A Guide to Tax Relief & Homeworking
Written by Corporate Tax Manager, Adam Thompson
Homeworking was already becoming more commonplace, but with the outbreak of COVID-19, millions more people will be working from home, so it is important to understand the potential tax savings which can be made.
In this article, we have briefly outlined the tax position for:
- Sole traders
- Limited Companies
1.1 – Employer payments
Since 2003, employers have been able to make tax-free payments to help employees cover their reasonable additional expenses incurred while working from home. Eligible payments are not subject to either income tax or national insurance.
What costs can the payments cover?
The reimbursements can only cover reasonable additional costs incurred by the homeworking employee. There are two main approaches.
Firstly, the employer can pay the following fixed amounts:
£6/week for weekly paid employees (£4/week prior to 6 April 2020); or
£26/month for monthly paid employees (£18/month prior to 6 April 2020).
The advantage of paying at these rates is that there is no need for the employer to justify the expenditure and the employee does not need to keep records of their additional costs.
Alternatively, the employer can reimburse the actual additional costs incurred by the employee. Allowable costs include:
- additional heating and lighting costs
- additional insurance
- metered water
- telephone or internet access charges
- business rates (if applicable)
Only the increase in costs incurred by the employee can be reimbursed. Costs that would be the same whether you work at home cannot be included. Such costs might include:
- mortgage interest or rent
- council tax
- water rates
For costs such as broadband internet connection, HMRC say that if the employee is already paying for a connection before they started working from home then this is an existing expense and cannot be reimbursed tax-free. If, however, the employee is not connected to broadband and needs a connection to work from home, then this would qualify as an additional cost which the employer could reimburse tax-free.
1.2 – Employee tax relief
If an employer does not choose to reimburse some or all the homeworking employee’s extra expenses, then the employee is not automatically allowed tax relief on their extra costs. Tax relief for extra costs is only given if such costs are incurred wholly, exclusively, and necessarily for the employee’s work.
What costs can the payments cover?
An employee who can show that their home is a workplace can claim relief for the following expenses which, except for insurance, are very similar to the costs that can be reimbursed by their employer above:
- additional heating and lighting
- metered water
An employee cannot claim relief for the following expenses:
- mortgage interest or rent
- council tax
- water rates
Where, as is often the case, it is not practical to calculate the allowable extra costs, then a claim for £26 per month (£18 per month prior to 6 April 2020) for monthly paid employees or £6 a week (£4 per week prior to 6 April 2020) can be made without having to justify the figure. This does not cover the cost of business calls, for which an additional claim can be made based on actual costs.
An employee can make a claim online, by phone, by post or, if they are registered for self-assessment, through their tax return.
1.3 – Purchases of office equipment
The many new homeworkers as a result of COVID-19 will need additional equipment including monitors, keyboards and even desks and chairs in order to make a functional office space at home. Fortunately, following an announcement on 13 May 2020, some of the unintended outcomes which could arise here have been dealt with by the Government.
1.3.1 – Employer purchase
If the employer has purchased and provided any necessary equipment then, provided there is no significant private use, no taxable benefit in kind arises on the employee.
(If there is significant private use, then a benefit in kind will arise and so employers may wish to ensure that their employment policies make clear private use is not permitted.)
1.3.2 – Employee purchase and employer reimbursement
In the current circumstances, some employees may have purchased their own equipment personally to get set up as soon as possible. Employers may even have advised this and offered to reimburse the costs afterwards.
Usually, employer reimbursements of employee expenses are treated differently for tax purposes and this approach involving a subsequent reimbursement is normally taxable on the employee. This is clearly unwelcome, and therefore the announcement on 13 May 2020 of a temporary exemption from income tax and national insurance for such reimbursements is very welcome.
According to the announcement, as a temporary measure for 2020/21 (and also by discretion, the period 16 March 2020 to 5 April 2020 when much homeworking will have started) any reimbursement by an employer for the cost of equipment which was:
provided for the sole purpose of enabling homeworking as a result of coronavirus
and which would have been tax exempt if provided directly by the employer
Will be exempt from income tax and national insurance.
2. SOLE TRADERS
As a Sole Trader, you have two choices for how you claim tax relief for home working.
The first option is to you can choose to claim simplified expenses for the self-employed.
Simplified expenses for the self-employed mean you claim a flat rate for your allowable expenses based on the number of hours you work from home each month. You will need to work a minimum of 25 hours a month from home to qualify. If you use simplified expenses, then do not forget you can also claim the business proportion of your telephone or internet expenses as these are not included in the flat rate allowance.
The second option is to work out your actual costs by calculating the proportion of personal and business use for your home, e.g. the proportion of utility bill expenses incurred by your business. The government’s website www.gov.uk has a simplified expenses checker to help you decide which method is best for you.
3. LIMITED COMPANIES
3.1 – The simple options
As an employee or director, you can reclaim all your home working expenses from your company (rather than making a claim on your tax return), provided that you do perform some or all of your duties as a director or as a company officer from home.
You can claim:
HMRC’s approved homeworking allowance of £6 per week, or, alternatively, you can base your claim on actual costs, which may include:
- Metered light and heat
- Calls made on your home telephone
- Insurance, if there is business equipment insured under that policy
- Repairs if incurred on business equipment
- Phone and broadband costs, subject to the contract
- A proportion of the cleaning costs of your workspace, if the work is of the type that requires extra cleaning.
As directors are treated as employees you cannot claim:
- Mortgage interest or rent
- Water rates
- Expenses that do not have receipts i.e. cash wages of a cleaner.
3.2 – Rent part of your home to your company
A further option is that you may be able to rent out part of your property to your company.
If a director is working or basing a company at home, a license agreement can be agreed for the company to use, on a non-exclusive, or exclusive basis part of the home and any outbuildings.
Any agreement should be set up on an arm’s length basis.
The director(s) becomes the company’s landlord and charges an agreed rent.
This arrangement means that the director can offset a proportion of mortgage interest as well as council tax and other running costs against the rental income.
The result is that the director is put into a similar position to a sole trader.
3.2.1 – Setting up a rental agreement
A director cannot charge rent unless it is evidenced by some sort of formal agreement.
The conventional arrangement is that a non-exclusive licence is created for the company to occupy part of the property in working hours.
Any agreement should not be backdated (backdating agreements may be treated as fraud).
A board minute should record the agreement (if you are a one-man company the Companies Act dictates that you must minute all agreements).
The agreement does not have to be long or detailed; state what is made available, for how long, the annual rent and the terms of notice.
3.2.2 – Personal tax implications
If you were to rent part of your property to your company, then:
Rental income less related expenses must be declared on your tax return.
The owner should apportion expenses if necessary (rent/mortgage interest/council tax) in his rental accounts and also charge any other expenses that are appropriate (light and heat/telephone/repairs etc) and re-charged to the company as part of the agreement.
Rental income does not attract National Insurance, which makes it an attractive method of withdrawing profits from the company.
You will also need to be aware of the potential capital gains tax trap, as renting part of your home to your company, could disqualify you from claiming ‘Principal Private Residence relief’ (CGT exemption) on a future sale of the property. However, where an agreement is made for non-exclusive use by a company this will not affect your CGT position. If you granted an ‘exclusive license’ to the Company, then your ability to claim PPR relief would be proportionately restricted.
3.3 – A garden office
3.3.1 – Corporation Tax Relief
A room in the garden would be classed as capital expenditure, and as such would not be tax deductible. Moreover, because it is a ‘building’ it would not qualify for capital allowances either. This doesn’t mean that your company can’t pay for your garden office, just that it won’t be a tax-deductible expense.
The good news is that fixtures and fittings, do qualify for tax relief through capital allowances, so you can claim for your furniture, curtains, shelves, etc. The cost of installing power, including electrical wiring, light fittings and heating also qualify. Thermal insulation qualifies too, despite being part of the initial construction.
Running costs, including heating, lighting, water if separately metered, and repairs are also claimable.
3.3.2 – VAT
If your company is VAT registered, and not using the Flat Rate VAT Scheme, you can claim back the VAT on the cost of building your garden office. The one complication arises if the office also has a personal use. For example, if the kids use it for TV and games at the weekend, all that peace and quiet may come at a cost.
If there is personal use as well as business use, you’ll need to work out the pro-rata personal and business usage. For example, if it’s used for business during the week and has a personal use at the weekend, you could claim back 5/7 of the VAT. Personal use may also create a benefit in kind (see below).
3.3.3 – Personal use
If your company has paid for your garden office, and you also use it for personal use, this may constitute a taxable benefit in kind. In this circumstance you may need to complete a P11D, and pay income tax on the taxable benefit, which will be a proportion of the value of the building.
3.3.4 – Capital Gains Tax
Capital Gains Tax will only be an issue when you sell your home, so if you are planning on staying put for the foreseeable future it may not feature highly in your decision.
Tax legislation exempts your principle residence from CGT, if there is no exclusive business use on any part of your property. If your garden office is only used for business, you may have to pay CGT on part of your gains when you sell your home. For example, if it makes up 5% of the total floor area, 5% of the gain might be subject to CGT. This is not the case if there is mixed use, so it might be worth letting the kids use it at the weekend after all, depending on your plans and how much you’ll lose in VAT and income tax.