Q. I am a sole trader providing IT consultancy services to customers. I am registered for VAT. Can I use the cash accounting system for paying VAT and do I need to apply to HMRC to use it?

A. Usually, the amount of VAT actually paid over to HMRC is the difference between the business's sales invoices and its purchase invoices. These figures are reported to HMRC and the net amount paid, even if the invoices haven't been paid. This anomaly means that smaller firms often find they struggle with cash flow, since they are required to pay out money that they have yet to receive.

Under the VAT cash accounting scheme businesses:

• pay VAT on their sales when their customers pay them;

• reclaim VAT on their purchases when they have paid their supplier.

The business issues tax invoices as normal, but only accounts for VAT when, and to the extent, that payment is received. This means the business gets a cash flow advantage, which may be significant, depending on how long customers take to pay their bills. It also has the added bonus of built in bad debt relief!

This advantage is, however, offset by the fact that the business cannot recover input tax until it pays its bills, so the scheme will be most beneficial to a business selling services rather than goods, and which, therefore has relatively low taxable inputs.

Broadly, a business can use cash accounting if:

• it is registered for VAT; and

• its estimated VAT taxable turnover is £1.35 million or less in the next 12 months.

A business which satisfies these conditions can use the scheme without prior approval from HMRC.

See HMRC's Notice 731 for further details.

Source: http://gardnersaccountants.co.uk/news/tax-news/article/921/