If you are a trader (whether a sole trader, a member of a partnership, or a limited company), then of course you can deduct the business expenses you incur in the course of your trade, but what about expenses you incur before you start trading?
This article looks at how relief can be claimed for “pre-trading expenditure”.
When does a trade start?
This question is not as stupid as it sounds – I recently advised on a case where the date on which a trade had started made a difference of a whole year to the date on which the first payment of income tax on the profits would be due. If the trade had started before 6 April 2005, the first income tax would have been due on 31 January 2006, but as it had in fact started after that date, no income tax was payable until 31 January 2007.
In many cases, the answer will be obvious – if I decide to open a new pub, my trading starts on the day I open the doors to let in the first customer. As a general rule, for a trade which involves providing goods or services, the trade can only begin when:
- You are in a position to provide the goods or services concerned – so, for example, once you have bought your first batch of trading stock or raw materials, AND
- You either start to provide those goods or services, or at least offer to do so – so if no-one came into my pub on the day I opened it, I would still have started trading on that day.
If that is when a trade starts, then it is clear that in most cases you will have incurred expenditure before that date. If we stick with my brand new pub, before I opened the doors on that first day, I would probably have spent money on:
- Buying the building itself, and the “plant and machinery” such as fridges, beer engines, cookers, and so on.
- Buying the stock – the food and drink I intend to sell
- Hiring staff – I might, for example, have the serving staff come in a day or so in advance of the opening day for training
- If the pub is a rented one, paying rent for it in advance
- Getting my licence, insurance, and so on.
- Advertising the new pub
- Paying interest on any loans used to buy the pub or other things for the business
I might also start using something I had previously had for private purposes, such as a car or a computer, at least partly for the purposes of my new business.
We can break this “pre-trading expenditure down into several categories:
Expenditure not allowable
In the case of my pub, the cost of first getting my licence is not an allowable expense - it is “capital expenditure”, because it provides me with an “enduring benefit”. The cost of renewing it in the future, however, would be allowable. Note that if my pub were run by a limited company, the rules here are slightly different, but that is another subject.
Expenditure allowable on general principles
The cost of my trading stock will be an allowable expense, because basic accountancy practice says it is brought in at the lower of its cost or its market value – it does not matter that I bought it before I started trading. In the same way, the rent and the insurance premiums paid in advance are allowable to the extent that they relate to the period after I started trading, because accountancy practice says they should be spread over the period they relate to.
Expenditure that would have been allowable if I had already started trading
This is the “pre trading expenditure” I referred to at the start of this article. As far as the pub is concerned, it includes the staff wages for the period before the pub opened, and the rent, interest, and insurance costs for that same period. It also includes the advertising costs incurred before the opening day, and any travelling expenses – such as to buy stock from the cash and carry.
All this expenditure should be treated for tax purposes as if it was incurred on the day I started trading. This only applies if the expenditure was incurred in the seven years before the trade started – though I doubt if that restriction will cause many problems!
Capital Expenditure qualifying for capital allowances
The treatment here differs, depending on why I originally acquired the assets concerned:
- For assets (such as the plant and machinery used in the pub) acquired specifically for the purposes of the new trade, the expenditure is treated as if it was incurred on the first day of trading.
- For assets originally acquired for private purposes (such as my car and my computer) which are now going to be used for the trade, then I can treat them as if I bought them on the first day of trading, but I use their market value on that day, not their cost when I actually bought them (unless, exceptionally, their market value on the first day of trading is greater than their cost, in which case it is the cost I bring in).
Note that where assets (such as the car) are used for private as well as business purposes, the capital allowances claimed will be restricted to take account of that private use.
These can be tricky, because if, for example, repairs to the premises are needed before trading can start, HMRC may argue that they are capital expenditure – because they are part of the cost of getting established in business.
Repairs are a favourite topic in the Chartered Institute of Taxation professional exams, so this an area for specialist advice, but as a general principle, providing these three tests are passed, repairs done before the trade starts should be allowable as pre trading expenditure:
- The repairs are in the nature of regular maintenance rather than improvements to the premises, AND
- The repairs were not essential in order to make the premises fit for use in the trade, AND