MTD Cash Accounting: When You Can Use It (2026 Guide)

Cash accounting under Making Tax Digital is one of the most important yet misunderstood topics for UK sole traders, landlords, and small VAT-registered businesses. The rules changed significantly in April 2024, and they are set to become even more important as MTD ITSA rolls out from April 2026. This guide explains everything: what cash accounting actually means, when you can use it under MTD, whether it will benefit you, and the practical differences between cash basis for Income Tax and the separate Cash Accounting Scheme for VAT.

There are two different cash accounting schemes in UK tax that both interact with MTD. They are often confused but they work differently:

•       Cash basis for Income Tax (affects sole traders and landlords, default from April 2024)
•       Cash Accounting Scheme for VAT (optional scheme for VAT-registered businesses under £1.35 million turnover)

This guide is written by ICAEW chartered accountants who help UK small businesses choose between cash and accruals accounting every day.

What Is Cash Accounting? (Simple Explanation)

Cash accounting means you record income when you actually receive the money, and record expenses when you actually pay them. It is the simplest way to keep accounts because it follows your bank statement.

Cash Basis Example

A plumber does a job in March for £2,000. The customer pays in May. Under cash basis, the £2,000 income is recorded in May (when received), not March (when invoiced). If the plumber bought materials in February for £400 but paid the supplier in April, the £400 expense goes in April, not February.

Accruals Basis (The Alternative)

Accruals basis means you record income when it is earned (invoice date) and expenses when they are incurred (bill date), regardless of when money actually changes hands. The plumber’s £2,000 would be recorded in March. The £400 materials would be recorded in February.

The critical difference: Cash basis follows your bank account. Accruals basis follows your invoices and bills. Both are valid accounting methods. The choice affects when income and expenses hit your tax calculation, which affects timing of tax payments.

The Two Cash Accounting Schemes Under MTD

Understanding the distinction between the two schemes is essential:

A VAT-registered sole trader can use both simultaneously, using cash basis for Income Tax reporting and the Cash Accounting Scheme for VAT reporting. These decisions are independent.

Cash Basis for Income Tax (MTD ITSA)

Since 6 April 2024, cash basis has been the default method for sole traders and most landlords. This was a major change. Before April 2024, cash basis was optional and required a turnover under £150,000. Now it is the automatic starting point, with no turnover limit.

Who Can Use Cash Basis for Income Tax?

•       Sole traders (any turnover, from April 2024)
•       Individual landlords with property income under £150,000 per year
•       Certain partnerships with all individual partners

Who Cannot Use Cash Basis for Income Tax?

•       Limited companies (Ltd companies must use accruals)
•       Limited Liability Partnerships (LLPs)
•       Individual landlords with property income over £150,000
•       Partnerships with corporate partners
•       Anyone claiming certain reliefs incompatible with cash basis (share loss relief, patent income deduction)

Cash Basis Under MTD ITSA (From April 2026)

When MTD ITSA launches, cash basis will remain the default. Your quarterly submissions to HMRC will show income received and expenses paid during each quarter. This actually makes MTD easier than accruals accounting because you do not need to track invoice dates versus payment dates separately.

MTD ITSA simplification: Cash basis dramatically simplifies MTD ITSA quarterly submissions. You essentially report your bank transactions categorised by type. Accruals basis requires tracking multiple dates per transaction (invoice date, payment date, work-done date), making quarterly submissions more complex.

When Cash Basis Helps (Practical Scenarios)

1. Slow-Paying Customers

If you frequently invoice customers who take 60, 90, or more days to pay, cash basis defers your tax bill until you actually get paid. Under accruals, you would owe tax on invoices you have not yet been paid for, which can create cash flow problems.

2. Simple Businesses

Freelancers, tradespeople, small service businesses, and small landlords with straightforward income and expenses benefit from cash basis simplicity. Less work to keep records, easier quarterly MTD submissions, fewer chances for error.

3. Growing Businesses With Improving Cash Collection

If your business is growing but your credit terms are also improving (customers paying faster), cash basis creates a temporary tax benefit as unpaid invoices at year-end do not yet appear in your income.

4. Landlords With Rental Void Periods

Landlords benefit from cash basis when tenants pay late or void periods occur. Rent received (not rent due) forms the taxable income, matching real cash flow.

When Cash Basis Hurts (When to Use Accruals Instead)

1. Loss Restrictions

Cash basis losses can only be carried forward against future profits of the same business. Under accruals, you have more flexibility to offset losses against other income. If you expect regular losses (early-stage business, property refurbishment year), accruals may be better.

2. Large Fixed Assets

Cash basis treats capital expenditure differently. You claim the actual amount you paid in the year you paid it (rather than depreciating). For businesses with expensive vehicles, machinery, or property purchases, timing of tax deduction can be very different under cash vs accruals.

3. Businesses With Substantial Debt

Interest paid on business borrowing is fully deductible under both methods, but the timing differs. Businesses with significant loan interest, hire purchase, or lease payments may find accruals more predictable.

4. Complex Businesses

Manufacturers with work-in-progress, businesses holding stock, professional practices billing in stages, and any business where accounts are prepared for reasons beyond just tax may benefit from accruals consistency.

Warning about switching: You can move between cash basis and accruals but the transition creates timing adjustments that affect your tax bill in the switching year. Get chartered accountant advice before switching methods. Random or repeated switching triggers HMRC attention.

VAT Cash Accounting Scheme (Separate from Income Tax)

The VAT Cash Accounting Scheme is completely different from cash basis for Income Tax. It applies only to VAT-registered businesses and only affects VAT calculations, not Income Tax.

How VAT Cash Accounting Works

•       You account for VAT on sales when your customer pays you (not when you invoice)
•       You reclaim VAT on purchases when you pay your supplier (not when they invoice you)
•       Bad debts are automatically dealt with (unpaid invoices carry no VAT liability)

Eligibility for VAT Cash Accounting Scheme

•       VAT-registered business with turnover under £1.35 million (entry threshold)
•       Must leave the scheme if turnover exceeds £1.6 million (exit threshold)
•       Must be up to date with VAT returns and payments

When VAT Cash Accounting Helps

•       Invoice customers who take time to pay
•       Regularly have bad debts (customers who never pay)
•       Have cash flow constraints
•       Sell primarily to other businesses (B2B)

When VAT Cash Accounting Does Not Help

•       Get paid immediately (retail, hospitality, taxi drivers)
•       Buy supplies on long credit terms but sell for cash
•       Regularly reclaim more VAT than charged (would prefer earlier reclaim)
•       Approach the £1.35 million turnover threshold

Cash vs Accruals: Side-by-Side Comparison

Case Study: How Cash Basis Saved a Plumbing Business £4,200 in Cash Flow

An independent plumber based in the Nottingham area came to us in late 2025 struggling with cash flow. Turnover of approximately £95,000, with a mix of domestic emergency work (paid immediately) and larger commercial contracts (paid on 60-day terms). His previous accountant had put him on accruals basis in 2023 as part of a routine setup. He was paying tax on invoices he had not yet been paid for, and it was hurting.

His situation:

•       50% of work from small commercial contracts on 60 to 90-day payment terms
•       At year-end 2024/25, £12,400 in unpaid invoices sitting on his books
•       Under accruals, he owed £2,480 Income Tax on that £12,400 he had not received
•       Plus payments on account meant he was paying tax months before receiving the underlying income
•       Approaching MTD ITSA in April 2026 with no idea whether cash or accruals would suit

What we did:

1.     Reviewed his business pattern and identified cash basis as clearly beneficial
2.     Elected to switch to cash basis for 2025/26 tax year
3.     Prepared the transition adjustments (moving £12,400 unpaid at start of year off the books)
4.     Migrated bookkeeping to FreeAgent (free with his NatWest business account)
5.     Set up MTD-ready workflow with proper cash basis reporting
6.     Prepared him for MTD ITSA in April 2026 with cash basis as the default

Outcome: Cash flow improved by approximately £4,200 in the first year through deferral of tax on unpaid invoices. Ongoing benefit of tax always following actual cash received. Simpler quarterly MTD submissions from April 2026 because cash basis matches how his bank account works. Fee: £75 per month all-inclusive, easily justified by cash flow improvement alone.

How to Choose: Cash Basis or Accruals for Your Business

Choose Cash Basis If…

•       Your business is simple (freelancer, tradesperson, service provider)
•       You often get paid late by customers
•       You want the simplest possible bookkeeping
•       You do not hold significant stock or work-in-progress
•       You do not expect to make regular losses to offset elsewhere
•       Your business is a sole trader (Ltd companies cannot use cash basis)

Choose Accruals Basis If…

•       Your business is complex (manufacturer, professional practice, stock-based)
•       You want accounts to properly reflect what your business owns and owes
•       You expect losses in early years to offset against other income
•       You have significant fixed assets with different depreciation lives
•       You need audited accounts (Ltd companies over certain size thresholds)
•       Your landlord property income exceeds £150,000 (accruals is mandatory)

Switching Between Cash and Accruals

Switching from Accruals to Cash Basis

7.     At switch date, list all outstanding customer invoices (accounts receivable)
8.     List all outstanding supplier invoices (accounts payable)
9.     Prepare transitional adjustment: income already taxed under accruals is NOT taxed again when received under cash basis
10. Prepare parallel adjustment: expenses already deducted are NOT deducted again when paid
11. Update your MTD software to reflect cash basis method

Switching from Cash Basis to Accruals

12. At switch date, list all outstanding customer invoices
13. These become taxable income in the switching year (bunching effect)
14. Outstanding supplier invoices become deductible in the switching year
15. Any capital allowances position needs recalculating
16. Chartered accountant support strongly recommended for this switch

Switch year tax bunching: Moving from cash to accruals often creates a one-off tax bill increase in the switching year because unpaid invoices become taxable. This is why the switch should be planned deliberately rather than done casually.

MTD Cash Accounting: FAQs

Is cash basis the default for sole traders under MTD?

Yes, from 6 April 2024 cash basis became the default method for sole traders. This continues under MTD ITSA from April 2026. You can opt out of cash basis and use accruals if it suits your business better, but you must actively choose to do so.

What is the turnover limit for cash basis under MTD?

For sole traders, there is NO turnover limit for cash basis Income Tax (this changed in April 2024). For landlords, the limit is £150,000 property income per year. For the VAT Cash Accounting Scheme, the turnover limit is £1.35 million entry and £1.6 million exit.

Can limited companies use cash basis under MTD?

No. Cash basis for Income Tax is not available to Ltd companies. Ltd companies must use accruals accounting and will follow MTD Corporation Tax rules (planned from April 2027). However, small Ltd companies can still use the VAT Cash Accounting Scheme if VAT-registered.

What is the difference between cash basis and Cash Accounting Scheme?

Cash basis affects Income Tax reporting for sole traders and landlords. Cash Accounting Scheme affects VAT reporting for VAT-registered businesses. They are completely separate schemes. A VAT-registered sole trader can use both simultaneously.

Do I need to elect for cash basis under MTD ITSA?

No, cash basis is the default from April 2024 and remains the default under MTD ITSA. You do NOT need to elect for it. However, you DO need to elect to opt OUT of cash basis if you prefer accruals accounting.

What are the disadvantages of cash basis under MTD?

Losses can only be carried forward against future profits of the same business (less flexibility). Certain reliefs are not available (share loss relief, patent income deduction). Capital allowances work differently (actual payment, not depreciation).

Can I use cash basis if my turnover is over £1 million?

Yes, since April 2024. There is no upper turnover limit for cash basis Income Tax for sole traders. The old £300,000 exit threshold was removed. However, at higher turnovers accruals often works better for other reasons.

Does cash basis simplify MTD quarterly submissions?

Yes significantly. Cash basis quarterly submissions essentially report your bank transactions categorised by type. Accruals basis requires tracking invoice dates versus payment dates separately, which is more complex.

What is bad debt relief under cash accounting?

Under cash basis and the VAT Cash Accounting Scheme, bad debts are automatically handled. Because income is only counted when received, unpaid invoices generate no income and therefore no tax. Under accruals, you must wait 6 months.

Can landlords use cash basis under MTD ITSA?

Yes, landlords with property income under £150,000 per year can use cash basis and it is the default for most. Landlords over £150,000 must use accruals. Cash basis simplifies MTD ITSA quarterly submissions for landlords significantly.

Do I need different MTD software for cash basis?

No. All MTD-compatible software (FreeAgent, Xero, QuickBooks, Sage) supports both cash basis and accruals. You choose your accounting method in the software settings.

What happens if I switch from cash basis to accruals under MTD?

Transitional adjustments apply. Unpaid customer invoices at switch date become taxable in the switching year, potentially creating a tax bunching effect. Get chartered accountant advice before switching.

Is cash basis better for MTD ITSA overall?

For most simple sole trader businesses and small landlords, yes. Cash basis is simpler, matches real cash flow, defers tax on unpaid invoices. For complex businesses or those expecting regular losses, accruals may be better.

Can I use VAT Cash Accounting AND cash basis for Income Tax?

Yes. These are independent choices. You can use both simultaneously. Many small VAT-registered sole traders use both, gaining maximum cash flow benefit.

Does cash basis affect my payments on account?

Yes, indirectly. Payments on account are based on your previous year’s Income Tax bill. Cash basis timing effects can smooth income across years, which affects payments on account.

Get Cash vs Accruals Right – Free ICAEW Consultation

Choosing between cash basis and accruals is one of the most important accounting decisions your business will make, and MTD makes it even more important because it affects your quarterly submissions from April 2026.

At MTD – Making Tax Digital (part of B1 Accountants), our ICAEW chartered accountants advise UK sole traders and small businesses on cash vs accruals every day. We can:

•       Assess whether cash basis or accruals will suit your specific business
•       Model both scenarios showing tax impact and cash flow
•       Set up your MTD software correctly for your chosen method
•       Advise on VAT Cash Accounting Scheme if you are VAT-registered
•       Handle transitions between methods with proper adjustments
•       Handle ongoing MTD compliance at fixed monthly fees from £40