The cash accounting debate appears to have developed a life of its own.

I admit I was surprised when Mike Truman of Taxation magazine joined in on the side of cash accounting, and opened a poll on his site on the issue. However, he's now written a substantial piece which is well worth reading.

What I would stress though is that what Mike seems to be calling for is simplified accounting, not cash accounting. As he says:

I am beginning to wonder whether part of the problem might be the terminology: perhaps we should not be talking so much about cash accounting but rather a simplified tax regime for smaller businesses, which incorporates cash reporting, but which does not pretend to be creating a set of financial statements at all.

I happen to strongly disagree with Mike that what he then proposes does not create a set of financial statements at all, or that whether they are on an accruals or cash basis is not key. This is quite untrue. The reason is that at the core of his article is a call for tax accounting for micro businesses which involves declaration of an income figure less a fixed cost allowance to come to a figure of taxable profit. Any other interpretation of his suggestion must necessarily involve accounts, and they are financial statements by default.

But it's also true that if a figure for income is to be declared then rules must be used to ensure that this is properly computed (Nichola Ross-Martin's desire for a 'rule free' world remains a fantasy even in this system of reporting). And there is only one rule that can make sense if massive transitional problems on income recognition are not to arise when businesses move from a simplified form of reporting of the type Mike discusses to full accounting as and when the business grows, as some at least will. As I've noted before, it may so happen that for some businesses this will produce a result identical to that which cash accounting will achieve. So be it. That's acceptable. But a cash basis for income recognition generally would rule this option out from the start for reasons I have already discussed, and which Mike recognises as 'cogent'.

Others have asked me to comment on what Mike proposes. I'm more than happy to. In fact, I can concur (the above being noted) with large elements of his request for a simplified form of accounting for unincorporated micro-businesses turning over less than the VAT threshold. The reason is simple. I called for such a system for small business taxation reporting in March this year on Accounting WEB (whose indexing system is now so bad that I can no longer locate the article). Thankfully, however, I did turn the article into a Budget submission to Gordon Brown, so you can read it here.

You might notice that this arrangement is remarkably similar to that used in France , referred to by Mike and Dennis Howlett in one of his blogs on this subject. The arrangement is also used in Russia and some Eastern European states for micro businesses, and is I believe being examined for use in China. It does, therefore have a track record.

However, I did, I admit add a twist. I anticipated that, despite the figures I presented (which I think pretty reliable as a basis of debate) the Revenue would be worried about any such arrangement being abused. Let's be clear why that concern exists. Firstly, to offer an arrangement with a cut off induces consistent declarations at just below the cut-off limit. I understand (anecdotally, and I can't reveal my sources) that there are a remarkable number of three line accounts which show turnover of just below £15,000, for example. This might indicate a patten of evasion. (And before anyone jumps up and down, I said might). Second, there can be no doubt that accountants play games with tax systems. This is hardly surprising. Many of them thinks this their raison d'etre. In which case taxpayers who might take advantage of this option (and I stress I think that this is unincorporated businesses turning over less than the VAT registration limit) and who are represented by an accountant might be encouraged to prepare their accounts on the basis of full expense claims being made with the result under this option then being compared with the outcome using the election for a fixed allowance, with the lower of the two then being submitted. Candidly, I think this is likely to happen and as such concern any H M Treasury might have about loss of revenue from introducing this scheme might be justified.

But, I anticipated this. I said I thought the Revenue should go for this scheme because:

I think there's a real win in this for the Revenue. First of all, it would save masses of work for you. Second it would massively increase goodwill amongst a group who need to have that re-established (rightly or wrongly). Thirdly, if the allowances are set appropriately then this should stop many excessive claims for expenses, and the investigations that go with them. Fourthly, it will make any investigation easier and quicker to conclude because its scope would be limited to just two things namely whether the person was actually self employed and whether they had recorded their sales properly.

I continued:

You could even anticipate many such enquiries by asking anyone who opts for the scheme to submit one of two things with their tax return. The first would a list of the top ten clients by value. The alternative would be a list of takings by month for cash based businesses. Reviewing just this data would allow most enquiries to be heavily focused on unlikely self employments and unlikely patterns of disclosure. That might well increase the effectiveness of Inspector time. It would also allow concentration on the bigger issue in this sector - those who don't declare at all.

I stick by this. I will deal elsewhere with the suggestion that I have maligned small business by suggesting there is no evidence to support that fact that many systematically under-declare their earnings by noting now that the evidence of all research shows this to be true. I suspect that many fewer under-claim their expenses. To therefore focus on status and turnover and to require information allowing easier review of these two issues as a condition of being allowed to simplify accounting requirements, and maybe get a small tax benefit makes complete sense to me. I would seriously hope that all accountants would welcome this as it would mean a reduction in tax evasion had taken place.

The scheme I proposed in March was noticed by people with influence, including amongst others the Tax Reform Commission organised by the Tories. I regret that they did not take the idea on. Others I discussed it with also highlighted problems, some of which I refer to above. The most significant problem I was told of though was that apparently the Revenue may not have sufficient data to calculate reasonable expense deductions for the fairly wide range of businesses that would require these to be set, and that in practice there is almost no evidence of consistent expense ratios existing. I remain amazed by this. If given the data I am sure that I know enough tax academics and statisticians to achieve the required results subject to four amendments to my proposal. These are that the following expenses would not be subject to the scheme but would be claimed separately:

1) Labour costs subject to PAYE
2) Finance costs
3) Rent and rates (as opposed to a 'use of house' charge)
4) Bad debts

I think these are related to specific business choices and are likely to explain many of the variations in percentage expense deductions between businesses in similar categories. All are relatively rare in micro-enterprises or have a low transaction volume, meaning they are easy to record. The mix of specific claim and round sum deduction is unlikely to undermine the attraction of the scheme.

There's one other twist I'd add. That is that the option to simplify when taken should be for a three year period at least. That will reduce the pressure on the Revenue and taxpayers from accountants wishing to play games. But it's not that unfair. Even if a 31 March year end is used the election would not need to be made until over 18 months of the three year assessment period had passed if a tax return relating to the first period was submitted during the latter part of the allowed time period. If a 30 April year end was used the result for more than two of the three affected periods would be known before an election would need to be made. But this would still reduce the game playing.

With these amendments, and with the Revenue being willing to take the risk on some research I think this scheme would work. And I think it should be offered. However, I am fairly sure that accountants would not encourage anyone to use it. This is, of course, the experience of other currently available simplification schemes e.g. VAT flat rate schemes and the annual VAT declaration scheme. Why is that? Because (and I'll be blunt) accountants act in their own self interests in these matters and simplification does not pay for them, or their professional indemnity insurance risk and so when they chips are down they really don't believe in it, whatever they say. But the good thing though is that this scheme would really cut admin costs for these businesses, many of whom would no longer need an accountant. And I welcome that.

Accountants could then focus on the issue of small business accounting and setting appropriate standards for that, which is something quite different.