The New Fixed Rate Deduction: Premises Used for Home and Business

Premises often have more than one function and may be used both as a home and as business premises. While this may be a practical arrangement it can complicate the position as regards working out which expenses are deductible in computing the profits of the business.

As a general rule, expenses are deductible in calculating the taxable profits of a trade to the extent that those expenses are incurred wholly and exclusively for the purposes of that trade. Conversely, no deduction is given for expenses that are not wholly and exclusively so incurred. 

However, if an expense is incurred for more than one purpose, a deduction is not denied in respect of any identifiable part of that expense that is incurred wholly and exclusively for the purposes of the trade. This means that where an expense is incurred for both business and non-business purposes, a deduction can be given for the business proportion to the extent that this is identifiable.

There are many circumstances where an expense may be incurred for both business and private purposes. Examples would include a car used for business and private journeys and a phone used for work and personal calls. Similarly, where a premises is used both as business premises and as a home, expenses incurred in relation to those premises will have both a business and a non-business element. The list of potential expenses that may fall into this category would include electricity, gas, water, cleaning, insurance and suchlike. 

Where premises are used both as business premises and as a home, a deduction can be claimed for the premises expenses in calculating the profits of the business for tax purposes to the extent that those expenses are incurred wholly and exclusively for the purposes of the business.

It is likely that many of the expenses incurred in relation to the premises will be billed for property as a whole, rather than separately for the business and non-business parts. Therefore, some method must be used to ascertain the extent to which the overall expense relates to business use and is therefore deductible in computing the profits of the business. The legislation allows the expense to be apportioned on a `just and reasonable basis’. It does not specify what constitutes a `just and reasonable basis’ and indeed this may differ depending on the nature of the expense. For example, it may be reasonable to apportion the costs of cleaning the premises by reference to the floor area of the business part and of the home and the cost of electricity by reference to usage.

Claiming a deduction on the standard basis necessitates not only the keeping of records showing the total expense incurred, but also records to enable that expense to be apportioned between business and non-business use. In some cases, the apportionment will be straightforward and will not involve much by way of additional work. This would be the case where it would be reasonable to apportion the expense by reference to the number of rooms forming the business part of the property and the number of rooms used as a home, such as in the case of mortgage interest. However, where expenses are apportioned by reference to, say, usage, the burden imposed would be much greater. 

For example, to apportion an electricity bill by reference to usage, it would be necessary to take account of both the number and the nature of electrical items used in both the home and in the business. This is potentially a difficult and time consuming exercise.

Damian is a sculptor. He has a studio in a barn, part of which is used as a living area. Damian rents the barn and pays £2,000 a month in rent. 

The studio accounts for 75% of the floor area and the living area for the remaining 25%.

The rent is apportioned by reference to floor area and Damian claims a deduction for 75% of the rent (£1,500 per month) in calculating the profits of the business. 

As part of a package of simplification measures designed to reduce the burdens imposed on small business, for 2013/14 and later years a simple statutory method can be used to apportion premises expenses between business and non-business use where a property is used both as a home and as business premises.

The opportunity to claim a deduction on the fixed basis is available to sole traders and partnerships comprising partners who are individuals. It can be used where: 

• a person carries on a trade at any premises which are used mainly for the carrying on of the trade, but also by the person as a home; 

• the person incurs expenses in relation to the premises which are incurred mainly (but not wholly and exclusively) for the purposes of the trade;  and 

• in calculating the taxable profits of the trade, a deduction would be given in relation to the business proportion of the expense.

The fixed basis operates by disallowing a set amount of the expense for non-business use. The amount disallowed depends on the number of people who live in the property as a home. Therefore, the deduction allowed in computing the profits of the business is the full amount of the expense, less the statutory monthly disallowance for non-business use (determined by reference to the number of relevant occupants) as set out in the table below.

Number of relevant occupants Applicable amount

                   1                                                                       £350

                   2     £500

   3     £650

A `relevant occupant’ is an individual who at any time in the month or part-month occupies the premises as a home or stays in the premises otherwise than in the course of the trade.

Tip: using the fixed basis is simple and removes the need to undertake complicated apportionment calculations and the associated record-keeping burden.

As in the above example, Damian has a studio in a barn, part of which is used as his home. He pays mortgage interest of £2,000 per month.

Damian initially lives alone and uses the new fixed basis to claim a deduction for mortgage interest for 2013/14. From the table above, £350 per month is disallowed as relating to non-business use. Therefore Damian can claim £1,650 a month as a deduction in calculating his business profits. This is a higher deduction than that given under the standard basis in the example above. 

Later in the year, his brother and his brother’s girlfriend move in with him while they wait for their new home to be completed. The number of relevant occupants in the property during this period is now three and the monthly disallowance for non-business use is now £650 per month, rather than £350. Therefore, while there are three people living in the property, Damian can only claim a deduction of £1,350 per month in respect of mortgage interest in calculating the profits of the business. This is less than the amount as calculated by reference to the standard basis in the example above.

Although using the fixed deduction to determine the non-business element may save work, it may not always give the best result.

Choose the method that works best for you. It is necessary to balance the deduction given against the associated record-keeping burden.