VAT Cash Accounting Scheme Explained

The VAT Cash Accounting Scheme allows you to account for VAT based on when money actually enters and leaves your bank account, rather than when you issue or receive invoices. This can significantly improve cash flow if you give customers time to pay, but you need to meet certain eligibility criteria to use it.

How the scheme works

Under normal VAT rules, you must pay VAT to HMRC as soon as you issue an invoice to a customer—even if that customer hasn't paid you yet. Similarly, you can reclaim VAT on purchases as soon as you receive a supplier's invoice, regardless of whether you've paid it.

The Cash Accounting Scheme changes this:

• You pay VAT on your sales only when customers actually pay you
• You reclaim VAT on your purchases only when you've paid your supplier

This means the VAT you owe HMRC is based on cash that has actually moved through your business, not on invoices sitting unpaid.

Who can use the scheme

To join the Cash Accounting Scheme, you must meet all of these conditions:

• Your VAT taxable turnover must be £1.35 million or less in the next 12 months
• You must be up to date with all VAT Returns
• You must not owe HMRC any money (or if you do, you must have arranged to pay it)
• You must not have been convicted of a VAT offence in the last year
• You must not have been assessed for a VAT evasion penalty involving dishonest conduct in the last year
• HMRC must not have written to you withdrawing or denying access to the scheme

Your VAT taxable turnover includes everything you sell that's standard-rated, reduced-rated or zero-rated. Don't include exempt supplies or sales of capital assets when working out this figure.

Working out your taxable turnover

You need to estimate your taxable turnover for the next 12 months. If you've been VAT registered for at least a year, you can use your previous year's figures as a guide. If you've been registered for less than 12 months, use the same estimation method you used when completing your VAT registration application.

You can also base your estimate on business plans, pre-registration activity, or information from a previous business owner if these give a more accurate picture.

HMRC won't penalise you if your estimate turns out to be wrong, as long as you had reasonable grounds for making it. Keep a record of how you arrived at your estimate.

The exit threshold

Once you're using the scheme, you can continue until your annual taxable turnover (including disposals of stock and capital assets) reaches £1.6 million. If you exceed this figure, you must leave the scheme at the end of your current VAT period.

You should monitor your turnover regularly so you have time to adjust your records if you need to leave.

There's one exception: if you go over £1.6 million due to a one-off sale (such as selling a capital asset) and you can reasonably expect turnover to drop back below £1.35 million in the next 12 months, you may be allowed to stay on the scheme. Keep detailed records of why you believe this qualifies as a one-off event.

Benefits for your cash flow

The scheme particularly helps if you:

• Give customers extended credit periods
• Experience frequent bad debts

It's less beneficial if you're usually paid immediately when you make sales, or if you regularly reclaim more VAT than you pay.

Transactions excluded from the scheme

You must use normal VAT accounting (not cash accounting) for:

• Invoices where payment isn't due in full within 6 months of the invoice date
• VAT invoices issued before you make the supply or deliver the goods
• Goods bought or sold under lease purchase, hire purchase, conditional sale or credit sale agreements
• Goods imported into Northern Ireland from the EU
• Goods moved out of a customs warehouse or free zone

For these transactions, you must account for VAT under the standard rules even if the rest of your business uses cash accounting.

Using the scheme with other VAT schemes

You can combine the Cash Accounting Scheme with the Annual Accounting Scheme. This allows you to make monthly or quarterly VAT payments based on an estimate, then complete a single VAT Return at the end of the year.

You cannot use the Cash Accounting Scheme with the Flat Rate Scheme. The Flat Rate Scheme has its own cash-based turnover method instead.

How to join

You don't need to tell HMRC that you're using the Cash Accounting Scheme. Simply start using it at the beginning of any VAT accounting period, provided you meet the eligibility conditions.

You cannot apply the scheme retrospectively to previous periods.

How to leave

You can leave the scheme at any time at the end of a VAT accounting period. You must leave if you're no longer eligible.

You don't need to tell HMRC you've stopped using it, but you must account for all outstanding VAT—whether or not your customers have paid you. You can spread this payment over 6 months in most cases.

However, you must report and pay immediately if your VAT taxable turnover exceeded £1.35 million in the last 3 months, or if HMRC has written to you withdrawing your use of the scheme.

Sources

• VAT Cash Accounting Scheme
• Cash Accounting Scheme (VAT Notice 731)

This article provides general guidance based on current HMRC rules. For advice specific to your situation, speak to your accountant.