Use of home office: A quick overview
Who’s this guide for: Business owners whose company is based at home, or who carry out a substantial amount of their duties from home.
What’s the tax impact: There are two options for business owners to reduce their tax bill, either:
- The company reimburses the home working expenses. This can either be done using HMRC approved rates of £6 per week, or by identifying actual home working costs such as additional light, heating, insurance etc. In our experience, most Director’s end up claiming the £6 flat rate.
- Alternatively, the Director charges the company rent for use of part of the property. This approach enables Directors to cover some additional household running costs which are not available under option 1, potentially including mortgage interest and council tax.
How complicated is this: That depends which route is chosen, the approved £6 rate is as simple as it comes. If the Director decides to charge rent then it becomes a bit more involved, but is still fairly straightforward and will likely offer greater tax savings.
In the rest of this guide we look at the options in detail to help company Directors work out what’s right for them.
Use of home: Approved home working allowance
Since 6 April 2020, company Directors and employees have been able to claim a use of home allowance at a fixed rate of £6 per week. This allowance is based on HMRC approved rates and gives the company a total tax deduction of £312 per year.
The home working allowance is the simplest way for a Director and employee to claim for home office expenses, and as it’s an approved rate you don’t need receipts to claim it.
But most Directors usually balk at the flat rate. That’s because for those working from home full time the cost of doing so is usually a lot more than £6 a week. There’s heating, lighting, water, insurance, cleaning and potentially telephone and broadband costs to think about.
Working from home: Claiming home office expenses
As an alternative to claiming the approved flat rate, Directors and employees can claim for expenses directly attributable to working from home. So what sort of costs can be claimed?
Well, usually it’s possible to claim for costs which have increased as a result of working from home. That includes lighting, heating, insurance (if you’ve added business equipment or business use to your policy), cleaning costs associated with the office space. In addition, business telephone calls, and business broadband can be claimed. A note on broadband, it’s not possible to claim for normal home broadband – it must be a contract in the business’s name.
To calculate the directly attributable costs that can be claimed the Director or employee should identify the amount costs have increased. If working from home is new for them, then that’s not too difficult and it may be as simple as comparing the electricity and gas bill for the past 12 months to the previous 12 months – the increase is then attributable to them working from home! The same goes for other bills such as water. For telephone or broadband costs the Director should be able to identify the direct costs on a line by line basis.
Once the direct costs have been identified, they can be compared to the flat rate to work out the best option!
Use of home office: Director charging a business rent
There may be a way to save more money though by putting a rental agreement in place between the Director and the company.
The rental agreement is beneficial as it enables the Director to take account of other costs not available in the first two options we’ve seen. For example, they can offset a proportion of mortgage interest and council tax if they opt for the rental agreement route. So what’s needed?
Firstly, it’s absolutely essential that a formal rental/licence agreement is put in place between the Director and the company. Without this, they cannot charge the company rent. This will state what space is being made available and what the agreed rent is. It’s worth noting that under no circumstances can such an agreement be back dated – that would amount to fraud, so this is forward looking only.
The Director should get some advice on the rental agreement, but generally this should be drawn up on a non-exclusive basis, meaning the company has the right to use the space but this right is not exclusively theirs and so the family and other occupants continue to have a right to use it. This is preferential from a capital gains perspective because it should not impact the availability of principal private residence relief on the eventual sale of the Directors home.
The next consideration is what rent the Director can charge the company. Firstly, it’s important this is reasonable, and in line with what an unrelated person would usually be willing to pay to rent the space. The Director should therefore do some market research and determine what the going rate is locally for a similar, communal shared office space.
Use of home office: how is the rental income taxed?
The company should be able to take a corporation tax deduction for the rental expenses. However, this income will be taxable as rental income in the hands of the Director and will need to go on their personal tax return.
On the Director’s tax return they will be able to offset a proportion of the home running costs on a just and reasonable basis. Costs that can be offset include:
- Electricity & Gas bills
- Insurance
- Mortgage interest only (interest restriction rules may mean this is only available at basic rate)
- Council tax
- Water
This makes the rental route attractive, as the Director can offset additional home running costs compared to the other two options.
Use of home: tax planning points
We’re getting to the crux of things now – the reality is that from a tax planning perspective it makes sense for the Director to charge a rent that is broadly in line with the deductible proportion of their home running costs, so long as that is commercially justifiable. This means on their personal tax return there will only be a small or no rental profit.
To work out what proportion of costs are deductible the Director should first identify their total home running costs on an annual basis by adding up the annual costs for the bullets points above, for our example let’s say total annual costs are £8,000. Then, they should proportion this based on the space that the business will occupy. If the business uses one room for 90% of the time and there are 7 rooms in the house then the proportion would be £8,000 X 1/7 X 90% = £1,029.
As we can see, that’s a larger deduction than the £312 flat rate, generating greater tax savings for the company and for the Director.
Like all things when it comes to tax there can be a few pitfalls, and you should check there is no impact on your home insurance or that it does not trigger business rates. Of course, we’d be happy to talk this through with you.
If you think you could save some money and reduce your tax bill through a rental agreement then get in touch – we have template agreements ready to go and can help calculate household costs.
For more tax saving ideas for Directors check out:
