Dear Contractor Doctor
I have recently returned to contracting and have the opportunity to regularly work from home.
I’m considering building and fitting out a timber office with power, phones, Wi-Fi and plumbing in my back garden.
Can I claim the expense of building an office in my back garden through my limited company?
Contractor Doctor says:
“There may certainly be VAT and income tax benefits to be gained by putting an outside timber-built office through a limited company,” explains James Abbott, founder and head of tax at contractor accountant Abbott Moore.
“However, potential complications can include ineligibility for capital allowances, personal use of the office attracting a benefit in kind charge, and business rates being levied on what may be classed as a business property by the local authority.”
In Abbott’s experience, this situation is increasing as clients, particularly those in major city centres, seek to reduce their occupancy costs by allowing some employees and contractors to work from home.
Calculating the VAT benefits
If a contractor’s limited company is VAT registered and not under the flat rate scheme, it can pay for the purchase price of the timber garden office and its fit-out with communications and utilities. It can also claim back the VAT.
“If there is no private use allowed by the director or the family then all of the VAT can be claimed back. If there is some private use, then the VAT has to be restricted, and calculated on a fair and reasonable basis.”
This means working out the pro rata personal and business usage. So, if a contractor uses the office exclusively for business Monday to Friday and the family uses it for games and TV at the weekend, the contractor would claim back 5/7 of the VAT.
VAT benefits under the flat rate scheme, but beware the counter-intuitive rules
Abbott warns that the situation under the flat rate scheme (FRS) is more complex, and the rules are somewhat counter-intuitive, so contractors need to tread carefully: “Ordinarily, contractors can’t claim back VAT on business costs under the FRS. But if capital expenditure on goods exceeds £2,000, then the VAT on these costs can be reclaimed. And under the FRS there is also no restriction on private use.”
However, Abbott warns that contractors have to be really careful about what it is they are buying. He says the clue is in HMRC’s specific wording: “capital expenditure on goods”.
“If you buy a printer, then that clearly falls under the category of being ‘goods’. But the line is blurred with construction. Paying someone to build a house extension designed to be a new office is classed as a service.
“However buying what is essentially a glorified shed, then it is goods and it can be claimed. But, and this is the counter-intuitive bit, the cost of erecting the structure and fitting it out with utilities and communications is classed as ‘services’, so the VAT on that cannot be claimed.”
Contractors who procure their garden office from a single supplier that not only supplies the structure, but also erects it and installs the services, must request an invoice that has all of the costs clearly broken down.
The downsides: no tax relief under the annual investment allowance
“The main mechanism for small businesses to get tax relief for the costs of acquiring assets likely to last a long time is via the annual investment allowance (AIA). This enables businesses to claim up to £250,000 each year,” explains Abbott.
“The issue here is that not every kind of asset qualifies for the AIA. Structures and buildings are one class of assets that do not qualify, so it is not possible to get capital allowances for the costs of the timber office.”
At the end of each financial year when a contractor’s accountant is preparing the accounts and calculating the profits chargeable for corporation tax, they will add back depreciation and then use the taxman’s rules to calculate the capital allowances.
“So, for example, if a contractor buys a computer for £900, the accountant will set off £300 a year against profits over three years,” continues Abbott. “When the accountant does the corporation tax return, they will add back the depreciation, which increases the profit.
“The taxman’s rules then say that, under the AIA, you can deduct £900 from the profits, so the profits are lower for corporation tax purposes than reported in the actual accounts.”
There may certainly be VAT and income tax benefits to be gained by putting an outside timber-built office through a contractor limited company
James Abbott, Abbott Moore
What this means for the outside office costing £10,000 is that the building will be written off over 10 years at £1,000 each year. The £1,000 is added back in to the profit and loss account, showing a higher profit. But because the shed is a structure, there is no reduction of the £10,000, and no corporation tax relief.
Benefit in kind (BIK) and capital gains tax (CGT)
“Tax legislation exempts the sale of a principal residence from capital gains tax,” says Abbott, “and this principle will apply to a contractor with a home office in their house as long as there is no exclusive business use on any part of the contractor’s property.”
For contractors with an office in a spare bedroom, this is rarely a problem, as evening, weekend and guest use of the home office prevents it being classed as exclusively used for business.
“But if a contractor has bought a timber office exclusively for business use and put it on their land, and the office represents 5% of the total floor area, then 5% of the gain when the contractor comes to sell their home will be chargeable to capital gains tax, unless there is mixed use” he adds. The contractor might also have to consider whether the company is due any share of any sale proceeds when the shed is sold with the house.
There is a trap, though, flags Abbott: “A bit of mixed use of the garden office will get around the CGT, but then HMRC may try to prove that the contractor is liable for a benefit in kind (BIK) income tax charge on the benefit they are gaining from the use of what is a company asset. If that happens, contractors must seek professional advice.”
Business rates and planning permission
The final disadvantage is business rates: “In my experience, contractors don’t normally have business rates levied by their local authority on a timber garden office, although they might do if they have made structural changes to their property.
“Contractors should contact their local authority and explain what they are planning. This is important for two reasons. Firstly, the office may require planning permission.
“Secondly, if the local authority is planning to levy business rates, then it is best the contractor knows from the outset so they don’t have a nasty surprise and a bill of thousands of pounds twelve months down the line.”
Benefits of buying a back garden office via a contractor limited company
Abbott acknowledges that, what with FRS complications, capital allowances, capital gains tax, benefit in kind and business rates, many contractors may wonder whether there really is any benefit to be gained from buying the office as a business expense.
He counters: “Contractors can gain by reclaiming the VAT on the cost of the shed. This could amount to a worthwhile sum, depending on how much the office and its installation costs.
“The other aspect is to consider what the contractor has to do to buy the shed personally. The purchase must be funded out of personal funds and the way to generate these is to generate profits.
“The cash must be extracted from the company, which attracts a 20% corporation tax bill, and is then paid to the contractor, who, if a higher rate taxpayer, will face the equivalent of a further 20% income tax on their dividend.”
If the company buys the office, it cannot claim corporation tax but it does mean that the contractor does not pay an additional 20% income tax on their dividend.
“At the very least, the contractor should be able to save some VAT,” concludes Abbott, “and they may be able to stay out of the higher rate band and pay less income tax.”