Lee Sharpe explains that although there is tax relief for pre-trading expenditure, there are numerous conditions to navigate.
Introduction
As a basic principle, expenses may be claimed only against the income they generate. This article aims to help you make sure you can claim relief on expenses – even when they have been incurred before the income starts.
The basics
There is provision in the legislation to deal with – and to allow – pre-trading expenses. We shall look at the various scenarios in turn. A key point is that the tax relief cannot be claimed until the business actually starts. Note it is not always easy to say when a trade has ‘commenced’.
Self-employed – trade, profession or similar
A deduction for pre-trading expenses will be given where:
- the expenditure is incurred no more than seven years prior to the commencement of the trade proper;
- it would be an allowable expense if incurred once the trade had actually commenced, (“would it be an allowable expense if incurred now, after the trade has started?”);
- the expense cannot already be deductible against trading income – preventing a double-claim; and
- the expense must be incurred by the person who ultimately carries on the trade
The eligible period – up to seven years – is fairly generous, and will easily cover most businesses (it could be argued that, if a business takes seven years to get off the ground, it may not be viable in the first place!).
Having said that, I have come across two nascent business ventures that actually came up against this seven year limit. One was a project to devise a scheme of finance that was acceptable to a particular set of religious beliefs. The other was a property development project which had stalled early on, nevertheless at considerable expense.
The condition that the pre-trading expense would need to be allowable if claimed in an ongoing trading business blocks the usual suspects, such as private expenditure, entertaining and capital costs (but see later for the separate rules for capital allowances).
How to claim the relief
The expenses are added together and – for tax purposes only – claimed on the day that trading commences, alongside the normal expenses incurred once the trade starts. Since they are aggregated with post-commencement expenses in the first trading period, they will simply reduce the taxable profits of the first trading period, or perhaps create (or enhance) a loss.
For reference, the legislation is at ITTOIA 2005 s 57; HMRC guidance is in their Business Income manual BIM46350 and following.
Property businesses
Previous sections have referred to ‘businesses’ and to ‘trades’. Strictly, the words are quite different from a tax perspective: simply, a trade is a particular kind of business, and not all businesses qualify as trades.
For instance, a property investment business, where the owner rents out the property, is treated as a business but not normally as a trade. A similar regime applies for property businesses as for trading businesses, and provided the same criteria are met, (swapping ’property business’ for ’trade’ in the above conditions), then relief should be secured in the same way.
Remember that, ignoring overseas properties and the special regime for furnished holiday lettings, there is normally only one property business, regardless of how many properties you let out. So you should have to deal with ‘pre-letting expenditure’ only once, prior to letting your first property. Any expenditure after you first let one property, even on a new property prior to its being let, counts as ongoing property business expenditure.
The legislation at ITTOIA 2005, s 272 confirms that s 57 applies for property businesses just as it does for trading concerns. See also HMRC’s Property Income manual at PIM2505.
Companies – trading or letting
The rules for companies work in essentially the same way for companies as they do for individuals: pre-trading expenses (or pre-letting expenses) may be claimed immediately the business properly commences, subject to the conditions set out above and by HMRC in BIM46351, by virtue of CTA 2009, s 61.
Beware a trap; you are not the same legal person as your company: each is a distinct legal entity. But it is common for people to weigh up a business venture for some time before committing to buy or incorporate the company vehicle. They may well incur substantial personal costs prior to setting up the company that will ultimately run the business. It must be the same person who incurs the expense, who must also claim the tax relief on commencement.
The simplest approach is for the company to reimburse the director/employee for the expense(s) incurred, and to treat the cost of reimbursement as a deductible expense in the company’s books. But this potentially puts the director in a difficult position: he may be taxed personally on the reimbursement as a ‘benefit in kind’ – unless he can convince HMRC that it was a legitimate business expense incurred on the company’s behalf. To be fair, HMRC usually does allow such claims.
But if the claim is substantial and certainty is preferred, the individual can instead set up the company beforehand, then lend money to the company so that it can pay directly for its own expenses, reclaim them when business starts and repay the loan when profitable.
Capital allowances
While capital expenditure (pre-trading or otherwise) is generally not tax-deductible, certain capital costs may be claimed under the Capital Allowances route for plant and machinery and similar items, including cars, vans, office equipment and the like. Here again, where the capital expenditure is incurred before the trade or property business starts, it is deemed to have been bought when the ‘qualifying activity’ actually commences (CAA 2001, s 12; Capital Allowances manual CA23020).
But note that eligibility for the 100% annual investment allowance is calculated by reference to the date of actual acquisition, not the commencement date.
Reclaiming VAT on pre-trading expenses
There are provisions to reclaim VAT incurred prior to VAT registration, basically as follows:
- For goods such as stock or fixed assets, broadly up to 4 years prior to the date of registration, provided the items are still on hand at the date of registration and will be used to make VATable supplies. There are special rules for high-value capital items such as property.
- For services such as professional fees, up to 6 months prior to registration.
A business will generally register after the trade has commenced but it is possible to register as an ‘intending trader’ and the above periods can happily extend back prior to the date of commencement.
Do beware that expenses originally incurred for private purposes may be blocked even if they satisfy the above conditions.
VAT on pre-incorporation expenses
Since a company cannot register until it is actually incorporated, it is helpful that the VAT rules allow for the above periods to extend back prior to incorporation, on the basis that the expenses were incurred in order to make VATable supplies. See the VAT Regs 1995 Regulation 111 and VAT manuals VIT32000.
So when does trading actually commence?
This can be a difficult question to answer, and may well be the subject of a future article.
Practical Tip :
There is plenty of scope to ‘roll up’ expenses prior to business commencement and claim a tax deduction (and to reclaim VAT). But it is essential that suitable records be maintained, as they may be queried many years later.
