As a Professional Contractor or Freelancer you will probably find that you need to do some work at home, certainly some accounting and management, but also potentially to fullfill your contractual obligations for a client.
Knowing how much you can claim from your company is an important part of saving tax for the Professional Contractor and Freelancer.
HMRC provide guidance on what expenses can be claimed when working from home in their Business Income Manual updated in January 2007 and provide details of some specific examples.
HMRC also give specific guidance about claiming a proportion of the home running costs.
There are five possible options for calculating how much Professional Contractors and Freelancers could claim to reimburse their personal expenditure for working at home, and the options depend on the working patterns and business structure used.
Option 1 - The easy option - Self employed or Director/Employee
For Professional Contractors and Freelancers who work mostly at their clients sites and use their home to manage their business, keep accounts and search for new work an estimate of £156 per year which is the equivalent of £3 per week can be claimed as a round sum allowance as an employee or self employed person according to S316A of ITEPA 2003.
This will also be applicable where a person conducts some work at home, shares a PC with the family and does not have a specific business room set aside.
If you use this option there is no potential Capital Gains Tax liability on your main residence.
Option 2 - Apportionment of Costs - Self employed persons only
Where a Professional Contractor or Freelancer has a room set aside for thier work and where they do more than just managing their accounts and paperwork at home, the apportionment option could be used.
It is important that the room is still available for residential use, so it is still part business and part residential use.
In the HMRC manual BIM47815 it says:-
"… it is possible to apportion the use and cost of a room on a time basis, and to allow the expense of the room during the hours in which it is used exclusively for business purposes, in the same way as it is possible to calculate the business expenses of a car which is sometimes used for business purposes exclusively and sometimes used for pleasure."
With this option there are no Capital gains Tax implications if no single part of the residential property is used for business purposes only.
So if a room is set aside for the business it needs to be also available for reseidential use to ensure that there are no Capital Gains concerns.
The simplest way to get to a figure for the annual business cost for home working expenses is to follow these three steps.
Step 1 - Calculate the total cost for the property
The following expenses for the residential property can be included in establishing the running costs of the property:-
- Telephone Line Rental
- Telephone Call Costs
- Rent
- Council Tax
- Mortgage Interest
- Insurance
- Broadband Internet
- Repairs and Decorating
- Water Rates
- Cleaning
Step 2 - Apportion the total cost in respect of the area of the property used by the business, or for the amount used if the cost is a service: -
The most practical way of doing this is to identify a room that is being used for business and the number of rooms in the house.
So for a house with 7 rooms, one of which is used for business and residential use, the apportionment with 1/7th.
You could also do this by meauring the square footage for each room, and the square footage for the business room.
Where you need to apportion the costs of a service such as telephone costs or telephone line rental, a simple percentage of the total cost taken from a reasonable period of time would be sufficient.
Step - 3 Apportion the amount of time to the area used by the business. ( This does not apply to Telephone/Internet Costs )
You also need to allocate an amount of time out of the day that the room is used for business.
For instance if an 8 hour day is worked, but the room is available for use 24 hours then only 25% of the apportioned costs in step 2 can be used.
Option 3 - Director owning a property rents some of the use of the property to the Limited Company
In this method we try and use Option 2, which is available to a self employed person, and make it available to a Director of a Limited Company.
The Director of the company calculates the apportionment of the costs in Option 2 above and charges a rent to the company.
The Director shows the rent as income in a Self assesment Tax Return, and claims the apportionment of the costs as deductible against the income.
The net result of this is that a Limited Company is getting the same deductions as a sole trader, which seems fair and reasonable.
If the Director makes any reasonable profit from the rental then there will be income tax to pay.
Option 3 is effective if there are substantial costs in running the home office but bear in mind it complicates your tax return and may attract a challenge from HMRC.
You need to get complete documentary evidence of how you made the calculation including all receipts and invoices in order to respond to any HMRC challenge.
If the apportioned costs of working at home were more than £156, for each £1 above £156 there would be a Corporation Tax saving of £0.21p, and you would have to bear in mind the extra work involved and potential compliance issues if HMRC challenge your calculations.
For example if the apportioned costs were £300 then there could be a Corporation Tax saving of £30.24, and £500 then there would be a saving of £72.24.
Assuming the Director made no profit on the rent, there would be no tax to pay.
There would be no advantage on the Director making any profit on the rent from a tax perspective.
Option 4 - Director claims as a work from home employee, but claims for more than the £3 a week in Option 1.
Under Section 316 of ITEPA 2003 employees may be reimbursed free of tax and NI for expenses incurred in the performance of their duties that include accomodation and services.
The HMRC guidance manual EIM01474 refers to the employer reimbursing the additional costs of working from home.
An employer cannot pay for extensions or conversions of the employees residential property, this would trigger a benefit in kind charge.
The company can make an agreement with an employee that more than £3 per week is claimable ( Option 1 ) , but the agreement must be reasonable and clearly set out, and the employer must be able to justify how the amount was arrived at.
An example of how this could be calculated is given by HMRC.
The items that can be included in the calculation are fewer than in Option 3 because it is about the additional costs involved to the employee from working from home.
For instance mortgage interest would not be part of the calculation as it does not vary if you work at home or not.
HMRC make special mention of Internet Charges explaining that if the employee already had an internet connection before the home working agreement started then there can be no extra costs involved in the employee working from home.
If the connection had to be upgraded then there could be additional costs involved and this could be included in a round sum calculation.
If an employer agrees a round sum allowance involving a calculation for additional costs, the employee/director should keep recipts as proof of the aditional costs.
Some items that employers and employees might think of in relation to the additional costs involved in the employee being based at home would be:-
- Business Rates
- Light ( Not standing charges )
- Heating
- Internet Access
- Insurance
- Telephone ( Not fixed charges )
- Water (not standing charges)
- Cleaning
- Repairs and decorating
You need to get complete documentary evidence of how you made the calculation including all receipts and invoices in order to respond to any HMRC challenge.
The employee and employer should keep these records and also the agreement for home working.
If you are a Director and not paying National Minimum Wage as you do not have a contract of employment you can still agree to fulfill the role of Director working at home and be reimbursed for the additional cost you incur as a result of this.
Option Five - A separate business premises within the grounds of the house
Some Professional Contractors or Freelancers may use a Garden Office and in these circumstances there are different considerations.
For the purpose of this option the Garden Office needs to be exclusively for the business with no residential use.
If there is any residential use, we go back to the apportionment options.
A separate building, albeit a temporary stucture, used for business exclusively will be an asset for the business, and so the tax rules for this type of asset will apply.
HMRC will view your Garden Office as being separate from your main residence, and tax you accordingly, but also allow your deductions accordingly.
The purchase of the building and installing the building will be a capital asset for the business and the costs will be written off over a number of years.
The service costs for getting the building to a useable condition will be allowed as costs against the profits of the Limited Company.
For the running costs then only the costs associated with the Garden Office can be claimed.
In respect of telephone/internet an apportioned cost can be used based on usage, the guidance above still applies, whatever option you choose keep documentary evidence of your calculations.
For all other costs that are shared with the residential property such as electricity,water and gas it is only the extra costs involved in running the separate Garden Office, the amount you claim needs to be calculated based on previous residential useage and only the extra cost claimed.
Capital Gains Tax should not apply on the sale of the residential property that includes a Garden Office as long as the office is situated within the garden area.
VAT can be claimed on the purchase of a Garden Office, if you use the Flat Rate Scheme and the purchase is more then £2000 then you can still claim the input tax, but you need to ensure that your purchase is for an installed structure as one item, the input VAT on the services to install the structure are not claimable.
If there is any residential use of the structure then the vat would be apportioned accordingly.
A Note On Business Rates
The Valuation Office Agency give clear guidance on if your residential property will become liable to business rates.
There are some excelent examples and most Professional Contractors and Freelancers should not experience any problems with being assessed for business rates.
A Garden Office will almost certainly attract business rates, you may also need to consider planning permission.