Money: Tax relief can be twice as nice
Sunday 15 February 1998
But for the millions of self-employed people taxed under self-assessment there is a special concession available up until July which could help ease some of the financial pain. The concession gives double tax relief on so-called "capital expenditure" - computers, fax machines or even new suites of furniture for home offices. Normally 25 per cent of the cost can be offset against earnings in any one year. For purchases made before July, 50 per cent of the cost can be knocked off, reducing taxable earnings that much further.
The Inland Revenue makes a distinction between expenses - that is day- to-day running costs such as the phone bill, office rentals or business travel - and larger outlays, called "capital expenditure". Revenue expenditure or expenses, as long as they are for business use, can be wholly deducted from taxable profits, so small businesses or people who work for themselves do not pay tax on costs such as a business trip, or stationery. However anything of "lasting use in the business" cannot be claimed as an expense. Instead, the tax man operates a complicated system of capital allowances that allow part of the cost to be offset against tax over a number of years. In the first year, normally 25 per cent of the cost of most items can be claimed - there are special rules for purchases such as cars - with 25 per cent of the remaining balance claimed in the second year, and so on.
In his last Budget, Gordon Brown, the Chancellor, introduced a tax concession that lets small businesses and the self-employed claim double tax relief on capital expenditure in the first year, so long as the purchase is made by 1 July. This means that 50 per cent of the cost of a purchase, such as a new computer, can be offset, giving a tax incentive for bringing forward any purchases to take advantage of the extra relief. The Inland Revenue believes many freelancers and small businesses will do so, saving up to pounds 170m in the 1999-2000 tax year as a result.
Self-employed people can legitimately claim the cost of a whole range of purchases and services against their earnings in order to work out the profits they on which will have to pay tax. People working from home, for example, can claim part of the running costs of a home office, including heating and lighting, as an expense, as well as the cost of going to meet clients or installing and renting a separate phone line. The Revenue's requirement is that the expense is
"wholly and exclusively for the purpose of the business".
A self-employed bicycle courier is on safe grounds claiming for the costs of a bike, because it is essential to the business. If he or she never uses the bike for personal journeys, perhaps because of using a car or another bike at weekends, all the running costs are a legitimate expense. If the courier uses the bike privately, he or she can only claim expenses in proportion to the amount of business use.
A management consultant, though, would be on less clear ground. The bike would be a legitimate means of transport for going to visit clients from the office - even if the office is at home. A journey from home to the office, however, is classed as personal. In any case, it is only running costs: tyres, brake pads, or oil, that count as "revenue expenses". The cost of the bike itself is more likely to be classed as capital spending.
In practice, the difference between an expense and a capital item is not always so clear. The Revenue's rule is that any item of lasting value should be seen as capital, no matter how little it costs. Generally, though, items costing less than pounds 100 should pass as expenses.
Higher-rate tax payers will benefit most of all from Gordon Brown's concession, although the savings are not as dramatic as they might seem at first. "If in your first year, you spend pounds 10,000 on a set of office furniture and computers, normally you expect to get tax relief on 25 per cent, which saves you 40 per cent of pounds 2,500, which is pounds 1,000," explains Patrick Stevens, at accountants Ernst & Young. "This year it is pounds 2,000 not pounds 1,000."
Accountants point out that it is unwise to spend money just to save tax: the equipment still has to be funded. As Ian Leigh, of accountants Jeffreys Henry, suggests: "Don't let the tax tail wag the dog. "
There is another caveat, too: the goods actually have to be paid for before 1 July. Hire purchase deals fit into this time frame, but interest- free credit will not. The tax man will judge the purchase as taking place when the cash becomes due. If equipment has to be bought anyway, though, now is an especially good time to do it. It may even be worth borrowing, or foregoing interest on savings, to make use of the tax break.
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