Executive Summary
In the recent past, the government came-up with the introduction of a cash basis tax system, which was meant for the purpose of familiarizing businessmen and other stakeholders concerned to the easier and simple way to interpret tax structures.
Current report postulates the fact that with the introduction of the cash basis system most businesses, such as those owned by Andrew, could adopt the system in order to ascertain their exact tax obligation to the authorities.
Consequently, the report also notes that the tax system is an option to both individual tax-payers and large organizations as well. In its entirety, the report provides distinctive descriptions on such factors as processes of computing taxable profits, and also, providing a relevant and reliable distinction made between allowable and non-allowable deductions and expenses for that matter. Lastly, the report provides a positive recommendation to Andrew Moore to adopt the cash basis system given that it is much applicable to the current situation of his business.
Introduction
The immediate notion behind the introduction of a cash based tax system is to allow both individuals and corporations to be able to calculate their respective taxable profit amounts through the subtraction of receipts from recorded payments. It should be understood that the amount of taxable profits attained, under this system structure, is largely depended on immediate cash flows of an entity at any given time.
Most notably, it can be ascertained that the cash basis tax system is an approach introduced to tackle the needs of both individual companies and corporations at large. Thus, its diversification capabilities are applicable to any given business environment.
Cash Basis and Accruals Assignment
Computation of the Taxable Profits Using the Normal Accrual Basis
For the year ended 31 December 2012
Net profit $23,000
Add non-allowable expenses
Loss on the immediate disposal of an asset $300
Depreciation expense $2,700
Taxable Profit for the Business $26,000
Using the Cash basis methodology, the business taxable profits can be computed as follows;
For the year ended 31 December 2012
Receipts
Turnover receipts $75,000
Proceeds from disposal of a machine $600
Total receipts $75,600
Payments
Purchases $26,000
New equipment $5,000
Rent $3,000
Light and heat $1,000
Telephone $700
Stationery $500
Sundry expenses $350
Total Payments $56,550
Total Taxable Profits $19,050
An Overview of Cash Basis Tax System
Cash basis tax system, as earlier noted, was developed and imposed by the relevant government agencies with the sole purpose of making payment of taxes a simple activity. This exercise of paying taxes was thus made easier and straightforward for most small businesses. Under this tax system, tax liabilities for both individual taxpayers and large trade businesses are made apparent with certainty (Navani 2000).
Due to its simplicity, the tax system is meant for businesses, which are not incorporated and, therefore, are not placed at a fair position to conduct an accrual-based preparation of accounts. For this case, such businesses as those owned by Andrew are encouraged to pay their respective tax liabilities only on the accord of their receipts that are considered to be lower, as compared to allowable expense. This tax system, therefore, saves Andrew more time, given that he will not spend any time making accrual adjustments for the activity of his business.
Retrospectively, in this accord the cash basis tax system was formulated with a leeway for choosing to either adopt it or not. Thus, Andrew is not under any obligation to adopt this system into the operations of his business. This is mainly because his business is not incorporated, hence does not bear legal responsibility to adhere to certain accounting policies and procedures as stipulated under Generally Accepted Accounting Standards (GAAP’s) (Fama & French 1996).
Andrew can opt to adopt the cash basis tax system in case there is a clear certainty that his total receipts for the current year of operations do not go beyond the VAT registration limit proposed within that year. Statistically, the government sets this VAT limit at $79,000 for sole businesses or $158,000 for international based receipts. By taking a closer analysis into the receipt records of Andrew’s business, it can be ascertained that his business qualifies for the adoption of cash basis tax system.
By adopting this tax system, Andrew level of risk will be reduced to a manageable level since it is assumed that his business will likely experience a significant reduction of demand for its products in the near future. Given the fact that the cash basis tax system is optional and can be adopted at any given time, it is safe to recommend to Andrew that should the demand for his business activities will increase or fluctuate, and then, there is the option of either abandoning or adopting it whenever necessary.
The cash based tax system operates efficiently under a cash flow analysis methodology. Thus, income being one of the inflow of cash to the business, it should be recognized at the exact moment it is received, which is at the transactional level. Consequently, payments made by a business refer to the amount of money that the business will likely pay out as obligations to suppliers and credit financiers. For that case, payments should be recognized and posted at the very moment that they are made. Notably, payments, as a form of obligations by businesses, can assume either cash or check status, depending on the convenience level of paying the amount (Hesse 2000).
It is important to note that allowable expenses are categorized as being only those of expenses incurred by a business in the course of generating revenue. These types of expenses might include those expenses, which are incurred during the acquisition of non-durable forms of assets. For Andrew Moore case scenario, capital allowances will be not be enjoyed given his intentions of purchasing newer motor-vehicle (Hesse 2000).
Given his future loss uncertainties, Andrew should be aware that in cases of current losses for his business then, he has a leeway of carrying forward them into the future. By this manner, he will be able to counter the losses as the business year progresses. On a contrary, there is no dispensation within the tax system to allow for backdating of loses and thus, Andrew will not be able to counter the loss with other revenue sources (Hesse 2000). Significantly, the cash basis tax system is meant to allow for a single taxation phase for all allowable expenses. This is due to the fact that, by doing so, there is effective imposition of these taxes (Hesse 2000). The intention to relocate the business will earn him a mileage allowable expense. This, in turn, offsets any possible loss of cash flow from this activity, since the expense is incurred on an equal basis between the taxpayer and the government.
It is worth mentioning that the cash basis tax system allows for computation of business expenses incurred while conducting activities at one’s home. A flat rate coupon is allowed for such kinds of businesses. A determinable three tier banded rate is also another significant attribute of the cash basis tax system, since it is used for determining the necessary adjustments that can be made for businesses premises (Hanlon, Laplante, & Shevlin 2005).
Established in 2013, Finance Bill was meant to amend the 2005 Income Tax Act. Its sole purpose was meant to simplify expenses incurred by non-incorporated small businesses (Hesse 2000). For the case of Andrew, his plans to dispose-off the car will not attract any form of allowable loss or chargeable gains. Andrew is likely to incur most of the capital expenditures, while he makes effort to shift and expand his business.
The cash basis tax system provides a proposition that capital based expenditures, which are incurred in the course of asset acquisition, will only be allowed whenever it used for purposes of business development. Thus, it is considered to be an allowable expense item for taxation purposes. In this regards, it is recommended that Andrew purchase a newer motor-vehicle, since the current old one he possesses does not qualify for any tax allowable expenses. This proposition can be found in the cash basis tax system, which provides a stipulation that any given rate of mileage cannot be deployed for businesses use that have already enjoyed capital allowances for a vehicle. For the first 10,000 miles, a mileage for a newer vehicle is set at $45 per mile and a subsequent $25 per mile for miles past the 10,000 mark.
In regards to Andrew’s loan credit liabilities, the cash basis tax system stipulates that he can only be allowed the computation of the liability expense up to a $500 limit. Given the nature of his newer businesses, and should Andrew choose to use it for personal use, then he should consider making necessary adjustments in an effort of deducting personal expenses from those expenses incurred by the business as a whole. He should make sure to make necessary adjustments depending with the number of occupants present at the premise at any given time.
To be specific, the cash basis tax system has set a distinctive number of rates for personal use of premises meant for conducting businesses. Any single occupant is allowed to part with $350 per month, while two people occupying the same premise will be allowed a $500 limit. Subsequently, in case of 3 or more people within a single business premise, the rate is established at $650.
Concerning his plans to acquire equipment of hire purchase terms, the cash basis tax system stipulates that whenever an asset is acquired on credit terms, thus has been paid fully like in the case of hire purchase, the unpaid amount should be apportioned to stipulated pools in cases where the business abandons the cash basis tax system.
Should Andrew choose to adopt and abandon the cash basis tax system, a provision is made so that the resultant adjustable levels of income is apportioned over a period not exceeding six years from the exact year the abandonment was made effective.
Advantages and Disadvantages of Cash Basis Tax System
First, cash basis tax system allows for easier interpretation and comprehension by the tax payer at hand. For instance, in this case Andrew will only be allowed to present both the receipts and payment sheets for his business for purposes of computing taxable profit. In this regards, it will not present any form of challenge for Andrew to cram tedious accounting procedures in order to calculate his taxable profits. Second, with this tax system, cash flow activities are tracked on an accurate manner (Ayers, Jiang, & Laplante 2009). In this case, Andrew will be able to calculate both taxable profits and tax liabilities to the government on a more precise note. A simple fundamental principle for this notion rests with the fact that receipt are recorded as those amounts of money that are received to the business, while payments are those amount of cash that are paid out as obligations.
Third, there are opportunities for the business to use cash meant for paying taxes to conduct further business activities. This is possible by the mere fact that with the use of checks to pay taxes time is created between date of issue and actual pay date. Thus, Andrew will likely be able to use the withheld money meant for taxes to conduct more business operations and later use the money accrued to pay the tax obligation (Harvard Law Review 1960).
Fourth, the decision to adopt cash basis tax system will be complemented by its immediate ability to allow for planning. A taxpayer such as Andrew will find it possible to plan ahead of his operations by way of accessing the past performance of his operations in respect to both receipts and payments made. For this case, he will thus be able to know approximate amount of tax liability he owes to the government.
Disadvantage of the Cash Basis Tax System
One of the major disadvantages of the cash basis tax system approach rests with the fact that it limits a taxpayer to certain stipulated allowable expenses. Thus, it requires the taxpayer like Andrew to gain significant knowledge that he can use to distinguish between items that are allowable and those that are not (Thomas & Zhang 2011).
Recommendations and Conclusion
Personally, I recommend that Andrew should deploy the cash basis tax system given that it is applicable to his business operations. By adopting the tax system, Andrew is able to enjoy significant benefits of the system as a whole.
For instance, he is able to enjoy significant benefits attributed to purchasing newer motor-vehicle. The anticipation he forges for future operations will be countered by the apportionment of loss for a period of 6 years.
Given that his business is still in its initial phase of development and expansion in that matter, it is possible for him to withhold tax liability as check payments and thus, use it instead for future expansion and short-term growth of business operations.