Many small businesses are run from home and a proportion of the costs of running and maintaining the home can be deducted in computing the profits of the business.
Broadly speaking, expenses fall into two categories – fixed costs and running costs. Fixed costs are those that have to be incurred regardless of the level of trade. Costs that relate to the house as a whole will generally fall into this category. Running costs (or variable costs) are costs that vary depending on the extent of use, such as electricity.This strategy looks at how relief may be obtained for the fixed cost and at example of typical fixed costs in respect of which relief may be available.
1.1. Nature of Relief
Where a business is run from home and part of the home is set aside solely for business use for a specific period, a proportion of the fixed costs incurred in relation to the home will be allowed as a deduction in computing the business profits. It will generally be necessary to apportion the fixed costs between the business and non-business element. A reasonable basis of apportionment would be one which reflects the proportion of the house used for solely business purposes and the time for which it is so used.
Using an area of the house solely for business purposes can have capital gains tax consequences, as the main residence exemption does not apply to any part of the property used for business use. Where only a small part of the house is used solely for business, in most cases the availability of the annual exemption means this is rarely a problem in practice, as any chargeable gain arising is normally covered by the annual exemption. However, to be on the safe side it is sensible to set aside the room used for the business for sole business use during working hours to preserve the deduction for fixed costs but to make it available to the family in evenings and at weekends to keep it within the main residence exemption.
1.2. Typical Fixed Costs
Costs which may be incurred in relation to a house or other property and which are classified as fixed costs include:
- buildings and contents insurance;
- council tax;
- mortgage interest;
- rent; and
- repairs and maintenance.
Each of these is discussed in more detail below.
Depending on the nature of the policy, insurance can be either a fixed or a variable cost. Buildings insurance will generally cover the whole property, and where a business is operated from home a deduction can be obtained for a proportion of the premium.
As regards contents insurance, if contents are covered as part of a general buildings and contents policy, a proportion of the total premium can be deducted; likewise in relation to a separate contents policy that covers all household contents and does not exclude business items. However, if there is a specific trade policy, the premiums for that will be deductible in full, but there will be no deduction in relation to the domestic policy.
1.4. Council Tax
The extent to which a deduction is permitted in respect of council tax will depend on the circumstances. Council tax is a property-based tax payable on chargeable dwellings. By contrast, business rates are charged on commercial property. Depending on the size and scale of the business and the degree to which the premises are used for business purposes, the council may charge business rates.
However, where a trader merely sets aside a room in his or her home as an office, it is likely that only a council tax charge will apply. Where this is the case, the trader can claim a proportion of the council tax as a deduction in computing the profits of his or her business.
1.5. Mortgage Costs
Where the house is subject to a mortgage, a deduction may be permissible in respect of a portion of the mortgage costs. However, where the mortgage is a repayment mortgage it is necessary to split the payments into the capital repayment element and the interest element. Repayments of capital are not deductible, whereas a deduction is allowed in respect of the interest element and the trader can claim a portion of the interest element of a mortgage as a deduction in computing profits.
Where the trader rents his or her home and runs a business from a home office, a deduction is also available in computing profit if part of the home is used solely for business purposes. The allowable amount is the proportion of the rent payable to the landlord that is attributable to that part of the home used solely for business purposes.
It should be noted that where the business is run as a limited company, the homeowner can charge rent to his or her company in respect of the part of the home used by the company. The rent paid is deductible by the company in computing the profits for corporation tax purposes, and the homeowner is taxed on the rent that he or she receives. By contrast, where the business is operated by a sole trader, the homeowner cannot charge the business rent.
1.7. Repairs and Maintenance
All buildings will need some general maintenance at some point. Where part of the home is used solely for business purposes, a deduction is permitted for a proportion of general household repairs and maintenance to the extent that they apply to the property generally, rather than to a specific room. Examples of repairs and maintenance costs which may be apportioned include roof repairs and painting the exterior of a property. However, where the repairs or maintenance relate solely to a part of the room which is not used for business purposes, no deduction is permitted. By contrast, repairs or maintenance that relate wholly to the part that is used for business purposes are deductible in full.
It should be noted that no relief is available in respect of capital expenditure and a distinction is drawn between a repair (for which a deduction may be allowed) and improvements which are capital in nature and not deductible in computing profits. As a general rule, a repair restores something to its original condition, whereas an improvement significantly enhances it.
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