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Working from home: Deductions for employees - part 3. By Nichola Ross Martin

16th Jun 2008
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Zero penaltiesIn parts 1 and 2 of this series for employees, I reviewed the basics of s.316A and s.336 ITEPA which give tax relief in different ways for employees' homeworking expenses. In this article I am going to look at particular problems which might affect micro or one-man companies, and briefly consider IR35 and homeworking.

To re-cap, the type of expenses an employee/director might normally claim for an office at home are limited to:

  • Extra metered costs of light and heat
  • Business rates - if charged, not council tax
  • Internet access - providing the employee/director has not already put it in place
  • Insurance - if additional insurance is taken out to cover the home office and it is separable from the main premium
  • Telephone calls (not line rental), the employer may though pay for the installation and costs of a line for business purposes
  • Cleaning - if extra cleaning is required
  • Extra cost if water is metered

There is no deduction for mortgage interest or rent, following established case law. However, where additional borrowing is incurred to finance the creation of a workplace at home, the interest should be allowable, if the the workplace passes HMRC's substantive and objective tests. This would mean that subsequent disposal of the home plus workplace, there would be no principal private residence relief.

The same principles would also apply to rent, so if it was a requirement for you to be based at home, i.e. you are a sales rep and your patch is Scotland, but your employer is based in London, for instance, then it might be possible to claim the extra costs of renting. You would have to prove that extra rental was incurred, which might be problematical if you are already leasing a property.

Excessive expense claims

Where a director makes an excessive expense claim or an employer pays a round sum expense allowance which is not backed up by valid vouchers or receipts, the excess will be taxed as employment income (s 62 ITEPA 2003). When a payment becomes earnings, HMRC will be allow it in the company’s accounts because it has changed into remuneration. It will not be taxed twice.

Charging your company rent

As an owner-manager director, you have to act in the best interests of your company according to the Companies Act. You can save it rent and associated costs by basing the business at home/converting the garage or an outbuilding and basing operations there. It is only fair that you should be able to charge it rent. If you provide a serviced office (which is what most homeworkers tend to do), the rent should include services too.

Put together a rental agreement to give the business a non-exclusive license to occupy the designated home office. A non-exclusive agreement would allow the company to occupy the premises at limited times, or for a short period of time. This could be normal office hours, or longer. Most homeworkers have a tendency to work long and anti-social hours, so you need ensure that the agreement at least caters for the hours spent at work. You might like to check that your mortgage lender is happy with the arrangement. Also bear in mind that if you are operating a business on you premises you could well be assessed for business rates in the future.

Setting the rent

Rent has to be set at an arms’ length basis. Working out a basic rent to charge your company is not difficult. Look around you and see what is charged locally, local estate agents will give you an idea of rent per square meter, take an average of their findings, or failing that ask a surveyor to review your home office and give you a figure. Working out the cost of services provided at arms length is slightly more difficult. You can base it on local service charges or bill your company monthly or quarterly and charge a fixed % of your bills.

Rent and services for a licence agreement may also be calculated as if you were a sole trader. See: Sole traders and homeworking.

For example:

Bob has converted his garage into an office, plumbed in heating, insulated, wired and decorated and he now bases his business there. In his area the average costs of an office of around 16 square meters is £50 per week, and the average cost of a serviced office is £150 per week. He could charge his company £200 per week, or he might look at the actual costs.

If Bob were a sole trader he would make a homeworking claim based on all the running costs of his house, including mortgage interest. He apportions these (as for a sole trader) and lets say he does this by square meter and then he time apportions according to the hours available under the licence agreement. His figures come out at £300 per week, which seems at bit high compared to what is charged locally for serviced units. Under an obligation to act in the best way for the company he decides that this is reasonable – there would be extra parking costs and business rates if the office were elsewhere.

What rent charge is reasonable?

It is a question of looking at the facts of each case. Bob’s tax inspector might not like his argument for charging £300 per month, instead of £200. He might point out that Bob's company has only a non-exclusive licence to occupy the workshop. It is up to Bob to retain his workings to prove his calculations. Bob might want to revise his workings on an annual basis.

Trouble for consultancy companies: Home to work and travel rules

In part 1, I went over HMRC’s substantive and objective tests which are used to determine whether or not home is the permanent workplace. If home is not found to be a workplace then travel is not workplace to workplace, and so not in performance of duties of employment. If this is the case, you then approach the problem from the other side and consider whether the journey from home to work is ordinary commuting. The 24 month rule might deem the journey a temporary workplace. I recommend that you look at the travel rules for company directors, and look carefully at the examples give by HMRC in booklet 490.

HMRC's substantive and objective tests is can raise some problems for one man consultancy companies who are trying to maximise home office expense claims. Where a director is working nine to five at the main client’s premises it seems that homeworking claims may well be pretty insignificant as the director’s duties performed in his home office are limited to evening bookkeeping and administration. It seems to me that charging a company rent in these circumstances might well be over the top (not withstanding that each case is decided on its merits). For an easy life (i.e. unlikely to be challenged and no bookkeeping involved) I would advocate that owner-directors in that situation claim £3 per week from their companies, this is the HMRC approved scale rate for s 316A homeworking instead. For a fuller look at other methods of making a homeworking calculation go back to part 1 of this employee series.

Home working costs and IR35

I have not yet heard of a decided IR35 case where the employment was based at the worker’s own home, but that doesn't mean that it would be impossible. The fact that most workers under IR35 are based at the client’s premises practically rules out all claims for homeworking expenses in the deemed payment calculation. I have seen an IR35 near miss where an IT contractor operated an emergency helpline from home despite being mainly based at his client premises. In that case, I would suggest that a claim for homeworking costs or £3 per week under s316A might fall to be an allowable deduction for the deemed payment. It does all depends on the facts of the case. If the end client would normally allow homeworking which it may well do for the rest of its workforce, then it seems that a payment under s 316A would be a valid deduction in the deemed payment calculation. Otherwise, all homeworking costs are treated as covered by the 5% deduction in the calculation.

AccountingWEB.co.uk Tax Events

Working from home
Ever wondered what expenses you can claim if you work from home? Or how it affects your business rates, capital gains tax, tax relief, and VAT? Nichola Ross Martin, FCA, will guide you through the cryptic and bizarre rules that directly affect your financial well-being.

24 June - Novotel, Plymouth
26 June - ThinkTank, Birmingham

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Replies (9)

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By Anonymous
02nd Nov 2008 11:33

Mortgage interest & council tax in licence agreement?
Hi Nichola
Where you say "Rent and services for a licence agreement may also be calculated as if you were a sole trader", does this mean that an owner/director can charge a percentage of mortgage interest and council tax in the rental agreement where there is home office?
I came to your "Working from home" seminar but cannot find my notes anywhere, but think that this is what you said. Please can you confirm or refute this.
Thanks

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By Anonymous
02nd Nov 2008 11:31

Mortgage interest & council tax in licence agreement?
Hi Nichola
Where you say "Rent and services for a licence agreement may also be calculated as if you were a sole trader", does this mean that an owner/director can charge a percentage of mortgage interest and council tax in the rental agreement where there is home office?
I came to your "Working from home" seminar but cannot find my notes anywhere, but think that this is what you said.

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By Anonymous
17th Jun 2008 19:42

Hi Michael
Well, no, as it happens. One declares the rent received less allowable expenses (i.e. all those you worked out when setting the rent), this may produce a profit - taxed as rental income, or may just break even, if you decided not to profit out of the deal. In this way the company ends up paying its share of your mortgage interest/rent.

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By yardleystar
17th Jun 2008 10:55

Mortgage interest

From HMRC Business Income Manual:


BIM47820 - Specific deductions: use of home: specific expenses

Mortgage interest

If part of the home is used solely for business then an appropriate part of the mortgage interest is an allowable deduction. Repayments of capital are not allowable.

More detailed guidance on interest payments can be found at BIM45650 onwards

Example 2

Bill runs a small business. He uses one small room at home as an office, exclusively for the purposes of his trade (CG64660). The room represents 5% of the floor area of the house.

His Council Tax, insurance and mortgage interest bills total £4500. He claims 5%, £225.

His electricity bill for heating & lighting is £300. He claims £15, which is 5% of the total.

His total claim is £240 (plus the business proportion of his phone bill).

Although Bill has apportioned his electricity bill by floor area rather than usage, the amount claimed is small and there is nothing to suggest that his business use is significantly greater or lesser than his private use. It can be accepted as a reasonable estimate.

Example 4

Chris is an author working from home. She uses her living room from 8am to 12am. During the evening, from 6pm until 10pm it is used by her family. The room used represents 10% of the area of the house.

The fixed costs including cleaning, insurance, Council Tax and mortgage interest, etc total £6600. A tenth of the fixed establishment costs is £660. For the purposes of fixed costs, one sixth (4/24) of the use by time is for business, so Chris claims £110.

She uses electricity for heating, lighting and to power her computer, which costs £1500 per annum. Chris considers an apportionment of these costs by time and area. A tenth of the costs are £150 and half of these costs by time (4/8) relate to business use, she claims £75.

She also uses the telephone to connect to the internet for research purposes. Her itemised telephone bill shows that a third of the calls made are business calls. She can claim the cost of those calls plus a third of the standing charge.

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By Anonymous
17th Jun 2008 11:00

Sole traders
Steve,
The examples which you are citing are all for unincorporated businesses; the position for employees is very different. Note the title of this article.

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By Anonymous
17th Jun 2008 10:54

Mortgage interest
Sorry you are confused, Mahmood. Read through this case:

Baird v. Williams [1999] STC 635 - employment duties required a clerk to the commissioners to maintain an office, but not to borrow money at interest to enable him to buy an office. The private benefit overrode the business need.

Mortgage interest may be claimed by sole traders or partners though.

The reason that there is a difference is that that expenses for the self employed come under s 34 ITTOIA 2005 which allows you to apportion expenses where you can identify part or an identifiable proportion of an expense. So if 1/5 of your house if used for work 1/5 of your mortgage interest should be claimable (subject to any adjustments for periods of use).

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By ahson_u
16th Jun 2008 21:34

Mortgage interest deduction
Nicola, I came away from your workshop 'Working from home' thinking mortgage interest was tax deductible (pro-rated to the portion used for business)-not sure if the other participants had the same impression.

Can you kindly provide a reference to the case law which disallows mortgage interest if no new extension has been built. The law on this seems a bit weird. One person can buy a large house and locate his office in his new house and not be able to claim mortgage interest as a deduction where as another person buys a smaller house, builds an extension to carry out his business and claim mortgage interest as a deduction.

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By Anonymous
16th Jun 2008 20:34

PPR!
Spell checkers and UK tax do not go hand in hand!

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By petersaxton
16th Jun 2008 19:19

PPR
It's "principal private residence" not "principle private residence".

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