

The report confirmed that business owners are trying to get their tax right, but it identified that a significant proportion worry that they may have made unintentional errors in, for example, preparing a taxable income figure or claiming for capital expenditure. To address those concerns, in Budget 2012 the Government proposed a new cash basis for small unincorporated businesses, to apply from April 2013. I thank the Office of Tax Simplification for its work. The changes before us are a significant simplification that will help many businesses.

Photo of Sheila Gilmore Sheila Gilmore Llafur, Edinburgh East

Why, having accepted the recommendations of the Office of Tax Simplification, did the Government not accept the threshold the OTS suggested, which was set much lower—at about £30,000—than the VAT threshold that has been adopted?

Photo of David Gauke David Gauke The Exchequer Secretary

We looked at the recommendation. The concept of the cash basis is sensible, but many businesses with receipts of more than £30,000 are not complex and  the principles and approach that the OTS set out for some businesses up to £30,000 a year could apply more broadly.

The increased eligibility limit makes the cash basis available to more businesses. It is a step in the right direction and we want to go further. There are dangers in making comparisons with other jurisdictions, but I recently read a note on current tax issues in the US, where there is a debate about the cash basis—currently, I believe, at £500,000—and whether it should be increased.

To be fair, there is no exact like-for-like comparison between the systems, but we believe that the OTS proposed sensible recommendations and that the benefits should apply to more businesses, up to and including the VAT threshold. Since the announcement, HMRC has engaged extensively with businesses to ensure that we get the design of the regime right.

Schedule 4 sets out that use of the cash basis for unincorporated businesses and partnerships is entirely optional. To be eligible, a business must have receipts not exceeding the VAT registration threshold in the tax year. Certain, more complex business types and trades are excluded from the cash basis. The schedule provides that a business may calculate its profits based on receipts when they are received and expenses when they are paid. Tax relief for assets purchased, other than cars, is given as an expense instead of using capital allowances rules.

The schedule also sets out that deductions for interest on cash borrowings are restricted to £500 and that sideways loss relief is not available to businesses using the cash basis. In addition, no market value adjustment needs to be made when taking stock for one’s own use. The schedule also repeals the existing rules for new barristers, but they, too, will be able to use the new cash basis.

Amendment 55, tabled by the Opposition, asks the Government to publish an assessment of the impact on tax receipts of setting the entry limit to the cash basis at £30,000 instead of the current entry limit of £79,000. We do not believe that such an assessment is required. The cash basis is not a tax relief; it is intended to simplify tax for small businesses. The Exchequer cost of any entry limit is a one-off timing effect. That is due to adjustments made by businesses that switch to the cash basis. The money is recovered in later years as businesses cease trading. The cash basis is effectively revenue neutral over time.

The OTS proposed an entry limit of £30,000 and an exit limit of £40,000, which I assume is why the Opposition are interested in the Exchequer cost at the limit. However, the Government have opted for a higher limit because they wanted a larger number of businesses to be able to use the cash basis, if they want to. As I said, 3 million businesses are eligible at £79,000, more than 500,000 more than at £30,000. The Federation of Small Businesses has praised the Government for offering the simplification to more businesses. In addition, the entry limit is tied to the VAT registration threshold, an existing threshold in the tax system that small businesses recognise. We think that that will be helpful.

My hon. Friend the Member for Amber Valley tabled a number of amendments to the schedule. First, he suggests that the Government ask the OTS to publish a report on the impact of the cash basis and other tax  rules on encouraging small businesses to expand and increase employment. Secondly, he proposes an additional category of persons excluded from using the cash basis—those who have been convicted of an offence relating to tax evasion or the fraudulent claiming of one or more benefits. Thirdly, he tabled a technical amendment concerning the date, or deemed date, on which an election to use the cash basis has been made.

As my hon. Friend is aware, the proposals in schedule 4 are the result of the Government’s response to the OTS review of small business taxation. The Chancellor set up the OTS in July 2010 with a remit to review specific areas of the tax system and make recommendations on how to simplify them. The remit does not extend to reviewing the impact of changes to the tax system on business growth or employment.

The Government, of course, keep all tax policy under review. Also, HMRC and the Treasury routinely monitor the impact of economic reforms on a case-by-case basis. As such, we do not think it necessary or within the OTS’s remit to assess the economic impact of the cash basis or any other changes to tax.

The cash basis is designed to help the smallest businesses by allowing them to calculate their taxable profit on a basis that is appropriate for their business. As such, the Government consider that the cash basis is not a benefit that should be withdrawn as a punitive sanction. To do so could force a business to use an accounting basis that is not appropriate and would be counter-productive.

Existing procedures are in place to control and monitor the compliance of defaulters and, additionally, there are technical issues with the amendment that would prevent it from operating effectively. I appreciate that my hon. Friend tabled it as a probing amendment. The Government do not recognise that an amendment to the date of election to use the cash basis is necessary. The election is made when filing a return and so any election outside a return might cause an additional administrative burden.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

I am interested that the Minister is not persuaded by amendment 5 on the grounds that he does not want to add a further exclusion to those persons who might be eligible to use this scheme. I worry that he dismisses it too lightly. If we know individuals have been convicted of fraud or tax evasion in the past, are there not legitimate grounds for thinking that this constant switching in and out might be too tempting a regime in respect of abuse? There are a number of other exclusions and I do not quite see why he turns his back on that one.

Photo of David Gauke David Gauke The Exchequer Secretary

I was going to turn to the issue of switching in or out—the hon. Gentleman’s “hokey cokey” argument—in a moment. It is worth pointing out that the aim of the cash basis is to provide an appropriate means of assessing tax liability. It would be unfortunate if we forced the business not to use the most appropriate accounting basis.

The essence of the argument is that there will be greater vulnerability to avoidance or evasion, but I am not sure that that is necessarily the case. Indeed, one could look at sideways loss relief, which is not allowed under the cash basis. Sideways loss relief could be abused, but only under the accruals basis. I am not sure that I necessarily accept the premise of the concern.

I turn to the potential risk that, with a business moving from the cash basis to the accruals basis, tax might not be paid. The comments that the hon. Gentleman read out from the website were based on the original proposals. Since then, the rules have been tightened. He set them out in a somewhat tentative form and rightly so. Following the consultation, it is clear that the cash basis is an opt in and stay in regime that allows a person to opt out, but only when business circumstances change.

In circumstances where a business is expanding and wishes to claim more than £500 interest deductions or to claim sideways loss relief or it decides to register for VAT, it could move from the cash basis to the accruals basis. But a business changing between cash and accruals basis would need to make transitional adjustments such that income was only taxed once and relief for expenditure was only given once. I hope that that has addressed the hon. Gentleman’s concern.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury) 10:00, 21 Mai 2013

I am grateful to the Minister for addressing the point. He says that there is now to be an opt in and stay in basis until business circumstances change. Just so that I can find it and be clear, where in schedule 4 is “a change in business circumstances” defined? If it is self-defined—“My business has grown by x amount,” or, “I am moving into some sort of different state”—it is important that we see how strong the rules are on the stay in part of that opt in and stay in arrangement. Where is that business change defined?

Photo of David Gauke David Gauke The Exchequer Secretary

I will turn to the definition immediately. If the hon. Gentleman cares to look at part 31D of schedule 4, on page 163 of the Bill, he will see:

“An election made by a person under section 25A ceases to have effect if…there is a change of circumstances relating to any trade, profession or vocation carried on by the person which makes it more appropriate for its profits for a subsequent tax year to be calculated in accordance with generally accepted accounting practice”.

The point is that, as the hon. Gentleman has set out, there is concern that frequent switching from one system to another could result in benefits for particular expenditure being given more than once, or in income not being taxed at all. However, there are constraints on that, and I think he will find that the concerns he has seen were raised about an earlier version of these proposals.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

I am grateful to the Minister for his response, because this is a learning process for the whole Committee—I had not spotted that provision in part 31D on page 163. However, is he really confident that he can get away with describing this as an opt in and stay in regime when the only constraint on a business regarding flipping and switching between cash-basis and accrual-basis accounting is that they have to say that there has been a change in their circumstances, which is undefined, and that

“the person elects to calculate those profits in that way”?

I do not really see that that is a strong constraint that he can describe as a stay in provision. It is essentially a meaningless legislative provision, is it not?

Photo of David Gauke David Gauke The Exchequer Secretary

I do not accept that. There are transitional arrangements: if somebody moves between the cash basis and the accruals basis, there is a need to make transitional adjustments such that income is taxed only once and relief for expenditure is given only once. That protects the Exchequer in such circumstances.

Photo of Nigel Mills Nigel Mills Ceidwadwyr, Amber Valley

The Minister will be aware that there is precedent elsewhere such that where someone has elections to choose what regime they apply, they have a five-year window. Once they are in, they are in for five years, and if they leave, they are outside for five years. That way, people cannot yo-yo around by choice if they think that they could benefit from changing each year. There is some attraction to that here—we want people to think, “This is better; I want to be in,” and then once they are in, they are there for five years unless they blast their way out of the upper threshold.

Photo of David Gauke David Gauke The Exchequer Secretary

I appreciate the point that my hon. Friend makes. There are, however, some challenges if we are too prescriptive. For example, if a business wants to make use of sideways loss relief, greater use of interest deductions and so on—essentially, if their business becomes more complex before they have even gone beyond the VAT threshold—it would be a pity to constrain it in such a way that they could not go down that route. I believe we have got the balance right. As I say, transitional adjustment will have to be made to ensure that all income is taxed at some point and all expenditure receives relief only once.

I now turn to some of the other issues. The concern that a partnership might not be able to reach a conclusion is no different from any other issue that affects partnerships. I hope that any partnership seeking to clean my windows would be able to reach an agreement on that. Given the concerns the hon. Member for Nottingham East raised, I will not be looking to employ him as a window cleaner or a plumber.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

What about my hon. Friend the Member for Newcastle upon Tyne North?

Photo of David Gauke David Gauke The Exchequer Secretary

Perhaps the hon. Member for Newcastle upon Tyne North has got a better chance. This is a matter for normal partnership arrangements. It is for partnerships to determine how they wish to do it. It is normally the controlling partner who makes the final decision, and if there is no controlling partner, then a nominated partner. But it is a matter on which partnerships must reach a decision in the normal way. I see no reason why partnerships cannot deal with it.

I hope that those answers have helped explain to the Committee how the cash basis will work. The Government appreciate that UK small businesses make a significant contribution to the economy and public finances, and it is right that the Government support those businesses. The clause and schedule give 3 million small businesses the option to simplify their tax calculations and have greater certainty over their tax affairs. I hope that the Committee welcomes them.

Photo of Sheila Gilmore Sheila Gilmore Llafur, Edinburgh East

It has been suggested that these changes will help to align the system for universal credit. Will the Minister explain how?

Photo of David Gauke David Gauke The Exchequer Secretary

I am grateful to the hon. Lady for raising that matter. Indeed, I should also respond to the point that was raised by my hon. Friend the Member for Amber Valley. The calculations for cash basis and universal credit have been aligned as much as possible. Some differences do remain, as the calculations are for different purposes. Just to give one example, payments of tax and national insurance contributions are included as deductions in the universal credit calculation, but are not deductions for income tax purposes. There are some differences, but as far as possible we have tried to align those definitions.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

I sense the Minister’s peroration is coming. Before he does so—I might have missed this in the blink of an eye—on amendment 55 we sought a figure for the impact that the shift to the cash basis will have on HMRC receipts. Has he calculated what that figure is, because it is quite crucial?

Photo of David Gauke David Gauke The Exchequer Secretary

Those numbers are included in the Red Book and the tax information note. In terms of Exchequer impact, overall the shift is revenue neutral. I think this may be in the Budget 2012 documentation. To help the Committee, there is a cost to the Exchequer in 2014-15 of £165 million, a benefit in 2015-16 of £25 million, a cost in 2016-17 of £5 million, and then after that it is negligible. Essentially, this is a timing issue. There is a cost in 2014-15, but it is not because less tax is paid; it is because the tax is paid in subsequent years.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

I have found the figure on page 66 of the Red Book. If the measure is revenue neutral, why will the Exchequer lose £165 million in 2014-15, recoup only £25 million in 2015-16 and then lose £5 million in 2016-17? That does not look revenue neutral to me.

Photo of David Gauke David Gauke The Exchequer Secretary

It is essentially about timing: the tax is paid, but in later years. On such issues, the difficulty is that the Red Book does go to the end of time. The money will be paid, but it is shifted to the right. There is no total cost over a period that incorporates everything. As sometimes occurs in the tax system, there is a delay to the payment of the tax, but it will be paid in total.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

The Minister suggested that the tax had been shifted so far to the right that it goes beyond the frame of the Red Book, which is to 2017-18. If that is the case, why does the measure go back into loss in 2016-17? I could accept his point if the figure was minus £165 million in the first year—2014-15—and that it somehow recovers even beyond 2017-18, but it is back into loss again in 2016-17.

Photo of David Gauke David Gauke The Exchequer Secretary

Let me see whether I can make the issue clear for the hon. Gentleman. There is a delay in a certain amount of tax being paid each year. For example, certain sums that would have been paid in 2014-15 will be paid in 2015-16, but, equally, some of the sums that would have been paid in 2015-16 are then paid in 2016-17 and so on. The scorecard cannot reflect the fact that there is a shift to the right, as it were, because a sum of money is now consistently paid later than previously. The first year, as we adjust from one system to another, can be seen on the scorecard, but the reality is that the same total amount of tax will be paid.

Photo of David Gauke David Gauke The Exchequer Secretary

I will give way for one last time. I fear that the hon. Gentleman and I may be struggling to understand what we are saying to each other, although I think that I have been clear to the Committee.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

One of us is struggling for sure. Essentially, the Minister seems to be saying that the effect of the shift in the Red Book figures is a cost of £140 million to the Treasury, which is a loss to the Exchequer of a considerable sum of money. He says, “Oh well, it will be recovered further down the line,”, but that is a big example of kicking the can down perhaps a very long road, with that £140 million never being recovered by the Exchequer.

Photo of David Gauke David Gauke The Exchequer Secretary

As I say, the issue is tiny. The costs have of course been certified by the independent Office for Budget Responsibility, and a published note on the costing can be found on the Treasury website, which I am sure that the hon. Gentleman has visited.

In conclusion, the change is a significant simplification for a large number of businesses. It is a consequence of the hard work of the Office of Tax Simplification. It will make a difference to many businesses by reducing some of their concerns about complying with the tax system. It is consistent with what the Government are doing to make life easier for small businesses. The employment allowance will come in next year, which will also be of substantial benefit to small employers. Given my clarification, I hope that hon. Members will not persist with their amendments but will support the clause and schedule.

Photo of Nigel Mills Nigel Mills Ceidwadwyr, Amber Valley 10:15, 21 Mai 2013

I am grateful to the Minister for his clarifications. Given the amount of work that the Office of Tax Simplification has, moving it into the field of economics would probably not be the most productive use of its time, so I will happily seek leave to withdraw amendment 3.

One of the perils of being a humble Back Bencher is the difficulty of drafting amendments that can be legally operative; it is clearly beyond my drafting talents. I will therefore not seek to press amendments 4 to 6 to a Division.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

I am not convinced that the Treasury has a proper grip on the financial impact on the Exchequer of the move to the cash basis. It looks as if it will cost the taxpayer at least £140 million, at a time when the Government’s finances are in difficulty and, in many ways, worsening. We should at least have a proper and open assessment about when and how far the can will be kicked down the road. I will seek to test the views of the Committee on amendment 55.

The hon. Member for Amber Valley has tabled some interesting amendments, particularly amendment 3, which I wish to support. He has indicated that he wants to seek leave to withdraw it, but I would like to test the Committee’s view on that as well.

Photo of Nigel Mills Nigel Mills Ceidwadwyr, Amber Valley

I beg to ask leave to withdraw the amendment.

Hon. Members:


Question put, That the amendment be made.

The Committee divided: Ayes 12, Noes 17.

Rhif adran 2 Decision Time — (Except clauses 1, 3, 16, 183, 184 and 200 to 212, schedules 3 and 41 and certain new clauses and new schedules) - Clause 17 - Cash basis for small businesses

Ie: 12 MPs

Na: 17 MPs

Ie: A-Z fesul cyfenw

Na: A-Z fesul cyfenw

Question accordingly negatived.

Clause 17 ordered to stand part of the Bill.