Jennifer Adams suggests potential tax issues and opportunities when working from home.
The vast majority of landlords work from home using a spare room as an office. At the end of the tax year they might find that they receive an electric bill which is slightly larger than usual, or a larger telephone bill reflecting the increased number of hours working from home.
A self-employed landlord whose properties are held in his own name is permitted to deduct some percentage of the cost incurred for income tax purposes against the rental income received, as a business will exist in HMRC’s view. However, should the properties be held by a limited company the rules are slightly more restrictive and even can be described as complicated because, unlike a self-employed individual, the company and director are separate legal entities.
Tax relief can be claimed but care is needed in claiming the maximum relief possible. The remainder of this article details the differing methods of calculation, discussing difficulties that may be met in making the claim.
‘Wholly, exclusively and necessarily’:
As a self-employed landlord, an expense will be allowable against rental income if it passes just the ‘Wholly and exclusively’ test. Therefore, strictly, if an expense is not ‘wholly and exclusively’ incurred for the purposes of the rental business, it may not be deducted. In practice, though, some dual purpose expenses are permitted should it be proved that a proportion has been incurred for the purposes of running the business.
The same expense incurred by a director/employee must pass more restrictive tests. HMRC only allows the deduction of expenses incurred by the director that have been ‘wholly, exclusively and necessarily’ incurred in the administration of renting the property/properties. The expenses incurred by a director personally, for the use of his home as the office will therefore not come within this definition as the electricity bill, for example, would be in the directors’ name and be paid for by the director – i.e. not ‘wholly, exclusively and necessarily’ incurred. If the business is run from premises in the name of the company then related expenses are fully allowable and technically any expense reimbursed to the director is taxable.
However, HMRC appreciates that there may be some element of duality of purpose should the administration of the renting business be run from premises not owned by the company but is the directors’ residence. The difficulty is in calculating how much can be claimed and how the claim should be made.
What are the options?:
- The company is permitted to pay a minimum amount of £4 per week to the director/employee under the ‘homeworking rules’ in ITEPA 2003, s 316A (see HMRC’s Employment Income manual: www.hmrc.gov.uk/manuals/eimanual/EIM01472.htm). The payment is exempt for the individual. The higher rate taxpayer director will obviously obtain most benefit from this arrangement not being taxed on this amount. There are, however, two tests that must be met in relation to this claim. First, there must be an arrangement in place between the company (employer) and the director/employee (these arrangements are not required to be in writing but invariably will be). Secondly, the employee must work at home on a regular basis under these arrangements (which will be the case for the landlord company director running the administration from home).
- The company pays rent to the director of an amount in excess of the £4 per week limit for ‘home working’. Under this arrangement, the agreement needs to be in the form of a formal ’licence to occupy’ between the two parties. If HMRC allows the additional amount the company will receive a tax deduction on the rent as an expense of the company and the director receives a contribution towards the costs, again not taxable. Supporting evidence is needed to confirm that the amount being claimed is no more than the additional household expenses incurred. Otherwise, there will be an element of ‘bounty’ taxable as additional income on the individual. Again this arrangement is more beneficial for the higher rate director.
- Alternatively, the company can pay rent for the use of the home, which equates exactly to the expenses claimed. The company will obtain full tax relief, the rent received being declared as taxable income in the hands of the individual, but against that can be deducted the same amount as the expenses incurred. The amount of expenses to claim will need to be calculated with more precision than is used under the ‘home working claim’.
Again, a formal rental agreement should be used and it is suggested that the rental payments be made from the business account into the directors’ private account rather than as a credit into the director’s loan account because this will create a clear distinction between company money and personal money. This arrangement is again particularly beneficial to the higher rate taxpayer. The director should not make a profit under this arrangement, as otherwise an element of ‘bounty’ will be taxable.
The calculation of rental/costs are usually based on the share of house (room by room excluding kitchens and bathrooms, or even by square footage) used as an office.
Points to consider – mixture of personal/private use:
- When determining the amount under points 2 and 3 above (other than the £4 per week ‘working from home’ exempt limit), the rooms used must retain a mixture of personal/private use to prevent any possible capital gains tax problems on sale. A suggestion would be for agreement to state that the amount of rent charge is based on a Monday-to-Friday usage and possibly include a statement confirming shared use of facilities. It would be best for a solicitor to draw up the agreement.
- There may be a concern surrounding separate rates charged for office use. However, the Valuation Office Agency states that exemption is possible provided that the room is not exclusively used for business or not built or specially adapted for the business (see www.voa.gov.uk/corporate/Publications/workingFromHome.html).
Practical Tips:
1. ‘Rent-a–room’ relief is not relevant where a room is rented to a business.
2. Rental income without a proper agreement may be treated as a loan or as a distribution.
3. Care is needed that the rent is not excessive, as otherwise the amount may be disallowed in the company’s tax computation.
