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The Smart Guide to Business Taxation 2006-07 by Mark McLaughlin CTA (Fellow) ATT TEP

Mark McLaughlin CTA (Fellow) ATT TEP, General Editor of TaxationWeb, outlines tax considerations for self-employed taxpayers who work from home.Many businesses operate from home. Even if separate business premises exist, the proprietor will often work at home as well. What expenses can be claimed against business profits? The statutory rule for claiming tax relief on business expenses is that they must be ‘wholly and exclusively’ incurred in connection with the trade or profession.

Strictly speaking, an expense used for both business and private purposes cannot be deducted, unless the business proportion can be separately identified. However, where claims such as ‘use of home as office’ are concerned, many taxpayers (and accountants) have apportioned business and personal expenditure, on the assumption that this would be acceptable to HM Revenue & Customs (HMRC) provided that the business element is not excessive and has been calculated on a reasonable basis.

HMRC’s view?

Tax relief claims are often made by self-employed individuals who work from home. They claim for a proportion of the running costs of a property used partly for business purposes. This expense is normally described in the accounts as 'use of home as office' or similar. HMRC originally wrote to some self-employed taxpayers in 2004 setting out ‘Frequently asked questions for the self-employed’. These included the question: ‘I sometimes carry out work for my business at home. Can I claim part of my property running costs?’

HMRC’s official answer surprised many tax advisers because it included the statement: ‘If the part of the property used for business purposes is also used for some other purpose at the same time then no deduction is due.’

It has been the practice of most accountants and tax advisers in the past to claim for use of home as office even where there was no exclusive use of a specific part of the home. Provided that the claim relates to the business proportion of property running costs, calculated or estimated on a reasonable basis, there seems to be no reason why the expense should not be allowable.

HMRC’s guidance to taxpayers has been updated and the 2006 version reads:

‘Can I deduct part of my property running costs if I use my home as an office?’

‘If you use part of your home solely for business (for example you use a room or an identifiable part of a room solely as an office), a proportion of the running costs of the home are allowable. These might include a proportion of insurance, heat & light and mortgage interest. If the part of the property used for business purposes is so used for only part of the time, you can claim part of the running costs. Calculate the amount by reference to the time that part of the property is used for business purposes, and the power-consuming equipment used in the business. The deduction should reflect the underlying facts. For example, a potter who uses an electric kiln every day will use far more electricity than a jobbing builder writing up their records in the spare bedroom once a week. If you use part of your home exclusively for business purposes, you may be liable to Capital Gains Tax on that part when you come to sell it.’

Tax relief claims

As mentioned, the statutory rule for claiming tax relief on business expenses is that they are 'wholly and exclusively' incurred in connection with the trade or profession. Strictly speaking, an expense used for both business and private purposes cannot be deducted unless the business proportion of that 'mixed' expense can be separately identified. However, where claims such as 'use of home as office' are concerned, HMRC has, in the past, generally accepted an apportionment between business and personal expenditure, provided that the business element is not excessive and has been calculated on a reasonable basis (although problems can arise with 'round sum' claims – eg £10 per week – where no proper attempt has been made by the taxpayer to ascertain the business element).

Which expenditure?

A self-employed individual will incur household expenses when working from home. The types of expenses that may need to be taken into account include:

• rent;

• gas and electricity;

• cleaning (eg. window cleaning, domestic cleaners);

• council tax;

• home and contents insurance;

• water rates;

• repairs and maintenance to the house; and

• business rates (if applicable – see below)

Mortgage interest relief in respect of the business element could also be taken into account in the ‘use of home as office’ claim. In addition, repairs and decoration of the area used for business purposes should be claimable in full.

Business rates

A potential worry for home-based workers is whether the local council will charge business rates for that part of the property used for work. This will depend on the circumstances of each case. The Valuation Office Agency (VOA) provides the following guidance at:

www.voa.gov.uk/council_tax/working_from_home.htm:

‘There are many considerations that we must make in deciding whether a room in a house used as an office should be liable to business rates and each case is considered on its own merits. We will consider the effect of the extent and frequency of the non-domestic use of the room and any modifications made to the property to accommodate that use’.

The VOA also provides examples of situations that might affect liability to council tax and business rates.

Home workers may be able to draw some comfort from a Lands Tribunal ruling against the Valuation Office Agency (VOA) in the case of Tully v Jorgensen, heard in 2003. This ruling involved Mrs Tully, an HMRC employee working at home on disability grounds, being physically unfit to travel to work every day on account of a back injury. HMRC provided equipment to enable her to set up an office in a spare bedroom. No structural work or adaptation was carried out to enable Mrs Tully to work there, and no business meetings were held at the property. The VOA assessed the property partly to non-domestic (ie. business) rates. However, the tribunal allowed Mrs Tully's appeal against the non-domestic rating assessment.

This could be an important decision for home-based workers who use a room at home, particularly where the following factors are involved:

• the room and property is not structurally adapted for work;

• the work area is not separately identifiable from the remainder of the room or house;

• the furniture or equipment is not inconsistent or incompatible with domestic use;

• no staff are employed in the room or house;

• there are no outward indications of a separate business premises or entity; and

• no meetings take place in the room or house on work related matters.

The President of the Lands Tribunal in the Tully case added: ‘I see no significance in the fact that she is employed rather than self-employed and that all her work, apart from meetings, is carried on there.’

Working out a claim

Assuming that your bills relate to the entire house, how should a claim be calculated? There is no ‘standard’ recognised or approved method. However, one possible way of working out the business element is as follows:

(a) count the number of rooms in the house, excluding the hallway, bathroom and toilet (unless customers visit your home regularly and use those amenities;

(b) establish the fraction or percentage of the house used for business purposes (this could be calculated by reference to the number of rooms, or for example by reference to the floor space used). If only part of a room is used for business, use your best judgement to make an apportionment;

(c) make a list of all the relevant household expenses incurred during the year or period in question (ie. those with ‘mixed’ business and private use) and add them together;

(d) apply the business fraction or percentage calculated in (b) to the total expenses in (c) to give the business proportion of ‘mixed’ household expenditure; and

(e) add to the total in (d) any expenses ‘wholly and exclusively’ incurred for business purposes (eg. repairs or maintenance to a ‘business area’ of the house), to give the total ‘use of home as office’ claim.

Making the claim

A claim for use of home as office is made in the Self-employment supplementary pages of the Self Assessment tax return (ie. in box 3.52, for 2006 returns). It is also a good idea to explain in the ‘Additional information’ section of the Self-employment pages how you arrived at the deduction claimed. This can reduce the chances of the taxman making an ‘enquiry’ or ‘discovery’ in respect of that claim later on.

Use of home ‘health warnings’

If there is exclusive business use of a specific part of the home, the taxpayer will need to consider the implications carefully before proceeding to claim a deduction. When the house is sold the normal capital gains tax exemption on the disposal of a 'principle private residence' will be subject to a potential restriction in respect of any part of the gain that relates to exclusive business use. In addition, business rates might become payable in respect of the non-domestic use of an area of the house. The potential costs and benefits of a 'use of home as office' claim may need to be compared. Claims for ‘use of home as office’ are therefore subject to these ‘health warnings’.

Mark McLaughlin CTA (Fellow) ATT TEP
November 2006


Mark McLaughlin is the author of ‘The Smart Guide to Business Taxation 2006-07’ (price £14.99), from which the above article is adapted. For further information and ordering details for this pdf book, click here