If you sometimes work at home in relation to your business, you may be able to reduce the tax you have to pay on your business profits, by taking some household expenses into account. Read on to avoid missing out.

Taxable Profits

If you are a soletrader, then you pay income tax on your taxable profits i.e. your business income less allowable costs incurred to generate this income. We use the term “allowable” here, because this does not include all the costs that you might reasonably expect. Our article on “Tax Deductions” considers some costs which are not included, but here we look some good news. There are other costs which you might not think of as being linked to your business, but a proportion of which you may be able to deduct in this way, to calculate taxable profits.

Note that the issues here are only appropriate for soletraders i.e. individuals who do not run their business through a company.

Allowable costs

It is important to realise that, usually, as soletrader, none of the money which you “take” from the business and use to pay your living costs such as rent, mortgage, food and utility bills etc are deductible cost, when calculating taxable profits.

In fact, a one-man or woman consultancy business may have few costs associated with it to deduct. Stationery costs may be an example. You may even be able to agree with your clients that they will reimburse costs such as your travel etc. If that is the case, then these are not deductible again.

However, it is common for soletraders working from home to claim costs under a “home as office” category. These often include some element of your home’s heating, lighting, insurance, council tax, telephone and broadband bills. If you rent your property, a proportion of the rental costs may be deductible, or if you are a home-owner, a proportion of your mortgage interest costs. Watch out though - the capital payments in respect of your mortgage are repayments of the loan itself, and as such are never allowable costs for these purposes.

We are specifically concerned here with household costs, not costs of buying equipment, using your car etc, which are matters for another day.

Only the element of these costs which relates to business usage is deductible in computing taxable profits, but how can you work out this element?

Apportioning expenses

You will receive a single bill, or pay a single amount, for each of these expenses i.e. not divided depending on how you “use” what you have purchased.

As is often the case in tax, there are no hard and fast rules dictating how such bills should be split (or “apportioned”) between normal domestic use and “business” use, and so how much to claim as a deduction for the latter.

However, HM Revenue & Customs has given some guidance on the subject, and we derive the following key points from this.

• The correct apportionment depends on the underlying facts. Ok, so not a massively helpful point but does emphasise that all cases must be separately considered.
• More than one method of apportionment may be appropriate in a single case, but if different methods give very different results then this demonstrates that one is probably not suitable. The guidance uses the example of apportionment by area, and the use of either floor area or number of rooms.
• The HMRC inspectors are directed to accept a reasonable estimate if there is “only minor business use of the home”, and the estimate is consistent with the underlying facts.
• While there are no set rules for certain business sectors, if the same type of businesses are conducted in the same way, then similar deductions might be expected.
• Three factors to take into account when apportioning an expenses are: area, usage (i.e. for expenses that can be measured in units such as electricity) and time.

If this is all still as clear as mud, HMRC give some examples, and we discuss some interesting points from these in the second of our articles. We also recommend you visit the HMRC website at www.hmrc.gov.uk - typing “BIM47825″ into the search field will take you to the examples.

Warnings

If it sounds too good to be true, well, there are some notes of caution.

You must be able to support these deductions. As with any way which reduces the tax you pay, by making a claim for such costs you do hold yourself out for a possible enquiry (and will have to pay extra tax, interest and possibly even penalties if eventually this is settled against you), but as a self-employed person you are arguably of more interest to HMRC anyway, and if you have been reasonable in your logic to make these deductions, and have evidence to support this, then you have nothing to hide. You should discuss with your accountant what disclosure you should make in respect of these expenses on your tax return.

More widely though, if you claim to use part of your home for your work, and claim associated costs as explained above, then this does expose you to some negative consequences. Arguably these consequences exist in any case, but are highlighted by the claim. These may be legal (for example, a rental lease may prohibit you from such a use, or your house insurance may not be valid) but these are beyond our remit here. However, we highlight two tax-related consequences here: business rates and capital gains tax.

Business rates

If you do work from home, then there may be a risk that the part of the property used for business purposes will suffer business rates rather than Council Tax(with Council Tax being applicable to the rest of the property), which may lead to a higher tax bill.

Factors determining whether your particular arrangements make you liable for business rates include the frequency and extent that an area of the house is used for the business, whether any modification have been made to the property to enable this, and what alternative domestic use that area also has, if any.

The Valuation Office Agency has a factsheet “Council tax and business rates: working at and from home” with some examples which may help you assess this.

Capital Gains Tax

You potentially pay capital gains tax whenever you sell something that is not stock of your trade. So when you sell your home, the reason why capital gains tax is not usually paid, is because of a specific relief available because your house was your “principle private residence” (PPR), in simplistic terms, where you live. Therefore, watch out if you start claiming that you run your business out of part of your house, because when you come to sell that property, part of your PPR may be denied.

As with all our information in The Business Lounge, this is not comprehensive tax advice, and may not apply to your specific circumstances; to discuss how these issues affect you, contact your accountant.