MONTHLY FOCUS: TAX CONSIDERATIONS FOR HOME WORKERS IN THE POST-CORONAVIRUS ERA

Even though coronavirus-related lockdowns are now in the past, it appears that homeworking remains popular - even if it is only for one or two days a week. What are the tax implications here?

MONTHLY FOCUS: TAX CONSIDERATIONS FOR HOME WORKERS IN THE POST-CORONAVIRUS ERA

Basic principles for the self-employed

What are the basic principles?

The basic rule for the self-employed is that they can deduct expenditure incurred wholly and exclusively for the purposes of their business, including a proportion of any expense incurred partly for other purposes where there is an identifiable element that is incurred wholly and exclusively for business purposes.

This means that if part of the house is used wholly for business purposes for some of the time, a proportion of the household expenses can be claimed.

HMRC accepts that this can include an appropriate amount of both fixed and variable household costs, where there is business use of substance. It does, however, distinguish true homeworking from incidental, casual and occasional use, such as for writing up records once a week.

Example 1 - Owned property

David uses the spare bedroom in his four-bedroom house as an office, where he typically works 6.5 hours per day on weekdays for 48 weeks of the year. In addition to the four bedrooms, the house also has two reception rooms, a kitchen, a bathroom and two toilets.

At its simplest level, the calculation that HMRC proposes suggests that the individual apportion relevant costs based on the proportion of use on a room basis.

Kitchens, bathrooms, toilets, lobbies and hallways, being merely ancillary to the rest of the house, are generally ignored for these purposes, so we can effectively treat the building as a six-room house. David’s total and business usage can be set out in the following terms:

Total use = 6 rooms x 24 hours x 7 days x 52 weeks

52,416 room-hours

 

Business use = 1 room x 6½ hours x 5 days x 48 weeks

1,560 room-hours

2.97%

So, the business element of David’s household costs can be taken to be 3%; the principal costs are set out below.

Note. In the case of mortgage payments, it’s only the interest element that can be claimed and not any element representing capital repayment.

Mortgage interest (£300 per month)

£3,600

 

Council tax

£1,750

 

Insurance

£350

 

Electricity/gas

£1,300

 

Total

£7,000

 

Business use (3%)

£210

£17.50 pm

 

Example 2 - Rented property

For the purposes of later comparison, this next (largely identical) example shows the position in respect of a rented property.

Like David in Example 1, Claire uses the spare bedroom in her rented four-bedroom house as an office. Again, she typically works 6.5 hours per day on weekdays for 48 weeks of the year. In addition to the four bedrooms, her rented house also has two reception rooms, a kitchen, a bathroom and two toilets.

The facts are identical to the first example, but this time the property is rented meaning that the expense of occupation is much greater, resulting in a larger claim.

Rent (£700 per month)

£8,400

 

Council tax

£1,750

 

Insurance

£350

 

Electricity/gas

£1,300

 

Total

£11,800

 

Business use (3%)

£354

£29.50 pm

 

Both these examples are simplified, and it may be that on a more precise allocation the amounts calculated might be smaller or greater. For example, the room used as an office might be especially large or small compared with others in the home and therefore an alternative apportionment of expenses should be considered.

The examples do, however, provide a useful contrast to the flat-rate deductions that are considered later.

 

What are the bases of apportionment?

HMRC rightly distinguishes between fixed costs - the first three items listed in the table above - and variable costs - the electricity and gas - which might be apportioned on different bases.

For the fixed costs, instead of a room basis the individual might use floor area, particularly if there are any large open-plan spaces in the house.

For the variable costs, it’s often going to be more appropriate to measure the usage.

For example, it might be that David lets his central heating run from 6.00am to 9.00pm, a period of 15 hours, rather than the full 24 hours in the day, and we can revisit our percentage calculation to ascertain annualised figures.

Alternatively, supplies can sometimes be separately metered and this might mean apportionment is easier or might not be needed at all.

 

What costs can be claimed?

Water and sewerage charges

There are also probably many other costs that aren’t included in the above examples; an obvious omission is water and sewerage charges. HMRC does say that where business use is minimal none of the water charges would be considered allowable. The only other situation it expressly mentions is where there’s a separately metered business supply which is fully allowable.

In between the two situations there may be a basis for apportioning the expenditure. Unlike the other variable costs, there’s likely to be a higher non-business element: baths, showers, washing up, etc. So, it may be more appropriate to include a more moderate proportion; although in David’s case if expenditure is moderate, we could probably apply the same 3%.

Telephone and broadband

Another obvious omission from the example is telephone and broadband charges. The variable costs of broadband and telephone usage can be apportioned between business and private and the fixed costs can be apportioned based on the extent of the business use.

However, in the context of the flat-rate deductions (simplified expenses), HMRC issued Business Brief (14/13) in 2013, which says that where private use is minimal, the whole expense can be claimed.

Repairs and cleaning

HMRC’s guidance also says that general repairs and cleaning can be apportioned like the fixed costs, but repairs and cleaning to specific parts of the property should be apportioned according to the use of that specific part. This seems entirely fair and reasonable.

 

Capital expenditure up to 29 October 2018

Finally, the other types of expenditure that haven’t been mentioned are mainly capital in nature, such as structural alterations to the property and furniture for the office. For expenditure prior to 29 October 2018 no income tax deduction is likely to be available for structural alteration costs, unless they fall within the limited categories of expenditure on buildings that qualify for plant and machinery capital allowances, such as integral features and certain other fittings.

Note. Broadly, integral features are additions to structures which compliment or are in themselves a form of equipment, but which aren’t plant or machinery. Integral features are defined and listed in legislation. Examples of commonly claimed integral features and fixtures which qualify for capital allowances are:

Integral features

  • lifts, escalators and moving walkways
  • space and water heating systems
  • air-conditioning and air cooling systems
  • hot and cold water systems (but not toilet and kitchen facilities)
  • electrical systems, including lighting systems; and
  • external solar shading.

Fixtures

  • fitted kitchens
  • bathroom suites; and
  • fire alarm and CCTV systems.

The cost of furniture qualifies for capital allowances including a 100% deduction in the year of expenditure as part of the annual investment allowance (AIA). The AIA applies to £1 million of capital expenditure between 1 January 2019 and 31 December 2021. Before and after those dates the AIA is £200,000. Where there is private use of the furniture or other assets, the amount of capital allowances claimed should be proportionately reduced.

 

Capital expenditure on and after 29 October 2018

A new tax allowance known as the structures and buildings allowance (SBA) was created in October 2018. It allows companies and unincorporated businesses to claim CAs for the cost of creating, altering or renovating a structure or building. Where CAs have been claimed for the cost of plant, equipment or integral features the SBA cannot be claimed for the same asset.

In practice the SBA is unlikely to apply to homeworkers because it does not cover a structure or building if “it is used by any person as, or for purposes ancillary to use as, a dwelling-house”. However, where, for example, an outbuilding which is located near to the home but not “situated on land that is, or is intended to be, occupied or enjoyed with a building or structure that is in residential use as a garden or grounds” is constructed or converted solely for business use and does not have an ancillary function as part of the home, the SBA can be claimed for the capital costs (to the extent that CAs weren’t permitted under the main rules).

The SBA allowance is given as a deduction from profits in the same way as other CAs, but the amount of the deduction is just 3% per annum (2% up to 5 April 2020) of the qualifying costs on a straight-line basis. So if the owner spent £30,000 constructing an office and storeroom that is not for residential use according to the rules explained above, they could claim an SBA deduction of £909 per year for 33 years. If they stop using the outbuilding for business they cease to be entitled to the SBA, but there is no adjustment or claw back of the allowance as there can be with other types of CA. Instead when they sell or transfer the building or structure, e.g. they move home, the amount of SBA e claimed reduces the cost they can take account of for capital gains tax purposes.

 

How does HMRC apply the homeworking rules?

All of the points considered in this section are referred to in HMRC’s examples taken from its Business Income Manual BIM47825.

One point that HMRC makes consistently in its guidance is that unless there is business use of substance, it won’t allow a claim. However, it will accept reasonable estimates of home expenses for minor but genuine business use. It gives an example of a self-employed individual who uses their home for business purposes for just an hour a week writing up their books. They claim a deduction of £104 (equivalent to £2 per week), which HMRC finds acceptable.

Most of HMRC’s other examples given in HMRC’s manuals involve quite prudent claims, but at the other end of the scale is its Example 6 of Gordon, who claims 75% of the costs that have been apportioned to one particular room. If his house had six relevant rooms, that would represent 12.5% of the total costs.

HMRC’s examples allocate costs firstly to the room used for business purposes, often on a floor area basis, and then divide the costs of that room between business and personal use, as is shown in Example 4 of Chris.

Its examples also assume that the pattern of use is constant and the same hours are spent using the room for business seven days per week, 52 weeks per year.

The reality may be that the pattern varies between the working week and the weekend, and that there may be weeks when there’s no business use, as was shown in our examples for David and Claire.

HMRC’s final example of Bill who uses his home for entertaining, may be incorrect. It dismisses both the catering costs and the cleaning costs incurred by Bill as being non-allowable entertaining expenditure.

While it’s true that expenditure on entertaining is expressly not allowed by legislation, expenditure on a venue, for example the hire of a hall, at which entertaining takes place will, depending on the circumstances, usually be tax deductible. That position doesn’t change simply because the venue is the proprietor’s home.

Furthermore, the cleaning costs for the premises which Bill incurs probably will be allowable as a tax deduction.

 

What are the practical considerations?

The calculation of homeworking expenses necessarily involves estimation and subjectivity. Provided any judgements and estimates are reasonable, HMRC’s view is that it won’t disturb them just because it would have exercised its judgement or made an estimate differently.

Not everybody works a uniform pattern and, as has been noted, the pattern may vary on different days of the week and for different weeks of the year.

The pattern used in the calculation should, as far as possible, reflect reality and where necessary be an approximation. In order to help support any approximation made, in the face of a challenge from HMRC, it might be helpful to carry out a sampling exercise. This would involve recording actual business and private use over a few (representative) weeks in a year, perhaps repeated every few years to ensure that the approximated amounts remain current.

 

What’s the VAT position?

Where VAT is incurred on household expenses, e.g. on energy bills, it can be reclaimed to the extent that it relates to business use. There is no special formula for it; the rules simply require that no more than a fair and reasonable proportion is claimed.

Flat rate deductions for the self-employed

Instead of using the usually cumbersome apportionment method for calculating homeworking expenses, the self-employed can opt to use a flat-rate deduction. The flat-rate option has been extended to partners in a business partnership, except where one or more of the partners is a limited company.

Use of flat-rate expenses is optional and it’s possible to use different bases in different years.

What are the amounts of flat-rate deductions?

The amounts of the flat-rate deductions are set out below and are dependent on how many hours are worked at home.

Number of hours worked (monthly)

Allowable amount

(monthly)

 

25 to 50

£10

£2.31 p.w.

51 to 100

£18

£4.15 p.w.

101 and over

£26

£6.00 p.w.

 

Example

Jill worked 40 hours from home for ten months, but worked 60 hours during two particular months:

Ten months x £10 = £100 

Two months x £18 = £36

Total use-of-home expenses Jill can claim = £136

 

How does using flat-rate expenses compare with actual cost calculations?

David and Claire from the examples in the previous section, who both worked 6.5 hours per day at home five days per week, would be in the upper band. David, with the mortgage, came out with a rate of £17.50 and Claire, who rented, had a rate of £29.50 per month. The rates from HMRC’s examples at BIM47825 vary from £8 with minimal use to, where use is more substantial, between £15 and £57.

There will be winners and losers, so these rates are worth considering; plus since it’s possible to chop and change between calculations, it may be worth looking at both methods each year.

 

What’s included in the flat-rate deductions?

There is one area of difficulty in the interpretation. The legislation refers to a person being able to make the standard deduction for use of their home, but the standard deduction isn’t defined. It could be interpreted as just the fixed elements for simple use, not including any consumption of electricity, gas, water, etc.

HMRC, however, interprets it the other way as covering everything, including telephone and broadband. It issued a Business Brief (14/13) in 2013 confirming this interpretation.

Based on HMRC’s comments and examples in its manuals, it does seem unlikely that a minimum claim of £10 per month will meet with any great resistance where there’s at least some home use, even though the 25 hours plus requirement isn’t met.

 

Homes used for business

Introduction

Flat rates for businesses where the same premises are used both for the business itself and as a home have been introduced, as shown in the table below.

These typically apply to pubs, guest houses, family hotels, etc. Previously, it would have been necessary to do the reverse of our initial calculation and work out the private element of the expenses.

Have board and lodging agreements with HMRC been withdrawn?

For businesses like guest houses, etc. in certain areas, there used to be board and lodging agreements that provided a simplified calculation for private use of the business premises. These agreements were replaced by the fixed rates shown in the table below.

What are the amounts of flat-rate deductions?

The business can deduct all of the expenses of the property subject to a restriction in respect of the number of relevant occupants - this is broadly an individual who lives in the property not as a paying guest (including children).

Number of relevant occupants

Non-allowable amount (monthly)

1

£350

2

£500

  3+

£650

If any of the relevant occupants only lives at the property for part of the year, the employee only needs to apply the higher rate for the months that they live there.

Example

You and your partner run a B&B and live there for the entire year. Your child is at university but comes back to live with you for three months over the summer. Your overall business premises expenses are £15,000.

Flat rate: 9 months x £500 per month = £4,500
Flat rate: 3 months x £650 per month = £1,950
Total = £6,450

You can claim:
£15,000 - £6,450 = £8,550

 

Employees and directors using their homes

Introduction

Employees can only make a claim against their employment income for expenses that they’ve incurred wholly, exclusively and necessarily in the performance of the duties of their employment. The “necessarily in the performance” condition can be especially difficult to meet.

HMRC’s long-standing view is that most employees who work from home don’t do so out of necessity. It’s generally the case that they simply need somewhere to work, but it can be anywhere and the home is as good a place as any. This approach has meant that tax relief claims for employees’ household expenses when they work from home have generally been challenged by HMRC. While the rules haven’t changed, for 2020/21 only (this period could be extended) additional rules applied aimed at making tax relief easier for directors and employees who work at home. For example, in October 2020 HMRC announced that any employee who has worked from home for part of any week due to the coronavirus can claim the £6 fixed deduction (see below) for 2020/21. Usually, this is only available to those contractually obliged to work from home, and has since reverted to the norm.

Notwithstanding the special circumstances resulting from coronavirus, the changing landscape and greater occurrence of homeworking means HMRC’s approach has more recently softened somewhat and it won’t usually deny a claim just on principle as was previously the case. Further, where an employer requires an employee to work at home, HMRC can’t reasonably refuse a deduction for homeworking expenses that meet the wholly, exclusively rule.

 

How does the wholly, exclusively and necessarily rule work?

Essentially, an expense cannot be tax exempt or deductible if it simultaneously serves two purposes; one so that an employee can do their job and the other not, e.g. private use.

For example, the cost of lighting a room in which one person is working while another is simultaneously watching TV is not exclusive to one purpose or the other. It is therefore not deductible. Contrast that with lighting a room where the only individual occupying it is doing so for work and it’s correct to say that the cost of doing so is exclusive because it is serving only one purpose.

Of course, in our example it is practically impossible to calculate the cost of the energy used; however, tax law doesn’t concern itself with that. The cost is tax deductible, the difficulty is in how to calculate (estimate) it.

HMRC sets the level of proof required for domestic expenses to qualify for relief under the wholly, exclusively and necessarily rule very high. In practice, therefore, it is only likely to consider a claim under this rule where there is a clearly defined workspace, essentially that limits it to a room, which when in use for work is not used for any other purpose.

When calculating a claim using this rule  a similar apportionment method as that explained earlier for the self-employed homeworkers, i.e. by room or area as a fraction of a whole home, should be adopted.

But note that HMRC point blank refuses to accept that any part of a council tax bill or rent (if appropriate) meets the wholly, exclusively and necessarily rule, so regardless of the rights or wrongs of HMRC’s view, these should be excluded from the calculations.

Note that where an employer is satisfied that an employee’s homeworking costs meet the tough requirements of the wholly, exclusively and necessarily rule, it can reimburse the expense tax and NI free because of the general exemption for such payments.

While there are easier options for employees (including directors) to obtain tax relief for homeworking costs, the wholly, exclusively and necessarily route is the most generous as it’s unlimited unlike the flat rate expense allowance.

 

How does the tax-free allowance for additional household expenses work?

To avoid the practical problem of working out homeworking expenses under the wholly, exclusively and necessarily rule, tax legislation includes an exemption to simplify tax relief for homeworking costs:

  • the exemption allows employers to make a tax and NI-free payment to an employee of £6 per week towards the cost of “additional expenses” incurred as a result of being required to work from home. It applies where an employee regularly works from home under arrangements agreed between the employer and employee; and
  • in practice HMRC usually accepts, but is not obliged to, that an employee who incurs additional household expenses because they are required to work from home, and who doesn’t receive any payment for them from their employer, can claim tax relief equal to the flat-rate tax deduction.

It’s only necessary for the employee to prove that they incur additional household expenses arising from working from home; they don’t have to prove how much those expenses are.

The maximum tax-free employer payment and tax deduction claimable is £6 per week or £26 per month without any evidence of the additional expenses being necessary.

If the amount paid by the employer exceeds £26 per month (or £6 per week) and no evidence of the additional household expenses is provided, the excess is liable to tax and NI in the same way as salary, i.e. the PAYE system applies.

Example

Stephen spends two days per week under a flexible working arrangement with his employer. It’s the employer’s policy to pay employees an allowance of £50 per month where they work two or more days a week at home.

Stephen believes that the additional costs of his homeworking are certainly no more than £26 per month and so provides no evidence to substantiate a greater amount of additional costs.

The first £26 of the £50 allowance is tax and NI free. The remaining £24 is taxable as additional pay on which PAYE tax and NI is payable.

 

What is the tax and NI exemption for “accommodation expenses”?

Another exemption allows employers to provide and pay for goods (without transferring ownership) and services at an employee’s home so that they can work there. Unlike other exemptions for homeworking expenses payments, there’s no need for the employee to work regularly from home or for there to be a formal agreement. Even where the employee gains a personal financial benefit from the goods or services, no tax or NI charge arises as long as the private use is not significant. HMRC’s view of what counts as “not significant” is quite generous, which means employees can get some real tax and NI-free advantage from this exemption. The main aspects of the exemption are:

  • there’s no financial cap
  • the employee must have a genuine need for the goods or services so they can do their job
  • the company must pay for the goods and services and be contractually liable for their cost. For example, a broadband contract must be in the company’s name even though it’s provided at the employee’s home.

The exemption can apply to, say, office equipment, e.g. a desk, chair, computer, etc., as well as services like phones and broadband.

 

How does the accommodation expenses rule apply to equipment for homeworking?

Where an employee or director owns equipment which they use for work, they are entitled to claim a capital allowance (CA) for the cost or market value of the equipment when they started to use it for work, proportionate to business use.

Example

Brianna works for Acom Ltd. In May 2023 she bought IT equipment costing £2,400 (including VAT) primarily for use by her family, but she now uses this for her job. She expects the computer to last four years before she replaces it and that the percentage of work-related use compared with the total over that period is 30%. She claims £720 from Acom. Brianna can claim a tax deduction for 2023/24 of £720 (£2,400 x 30%), but must reduce this by the payment she receives from Acom, i.e. £720. Therefore, her tax position is neutral. If Acom didn’t pay her, the CAs would reduce the tax payable on her salary.

 

What if the amount of business and private use varies?

Following on from the example above let’s assume that the business use of the equipment varies from Brianna’s 30% projection. For example, she stops using the IT equipment altogether in a year’s time. What are the tax consequences? Because of the quirky way that the CAs rules work the change in usage has no effect on the tax relief she has claimed. Therefore, neither Brianna nor Acom needs to review the tax treatment of the £720.

 

Alternative method for company owner managers

Introduction

Directors are generally in the same tax position as other employees. Unless they can substantiate a higher figure for homeworking expenses they can only be reimbursed tax and NI free by their companies, or claim a tax deduction, of up to £6 per week, even though they might work at home most of or even all the time.

 

Is there a more tax efficient alternative to claiming expenses?

Where a director is also the company owner, there is an alternative to claiming a tax deduction or receiving a tax-free allowance for their household expenses. They can charge their company a rent for the exclusive use of their home.

The rent the director receives counts as taxable income (the company can claim a deduction from its corporation tax bill for the rent it pays). Tax rules then allow the director to deduct household costs from the rent, much in the same way as a self-employed person can deduct them from their business profits. Because the rules for tax-deductible expenses from rent are less strict than those which apply to employees and directors, there‘s more scope for tax relief.

The amount of rent charged should be set at a level that exceeds the amount of deductible costs and can be any amount up to what would be chargeable as a reasonable market rent for the part of the house being rented. Any profit, i.e. rent less expenses, is taxable on the director.

Example

David from the first example in the self-employed standard calculation section has incorporated his business. If he charges a rent to his company, he will be able to deduct the £210 that he previously claimed as a tax deduction from his self-employed business.

If David had unused personal allowances of just over £1,840, he could charge the company a rent of £2,050 (£1,840 + £210) so that his rental profit uses up most of his remaining personal allowance.

However, David considers that he would be able to rent similar office space for £150 per month and so he decides to charge the company only £1,800, meaning that his rental profit is £1,590 and a small amount of his personal allowance will be unused.

 

What other points about the arrangement need to be considered?

Where the property rented out is owned by the director jointly with someone else, say their spouse, the rental agreement must be between the director’s company and all the joint owners.

Another point worth mentioning is that the flat-rate deductions previously mentioned only apply to trades, professions and vocations, and not to a property rental business. However, in practice, HMRC may be amenable to their use.

A similar arrangement can, if appropriate, be used to charge the director’s company rent for the use of any storage space that it uses, for example, to hold stock, old business records etc. at the director’s home. However, care needs to be taken over the exclusive use point.

Unfortunately, the rent-a-room scheme tax allowance can’t be used in respect of the provision of office space or other business accommodation. HMRC’s view is that the scheme only applies to accommodation used as living space. Challenges have been made to that view, but on this occasion, it seems that HMRC’s approach is the correct one.

 

Capital gains tax private residence relief and business rates

Introduction

Previous sections have looked at the income tax position of using a home for business purposes. In this section we consider the implications that using a home for business can have for capital gains tax (CGT) and business rates purposes.

 

What is CGT private residence relief?

For CGT purposes, there won’t be any taxable gain where an individual sells or transfers a property that they’ve occupied as their main residence throughout the period of ownership excluding certain permitted periods of absence.

Where there is more than one residence, it’s possible to elect which one will be treated as the main residence. Married couples and civil partners can only have one main residence between them.

 

Does business use of a home affect private residence relief (PRR)?

Using a home for business can affect the amount of gain that qualifies for PRR and, or the amount of relief that can be claimed. The two rules are separate, although they are often confused as a single rule.

The type of restriction which applies depends on whether the individual uses their home for work as an employee (that includes directors) or as a self-employed individual or business partner and for what fraction of the period of ownership they used the property for work. Which restriction applies is often academic because the result in terms of tax is the same, but that’s not always the case and therefore the correct restriction should always be applied.

Self-employed individuals and partners

If an individual sells a home for more than they paid for it, and they have used all or part of it at some time exclusively for the purpose of a “trade or business, or of a profession or vocation” (i.e. where they were self-employed or a business partner), that part of the gain must be worked out separately and does not qualify for PRR.

The calculation is usually made on a simple apportionment basis.

Example

Megan is a doctor who has recently sold the house that she occupied as her main residence for the last ten years. She makes a capital gain from the sale of £60,000. For a three-year period during her ownership, Megan used one of the reception rooms exclusively as a consulting room to see patients.

Megan estimates that the consulting room represents around 10% of the total floor space of the property. The house has no garden or grounds.

Because 10% of the property has been used exclusively for business purposes for 30% of the period of ownership, 3% of the gain (£1,800) cannot qualify for PRR and therefore will be liable to CGT. The remainder of the gain, £58,200, qualifies for PRR.

 

The rule only applies if part of the home is used exclusively for business. Therefore, setting up a workstation on a dining room table will not trigger the rule. However, if a room in the house is a dedicated office, the rule is triggered and a computation of how much of the gain cannot qualify for PRR needs to be undertaken.

The usual advice is to keep a personal bookcase or something similar in the home office so that it isn’t exclusively used for work. This doesn’t solve the problem. The rules say that “any part” of the house exclusively used for business will lose its CGT exemption. The division of a house into rooms is irrelevant, as the rule can apply to part of a room.

Nevertheless, it’s easy to get around the “exclusively for business” rule by the individual or members of their household using the room for non-business purposes. For example, using the computer for personal e-mail, watching catch-up TV etc., dealing with and keeping personal paperwork. In practice it’s a difficult rule for HMRC to enforce.

 

Employees and directors

If the individual uses part of their property for any purpose other than as a home, HMRC can reduce the amount of PRR they qualify for. An employee or director who sets aside a room in their home for work would be caught by this restriction.

Example

Tim is a director and recently sold the house which he has occupied as his main residence for the last ten years. Like Megan from the previous example he makes a capital gain from the sale of £60,000. Also like Megan, Tim used one of the rooms for work for three years.

Tim also estimates that the room represents around 10% of the total floor space of the property. The house has no garden or grounds.

The gain on which PRR could apply is £60,000, but strictly because 10% of the property has been used for a purpose other than as Tim’s main residence exclusively a restriction to the PRR is required. There is no set method for working this out, anything fair and reasonable is acceptable to HMRC. Therefore, the restriction to PRR could be calculated at £1,800, i.e. £60,000 x 30% x 10%, which equals 3%. You might therefore assume that £1,800 of Tim’s gain would not be covered by PRR. In practice, however, HMRC would agree to no restriction in the PRR being made. Thus the whole £60,000 gain is covered by PRR. The reason for this is explained below.

 

In its guidance to tax inspectors HMRC says “No adjustment” to reduce PRR “should be made where, for example, a room is used as a study”. However, it goes on to say “If a substantial part of the residence is used exclusively as an office” then PRR should be restricted. 

As an employee or director if the individual uses more than one room in their home for work, HMRC will expect them to reduce the amount of PRR claimed when they sell it. The rules say that the amount of PRR allowable should be reduced using a “just and reasonable” calculation. However, in our experience the risk of a significant CGT bill is small, so this should not be too concerning in practice.

Example

Sophie, a director of Acom, sells her house and makes a gain of £250,000. She owned it for 15 years and for ten of them exclusively used 15% of it for work purposes. PRR would normally cover the whole £250,000 gain, but a just and reasonable reduction would be £250,000/15 years x 10 years x 15%. That produces a figure of £25,000 which is the amount of gain to which PRR won’t apply. However, because Sophie is married, and she and her husband have their annual CGT exemption (£12,300 for 2020/21) available to set against the gain, only £400 of it is taxable resulting in a maximum CGT bill of just £112 (£400 x 28%).

 

What’s the government’s policy on business rates and homeworking?

The government doesn’t normally expect owners to pay business rates on their home where:

  • a small part of the home is used for a business (e.g. a bedroom - for part of the day as an office)
  • it is not used to sell goods or services to visiting clients or members of the public (as opposed to selling by post)
  • the proprietor does not employ other people to work at the premises
  • there have been alterations that are not for a domestic purpose (such as converting a garage into a hairdressing studio or installing a hydraulic car lift).

 

What are the business rates implications?

Where any of the conditions mentioned above aren’t met and part of a home is used predominantly for business purposes or homeworking, it may be that the part of the home can become liable to business rates.

This is a matter that will be decided by the Valuation Office Agency (VOA) and if there is uncertainty about whether a homeowner needs to pay business rates their contact number is 03000 501 501 (England) or 03000 505 505 (Wales).

Generally speaking, unless a large area of a home is used for business and it’s a very valuable property, small business rates relief is likely to mean that no business rates are payable.

 

What is the CGT private residence relief and business rates interaction?

If the VOA considers that any part of the property is liable to business rates, it’s more likely that CGT main residence relief will also be restricted. Conversely, if no part of the property is liable to business rates, it doesn’t necessarily mean that CGT main residence relief won’t be restricted.

However, in the examples given by the VOA, there are two of them (Example 2 of the software designer’s garage and Example 4 of the doctor’s makeshift consulting room) which are considered liable to business rates that might very well still qualify for full CGT main residence relief because there’s no exclusive use of any part of the property for business.

Other than these two examples, the business rates treatment and CGT main residence relief treatment would be consistent.

 

What are the practical considerations?

It’s essential that a record of the length of time and extent of the area of a main residence which is used for business is kept so that an accurate calculation of PRR can be made,  evidenced by contemporary records. Armed with this information, HMRC won’t be in a position to overturn the calculations.

Remember that where an area of a home is not used exclusively for business purposes no restriction to PRR is required. In practice, HMRC is only likely to challenge a claim if it can reasonably demonstrate that part of the home was wholly devoted to business, for example, if part of the property is annexed for an office or consulting room.