Jet Accountancy

During the Covid-19 pandemic, the advice was ‘work from home if you can’. As a result, millions of employees found themselves working at home, often at very short notice. Many still have not returned to the workplace, and homeworking (whether fully or flexibly) is here to stay.

Employees will generally incur additional costs as a result of working from home. They will use more electricity to run their computer and light their workspace and may use more gas as a result of having the heating on during the day.

While for many years there has been a statutory exemption that allows employers to meet or contribute towards the additional costs of working from home, in recognition of the homeworking requirements imposed by the pandemic, employees who do not receive homeworking payments from their employer are able to claim tax relief for the extra household costs that they have incurred while working from home.

Exemption for costs met by the employer

Employers can pay employees a homeworking allowance of £6 per week (£26 per month) tax-free, and without the employee having to demonstrate that they have actually incurred additional household costs of at least this amount as a result of working from home. The tax-free amount is the same, regardless of whether the employee is required to work from home full-time or one day a week. Consequently, the payments can be made to employees who work flexibly, working from home part of the time and at the employer’s workplace part of the time.

Where the employee’s actual additional household costs as a result of working from home are more than £6 per week, the employer can meet the actual costs tax-free, as long as the employee is able to provide evidence in support of the actual additional costs.

Tax relief for employees

Employees who have been required to work from home can claim tax relief for the additional costs of doing so where these are not met by the employer. HMRC will accept claims of £6 per week/£26 per month without needing evidence of the actual additional costs. Where these are higher, the higher amount can be claimed, as long as this can be substantiated.

HMRC are now accepting claims for 2021/22. Claims can be made online at www.tax.service.gov.uk/claim-tax-relief-expenses/only-claiming-working-from-home-tax-relief?_ga=2.193253997.1398232652.1624373729-980780301.1612354164.

Relief is given for the full tax year, even if the employee returns to the workplace before 5 April 2022. Employees who were entitled to the relief for 2020/21 can also claim for that year if they have not yet done so.

Where an employee is required to complete a self-assessment tax return, the claim can be made on the return. A claim of £6 per week (£312 for the year) will save a basic rate taxpayer £62.40 in tax and a higher rate taxpayer £124.80 in tax.

It is not uncommon to realise a loss in the early years of a trade. However, traders who commenced their self-employment in 2019 or 2020 may also have suffered as a result of the pandemic. Although the Self-Employment Income Support Scheme (SEISS) provided help for traders who also suffered from the impact of the pandemic, those who started trading in 2019/20 were unable to benefit from the first three grants (qualifying only for grants 4 and 5 if they had filed their 2019/20 tax return by 2 March 2021 and met the other eligibility criteria). Traders who started a business in 2020/21 are not able to benefit from the SEISS.

However, they may be able to claim loss relief under the early trade losses relief rules, and generate a tax repayment in the process.

Nature of the relief

The relief for losses in the early years of the trade allows a trader who makes a trading loss in any of the first four years of a new trade to carry that loss back against taxable income of the previous three years. The loss is set against the income of the earliest year first.

Accruals basis not cash basis

Relief for the loss under these rules is only available where the accounts are prepared on the accruals basis. Thus, if losses in the early years are likely, it is worth considering preparing accounts using the accruals basis to open up a claim to relief. This relief is not available where accounts are prepared under the cash basis –  where this is the case, the loss can be carried back against any previous trading profits of the same trade, should they exist, or carried forward and set against future profits of the same trade.

Case study

Polly was employed as a beautician earning £25,000 a year prior to setting up her own beauty business on 1 June 2020. Her business was badly affected by the pandemic, and in the 10 months to 5 April 2021, she makes a loss of £10,000. This is a loss for the 2020/21 tax year.

She can carry the loss in her first year back against her income of 2017/18, 2018/19 and 2019/20, setting the loss against her income for 2017/18 first.

She carries the loss back to 2017/18, setting it against her employment income for that year of £25,000, reducing her taxable income to £15,000 in the process. Carrying the loss back generates a tax repayment of £2,000 (£10,000 @ 20%).

Personal allowances may be lost

It should be noted that the loss carried back cannot be tailored to preserve personal allowances, which may be lost as a result.

For personal and family companies, a tax efficient strategy for extracting profits is to take a small salary and to extract any further funds needed outside the company in the form of dividends. However, while there are no restrictions on taking a salary if the company is making a loss, the same is not true of dividends.

Need for retained profits

Dividends can only be paid out of retained profits (i.e. profits left in the business after corporation tax has been paid).

However, if a company make a loss for a particular year, this does not necessarily preclude the payment of a dividend, as long as the company had retained profits at the start of the year, and the loss has not completely eliminated those profits.

Example

Andrew runs a personal company A Ltd. He prepares accounts to 31 July each year. At 1 August 2020, he had retained profits of £20,000. He expects to make a loss for the year to 31 July 2021 of £5,000. He will have retained profits available after taking account of the predicted loss of £15,000 from which to pay dividends.

Plan ahead

If a company needs funds outside the business and is unsure regards to future profitability, it may be worthwhile taking dividends while there are retained profits available.

Using the figures in the above example, assuming that Andrew has cash available, he may wish to extract all his retained profits as a dividend while he can to benefit from the more favourable tax treatment of dividends. If he makes further losses, his remaining profits may be eliminated, removing the option of taking a dividend.

The dividend will be tax-free to the extent to which it is covered by the dividend allowance (set at £2,000 for 2021/22) and any unused personal allowance. Thereafter, dividends (treated as the top slice of income) are taxed at 7.5% to the extent to which they fall in the basic rate band, at 32.5% to the extent to which they fall in the higher rate band and at 38.1% if they fall in the additional rate band. There is no National Insurance on dividends.

It is prudent to prepare management accounts to show that the company had retained profits at the time at which the dividend was paid, in case of a challenge by HMRC.

No retained profits

In the absence of retained profits, it is not possible to pay a dividend; any payment made that is classed as a dividend, will be made illegally and may be challenged by HMRC and reclassified as a salary or bonus payment, and taxed accordingly. However, if the company is loss making, but funds are need to meet personal liabilities, it is possible to pay a higher salary or a bonus, even where this increases the amount of the loss. The salary or bonus payment, and any associated employer’s National Insurance, can be deducted in working out the taxable loss, which may be carried back to generate a repayment of corporation tax.