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TaxZone Newthwire 91 - Working at home

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23rd Jan 2006
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Editor's Note
=============
Working at home was a rarity until recent years. The rapid
introduction of computer technology, changing social and
cultural patterns, the difficulties that commuters face in
travelling to work and the cost of office rents have changed
all that.

Employers now recognise that it is an advantage if some of
their employees are based at home, despite the (wrong)
suspicion in some cases that such trust will be abused. It will save the company money in terms of desk space and there are other advantages as well.

Equally many small businesses, particularly sole traders, are based at home. This saves expense, and often enables the business to run more efficiently.

One would expect HMRC to recognise these factors and take a sympathetic view of events in the 21st Century. However, this has not really occurred, and what relief is given is both grudging and meagre. This is another example where 'joined up government' has not emerged.

In this wire we will explore what tax relief can be claimed, both by self-employed taxpayers and employees, when they work at home.

Contents
========
1. Previous wires
2. Statutory background
3. Case law
4. Dual purpose expenditure
5. What can be claimed

(a) By the self-employed
(b) By the employed

6. The new HMRC statement
7. An alternative approach
8. Any Answers
9. Conclusion

1. Previous wires
=================
The subject of working at home and what expenses can be claimed has been touched on, to one degree or another, in the following previous wires:

Issue No. 1 - The family home - 13 May 2002
Issue No. 9 - Business deductions (1) - 2 September 2002
Issue No. 40 - The family home revisited (1) - 24 November 2003
Issue No. 41 - The family home revisited (2) - 8 December 2003
Issue No. 59 - Buy to let property - 31 August 2004
Issue No. 85 - Property taxes - 12 September 2005

2. Statutory background
=======================
As regards self-employed claimants, the relevant statute is now found at section 34(1)(a), ITTOIA 2005. This is the well-known provision that expenses are not tax-allowable, unless incurred 'wholly and exclusively for the purposes of the business, trade or profession'.

This provision is mirrored, for employed claimants, apart from one word, in section 336, ITEPA 2003, which limits deductions to expenses 'wholly, exclusively and necessarily incurred'.The addition of the word 'necessarily' is crucial to this particular claim and many others by employees.

Section 316A, ITEPA 2003 headed 'Homeworkers additional
household expenses' concerns the situation where the employer reimburses the employee for additional expenses incurred in working at home. In practice HMRC allow a figure of 2 pounds a week without query, but reimbursed amounts in excess of that figure must be justified by the employee. Note that this only applies to reimbursement of expenses by the employer - not a claim by the employee himself or herself without reimbursement.

3. Case law
===========
For a self-employed person, there are just two relevant
tribunal cases. In Gazelle v Servini SpC 48, a claim by an
accountant for 50% of household expenses (32,000 pounds)
totalling 16,000 pounds to be allowed against his professional income was put forward. One of the three bedrooms at the home was used exclusively as a library, and another was used for the storage of files. The taxpayer worked at home from time to time in order to be free from interruptions, and also entertained 30 clients or potential clients there each year. The Special Commissioner determined that the decision of HMRC to allow 10% of the annual costs, totalling 3,200 pounds, was 'not
unreasonable'.

Much more recently, the case of Ian Dixon v HMRC SpC 511
confirms that a proportion of mortgage interest relief can be allowed for tax purposes, where the home is used partially for business purposes. In this case HMRC wished to disallow 50% of the interest, but the Special Commissioner decided that the correct disallowance was 35%.

It has been almost impossible for any employee to claim any deductions at all for working at home until recently, and this reflected in the current case law. The two most relevant cases are:

Elderkin v Hindmarsh [1988] STC 267. A taxpayer employed by a firm of consultant engineers was required to work away from home for long periods. He was paid a 'living allowance' by his employers, and claimed that the allowance was 'wholly, exclusively and necessarily incurred in the performance of his duties', and that he should be allowed a deduction of a similar amount. The claim was rejected by the court.

Roskams v Bennett 32 TC 129. A claim by an insurance agent in 1950 for a deduction of 21 pounds a year for lighting and heating a room was rejected by the court.

Other case law demonstrates whether or not HMRC accept that the business is situated at the home. In Horton v Young 47 TC 60, a landmark case, a subcontract bricklayer was allowed motor and travelling expenses to various sites, on the basis that he was self-employed and his home was the business base.

A contrary decision was reached in the case of Jackman v Powell [2004] STC 645. A self-employed 'franchise' milkman was obliged to keep his milk float at the dairy, and claimed motor expenses from his home to the dairy in order to collect the float, and the journey home after returning the float. The court decided against him, and the motor expenses were disallowed.

Equally the case of Caillebotte v Quinn [1975] STC 265
establishes that a self-employed worker is not able to claim 'subsistence', unless he or she stays away from home, and the subsistence is part of the cost of travelling, accommodation and meals.

The HMRC Business Income Manual is also helpful regarding this type of claim, and reference can be made to:

BIM 46840 - Council tax and rates
BIM 45670 - Interest
BIM 45570 and 37060 - 'Wholly and exclusively'

4. Dual purpose expenditure
===========================
The difficulties faced by both self-employed and employed
workers are that any claim for use of home for business
purposes is likely to include dual-purpose expenditure. HMRC are not keen to grant any allowance for expenditure that would have been incurred in any case, whether or not the taxpayer worked at home. A very small part will relate to the additional costs of heating & lighting, as well as telephone calls.

In view of section 34(1)(a) it is clear that much of the
expenditure is not 'wholly and exclusively incurred' for the purposes of the trade, business or profession. It can therefore be seen that any claim, even by a self-employed person is by concession.

5. What can be claimed
======================
(a)Claims by the self-employed

A claim for 'use of home' as office has a historic precedent for self-employed workers. Many taxpayers have claimed a modest 5 pounds (or similar sum) a week, making an annual round sum claim for 260 pounds, in the past.

This is dangerous under self-assessment, where justification of any expense claimed in the self-assessment return is required. A 'round sum' claim opens the way for 'discovery' by HMRC under section 29, TMA 1970.

What can be claimed is a proportion of household expenses
relating to the room or rooms, including the garage, that are used for business purposes. For instance, if the business motor vehicle is kept in the garage, then that room forms part of the calculation. Bathrooms, kitchens and toilets are excluded from the calculation. The claim applies to the property, so that it is immaterial that it may be owned jointly by two partners.

Household expenses that can be included in the calculation
include:

# Heating
# Lighting
# Council tax. HMRC Business Income Manual at BIM 46840 is the
authority for this.
# Cleaning
# Water rates
# Buildings and contents insurance
# Maintenance and repairs
# Mortgage interest
# Sewerage rates
# Garden expenses, if clients or customers visit the property.

A proportion of the cost of buildings and contents insurance could be included under the heading of 'insurance' in the accounts and tax return, rather than included in the 'use of home' calculation.

Example 1

Hobson works at home as a self-employed accountant. His home has three bedrooms, and three reception rooms. One room is used almost exclusively (but not entirely) for business purposes. Clients visit the home from time to time and the 'business' car is kept in the integral garage. The household expenses outlined above (but excluding insurance) amount to 4,500 pounds for the
year to 5 April 2006.

Hobson considers that a fair claim would be 1/6th pf 4,500
pounds = 750 pounds for the year. The importance of working out these figures is that justification can be made if HMRC query the claim.

It is also important not to 'overdo' the claim, taking into account its concessional nature and the possible CGT trap that will be mentioned later. I am surprised that 3,200 pounds was allowed in the Gazelle v Servini case, and it is fairly certain that the taxpayer has or will face a CGT charge when selling the property as at least one room was used 'exclusively' for business. In the above example Hobson might limit his claim to 600 pounds, while being able to justify a higher amount. The advantage of doing this is to preserve a negotiating position if HMRC decided to challenge this head of expenditure. It is
not unknown for an inspector to suggest that only 1 pound a week is allowable. If one can justify about 15 pounds but only claim a little less than 12 pounds, then HMRC is on 'the back foot'.

Capital gains tax

Section 224(1), TCGA 1992 provides that the principal private residence exemption is partially lost if part of the private residence is used for business purposes. However the subsection refers to 'exclusive use' of a room or rooms for that purpose.

The traditional defence against any possible PPR restriction has been to make sure that no one room is used 'exclusively' for business purposes. In other words if Hobson, in the example above, kept a television and radio in his office, and also stored his personal collection of books, videos, DVDs and CDs there, then the room is not used exclusively for business purposes.

HMRC do not like this interpretation of the law at all, and have apparently stated, in their latest 'enabling letter' that if a claim for use of home is made then the CGT exemption on that part of the house will be lost. This statement does not stand up legally, but the department's frustration is understandable.

However, in some cases, one room or more will be used
exclusively for business.

Example 2

Supposing, in the above example, that Hobson had used one room exclusively for business. He had purchased his home in September 1998 for 225,000 pounds, and it was sold for 350,000 pounds in June 2006.

The gain on the property is 125,000 pounds. 1/6th is
attributable to the 'business portion', amounting to 20,833 pounds. This is the chargeable gain subject to taper relief and the annual exemption. One should also mention that Hobson falls into the taper relief 'trap'. This means that the calculation proceeds as follows:

Business proportion 20,833 pounds

Granted business asset taper relief at 75% 1/6th of 20,833
pounds = 3,472 pounds

Granted non-business asset taper relief at 25% (7 years) 5/6th of 20,833 pounds = 17,361 pounds.

Chargeable gain 20,833

Taper relief 3,472 @ 75% = 2,604
17,361 @ 25% = 4,340

Total taper relief 6,944

Taxable gain 13,889

Even taking into account the annual exemption of 8,500 pounds or more there is a very real prospect of some capital gains tax being payable at 20% or 40%, unless there are CGT losses brought forward.

Business rates

There had been some alarms that the Valuation Agency would
impose business rates on individual taxpayers working at home. However, following a case involving an HMRC employee who worked at home the Agency has stated that it will not normally take any interest in individuals working at home and attempt to impose business rates, except where the property is visited regularly by the general public.

Planning point

Make sure that clients who work at home do not overdo their 'use of home' claim. It must be logically based and
justifiable. 'Round sum' claims are discouraged. Also advise clients not to use one room of their home entirely for business, if at all possible.

(b) Claims by employees

There are two situations regarding employees who work at home. The first concerns reimbursement by the employer, which is recognised statutorily by HMRC in section 316A, ITEPA 2003.

In such circumstances reimbursement to the employee of 2 pounds a week for home expenses will not be challenged, even where the employee works at home by choice. Larger reimbursed amounts may be allowed, provided that they come within the wholly, exclusively and necessarily test. This is very restrictive, and the employee may not be able to justify more than the increased cost of heating and lighting, and the cost of telephone calls made (excluding the rental).

In cases where no reimbursement of expenses occurred HMRC were only likely to allow the additional costs of heating and lighting, and 'business' telephone calls. In addition, no relief at all was given unless the employee was obliged to work at home, perhaps reflected in the employment contract.

6. The new HMRC statement
=========================
Following section 316A one anticipated more concessions by HMRC regarding this subject. In fact this has not occurred, and the position for employees is, if anything, even more restrictive. This is as a result of details outlined in HMRC Tax Bulletin Issue 79, which supersedes the entry in the HMRC Employment Income Manual at EIM 32760.

The main points of the statement are as follows:

# Where an employee works at home by personal choice, this
prevents any relief being claimed at all (where not
reimbursed).

# Other conditions for a valid claim by an employee are:

(a) Substantial duties of the employment are performed at home.
(b) Duties cannot be performed without appropriate facilities and those facilities are not available at the employer's premises (or the employee lives so far away from the business premises that it is unreasonable for him or her to attend every day).

The basic conditions set out above must all be fulfilled for a valid claim by an employee. Tax Bulletin 79 contains 12 examples of situations where conditions are or are not
fulfilled.

The expenses that can be claimed are (remembering that this is a claim where no reimbursement has been made by the employer):

# The additional costs of gas and electricity.

# The metered cost of any water used in 'performance of the duties'.

# The unit cost of business telephone calls (including 'dial up' internet access).

It should be noted that no relief is given for a proportion of the telephone rental, council tax, rates, rent and water rates, mortgage interest, endowment premiums or household insurance premiums.

There is an automatic acceptance of a 2 pounds a week claim without query where the three main conditions are satisfied. However, where an employee makes a claim without reimbursement by the employer it can be seen that the relief is more restrictive than under section 316A.

Planning point

Advise employee clients working at home to try and persuade their employers to make it compulsory for them to work at home.

7. An alternative approach
==========================
An alternative approach, where the employee trades through his own personal service company, is for the individual to charge the company rent for partial use of one or more rooms at home.

The rent paid would be an allowable deduction in the company's accounts. The individual would receive rental income that would have to be declared in the personal self-assessment tax return. However, similar expenses to those claimable by a self-employed taxpayer could be claimed against the rent, with the rent set at a figure that slightly exceeds such annual expenses.

This approach relies on the individual being able to trade
through his or her own company, and there may be other
considerations to consider, such as IR35 and section 660A. It will also be necessary for the employee taxpayer to complete the Land and Property section of the self-assessment return.

Planning point

In order to forestall any HMRC enquiry, the use of a company (where other advantages accrue) may be a good move. The company may claim a reasonable rent for use of the home, and the relevant expenses may be claimed against the rental income by the taxpayer.

8. Any Answers
==============
Not unnaturally, use of home for business is a recurring theme in Any Answers on the TaxZone site. The following are a selection of queries:

Use of home - P11D entry
https://www.accountingweb.co.uk/item/128002/972/973/785

Nick Farrow, on 1 July 2004, asked whether a P11D entry was necessary if the employer paid more than 2 pounds a week to the employee for use of home. Stuart Jones replied in the affirmative. It would be necessary for the employee to make a claim in such circumstances under section 336, ITEPA 2003, whether or not a self-assessment tax return had been issued.

Use of home percentage
https://www.accountingweb.co.uk/item/131219/972/973/785

David Shepherd queried the position of the director of a one-man company who completes substantial work at home in his query of 26 September 2004. The study is used 100% for business, and there are five other rooms. Can 1/6th of the relevant expenses be claimed?

Some respondents missed the point that the client was an
employee, and therefore restricted in his claim. However David Lochhead suggested that the company paid a notional rent, against which the proportion of home expenses could be set. I would add that it is important that the client makes sure that some private use of the one room is made, in view of potential future CGT.

Use of home - Enabling letter - CGT
https://www.accountingweb.co.uk/item/141272/972/973/785

John R introduced the case of a new consultant doctor client on 19 May 2005. 900 pounds had been claimed for use of home for the profession. A calculation had been prepared by the adviser on the basis of 90% use of certain rooms that approximated to the figure claimed. The inspector referred to the current 'enabling letter' that states 'if no part of the property is used exclusively for business, then these costs are not allowable - even if there is business use'.

This was an enquiry case and the inspector suggested a lesser claim, and also issued a CGT assessment of 40,000 pounds apparently relating to a recent house move. John R also referred to any claim for the allowance of a proportion of mortgage interest.

A number of subscribers replied to this one, and Edwin Crump referred to the CGT taper relief trap that I mentioned above. In my view HMRC are incorrect about the statement in the enabling letter, as a matter of law. What they are saying is 'if you claim use of home as office, you will suffer a CGT restriction'. This may need to be tested before the Commissioners and courts in due course.

The CGT assessment was obviously issued as a measure to
pressure the client and his agent. As regards the allowance for mortgage interest, the allowance of a proportion is logical and ratified in the Business Income Manual, as mentioned above.

Other recent Any Answers questions and replies can be found at:

3 November 2004 - Use of home as office
https://www.accountingweb.co.uk/item/132938/972/973/785
2 February 2005 - Use of home - Limited company
https://www.accountingweb.co.uk/item/136528/972/973/785
6 June 2005 - Use of home claim
https://www.accountingweb.co.uk/item/141857/972/973/785
20 July 2005 - Use of home for shared expenses?
https://www.accountingweb.co.uk/item/143475/972/973/785
27 October 2005 - Use of home as office in OMB company
https://www.accountingweb.co.uk/item/147061/972/973/785

9. Conclusion
=============
It can be seen from this wire that this very small element of tax law and practice is causing an inordinate amount of
controversy and 'hassle'. I anticipate that further changes will emerge in the future, perhaps statutory or as a result of case law or HMRC statements.

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