Tips to benefit from – and traps to avoid.

Working from home may be many people’s dream come true. Whether it’s the employee of a forward thinking company in need of work flexibility, or a small business looking for a cash-flow head start through the reduction of overheads, working from home is likely to appeal to most.

There are many non-tax pros and cons when considering working from home but if you have made the decision what allowances and reliefs can you claim?

This article provides a quick reminder of the detailed provisions applying to the deductibility of such expenses, and highlights some of the pitfalls taxpayers encountered in the past, as demonstrated by some tax cases. This article does not deal with travel expenses.

With regards to expenses associated with working from home, the ‘wholly, necessarily and exclusively’ mantra so pivotal in taxation applies uniformly to a self-employed, a director, or an employee, as it is included both in the legislation applicable to the self-employed and that applying to employees. In practice, however, various costs incurred may in fact serve both a business and a private purpose. Should these costs be approportioned or excluded altogether? Are those costs treated in the same way by a sole trader, an employee and a director?

In this issue, we are dealing with the position of the sole-trader

The legislation underpinning the deductibility of expenses associated with working from home for the self-employed is s34 of the Income Tax Trading and Other Income Act 2005 legislation, which can be summarised as follows:

  1. Expenses incurred wholly, necessarily and exclusively for the purposes of the business can be claimed in full.
  2. Expenses incurred solely for private purposes or for purposes incidental to business (so mostly private) cannot be claimed at all.
  3. Expenses incurred for a dual purpose (both business and private) can only be claimed if it is possible to identify a specific part used for business. If it is impossible to identify and measure the proportion of the cost incurred which relates only to business, no amounts can be claimed.

For example, the cost of smart business attire cannot be claimed against tax, as it is impossible to separate the business use from the private use of clothing. Whilst smart office clothes serve a business purpose, their private purpose (clothes are seen to be used for warmth and decency) is primary, ever-present, constant and simultaneous to the business purpose. It is not possible to separate the two, so condition 3 above is not met.

On the other hand, costs of computer repairs carried out on equipment used for eight hours a day by a sole trader to build websites for clients, and two hours in the evening to watch movies in private time, can be time-approportioned and the business part deducted for tax purposes, as condition 3 is satisfied.

The following are examples of costs usually expected to be approportioned, before being deducted for tax purposes:

  • rent if home is rented, or mortgage interest if owned
  • council tax
  • water rates, only if metered
  • light and heat
  • telephone line rental, internet, and cost of calls
  • home insurance
  • house repairs
  • business equipment repairs
  • cleaning
  • revenue expenditure in connection with converting part of home into office
  • capital allowances for tools in connection with the above
  • capital allowances for business equipment and business fixtures and fittings.

It should be pointed out that approportioning a private expense in a sole trader’s tax accounts does not mean that the business incurs a liability that will be discharged by refunding cash. There is no separation between the sole trade and the individual running the trade, in the same way the director as an individual and his company are separate. A sole trader therefore can deduct rent in proportion to his home used as business premises, but cannot charge and refund himself rent.

There are various methods to approportion expenses, all valid as long they can be justified and based on evidence. Rent or mortgage interest, council tax, light and heat, home insurance, repairs to common parts of the building and cleaning can be approportioned based on the number of rooms or floor space used for business.

Costs should be further restricted if there is a significant, not incidental, element of private use. In instances where a fixed charge is incurred irrespective of consumption, for example in case of unmetered water rates, no claim is possible.

An element of judgement is involved when calculating business part, and this may vary depending on which cost is approportioned. For example:

Every day, Tina’s lounge is used for 10 hours for business purposes and 3 hours for private purposes. For 11 hours the room is unoccupied. The lounge represents 20% of the size of the property. The total annual cost of light is £1,100. Total annual mortgage interest is £900.

  • As the room is not lit or heated for 11 hours when it is unoccupied , there is a case for deducting 10/13 of the 20% of total light and heat costs to business, therefore £1.1k x 20% x 10/13 = £169
  • As mortgage interest is payable whether the room is occupied or not, there is a case for charging only 10/24 of mortgage interest to business attributable to the 20%, so £900 x 20% x 10/24 = £75

Approportioned amounts should:

  1. Be reasonable and not excessive
  2. Reflect the characteristics of real expenses – you should be able to demonstrate that you have actually spent the money in the period when the amounts are deducted. For example, if you deduct repairs and renewals, there needs to be evidence of the money actually spent by you.  In addition, in relation to relevant expenses, HMRC may expect to see year or year fluctuations, as use of home may differ year on year depending on business activity
  3. Paid by the self-employed and not someone else, for example a relative.

HMRC includes examples of work from home expense approportionment at BIM47825  and also question 7 in the Private and Personal Expenditure Toolkit .

Complications in real life

What is reasonable and not excessive

 In Gazelle v Servini [ 1995 ] STC 324, an accountant working from home who charged 50% of rent to business had this allocation reduced to 20% as proposed by HMRC.

He used his house to work frequently, sometimes during the day (to avoid office interruption), as well as during evenings and weekends. The house consisted of:

  • Kitchen
  • Living room 1 – used for client meetings, meeting prospective clients (30-40 clients a year), and mostly evening work
  • Living room 2 – no business use
  • Bedroom 1 – 1/7 of total house space, used exclusively as library
  • Bedroom 2 (small) – storage of practice files
  • Bedroom 3 – no business use
  • Garage – no business use.

The judge ruled in favour of HMRC on the basis that the use of the house for business was limited: the accountant received a client on average less than once a week, the bedrooms used for business were relatively small, and there was a lack of evidence from the taxpayer to support a higher than 20% proportion of claim suggested by HMRC: ‘It was for G to show what percentage of the expense of maintaining, heating and lighting his home was deductible. On the very limited evidence adduced the figure of 50% was too high. The Revenue’s figure of 20% was not unreasonable.’

The case shows how important it is to be able to present records evidencing the level of activity carried out from home. It is up to the taxpayer to demonstrate how he arrived at the amounts. Workings should be kept on file. If there is no record of how amounts are approportioned, HMRC may propose an allocation much harsher than would be expected. Information such as numbers of clients visiting premises, diaries documenting time spent working, meter readings and itemised telephone bills may be required to support approportionment. Maintaining this information is time consuming but may mean a difference between a 50% and a 20% cost approportionment and tax liability.

What if the home is owned jointly?

Some complications may arise when assets used by a sole trader are owned jointly by the sole trader and someone else.

For example mortgage interest proportion in relation to home office in a house owned jointly by a married couple needs to be restricted to amounts in relation to the other co-owner’s part being used by the sole trader (as the sole trader cannot charge himself for part of an asset he owns himself).

What if bills are in joint names?

There is uncertainty in how costs billed to another person living in the household, such as a husband, may be treated for business tax purposes. A factual analysis may be necessary to persuade HMRC in this case. In real life expenses can be paid by either spouse or both in equal or varying proportions. If the self-employed wife pays 70% towards a bill issued in their joint names and her husband 30% some adjustments may be required if amounts are material, but it has also been reported that HMRC may ignore the unequal split in settling the expense when assessing a relevant business proportion, and revert to the more basic fact finding – ie whether the expense was incurred in the first place and paid (in any proportion) by the self-employed.

Let’s simplify it

If the business is rarely run from home, it may be more convenient to claim a fixed rate deduction, instead of actual costs. The amounts that can be tax deducted are very modest, but it does allow them to escape the burden of keeping detailed records and receipts.

The rate applicable is based on the calculation of the number of hours that you work at your home/homes ‘wholly and exclusively’ for the purposes of the trade:

25-40 hours – £10 per month
51-100 hours – £18 per month
101 hours or more – £26.

Someone working 23.3 hours a week or more will be able to claim £312 per year towards use of home as office. If this amount does not fairly represent the value your business benefits from by operating from your home, taking into account the actual expenditure and maintaining sufficient records will be necessary. This is particularly worth the time involved if the sole trader works at home on a regular and frequent basis, rather than simply carrying out ad hoc administrative tasks. If you have dedicated office space in a room, even if sharing it with private household users or a separate office in an adapted room where private use is incidental, the tax saving made by deducting a clearly defined and reasonable proportion of home costs can make a noticeable difference to your bottom line over time.

Article from ACCA In Practice