Are pre-start up expenses tax deductible?
Jane has decided to turn her hobby into a business which she’ll run though a company. She bought stock and equipment for her hobby which will now be used for the business instead. Can it claim tax deductions for these costs? Brona MacDougall provides the answers.
You may already be aware that tax legislation includes special rules for tax relief in respect of business expenses incurred before trading commences. There are separate but similar rules for businesses that are to be run through a company or sole trader or partnership. However, there are two complications for the example above because the expenses:
• were incurred prior to the formation of the company; and
• related to an activity carried on as a hobby.
We’ll consider these points later, but first we’ll look at the general rules for pre-trading expenses.
Pre-trading costs – general principles
A tax deduction is allowed for expenses incurred within the seven years before a business begins trading as long as they would be deducible had they been incurred after trading commenced. A deduction is only allowed where the person (company) who incurs the expense uses it for their business when it commences.
Strictly, expenses incurred by an individual for a company prior to it being formed aren’t tax deductible under the pre-trading rules because the individual is not the person that eventually carries on the trade, the company is. However, Jane in the example above can get around this block.
After the company is formed Jane can claim reimbursement from it for the costs she incurred before. From the company’s point of view this expense, i.e. the reimbursement, is after incorporation and is therefore tax deductible under the pre-trading rules or, if the company has commenced trading, the normal rules. The tax position for the person who receives the reimbursed expenses must also be considered.
There are no clear rules on whether or not the example above would be taxable on the reimbursed amounts. But the good news is that in practice HMRC won’t tax reimbursements made in the circumstances described above if they wouldn’t have been taxable had they been incurred when the recipient worked for the company.
For expenses to be tax deductible they must be incurred for the purpose of the business. This means the company can’t get tax deductions under the pre-incorporation rules for day-to-day costs such as travel and phone bills which were incurred before Jane decided to make her hobby a business. On the other hand, a deduction can be claimed for:
• The cost of any stock bought for the hobby but used in the business.
• Other expenses incurred while the hobby was still active, not used in connection with it and used for the business.
• The value of equipment used for the hobby which is then used by the company for its business.
Only expenses incurred after the company has been formed can be claimed using the “pre-trading expenses” rules. To get around this the company, once incorporated, can pay for the value of any stock and equipment which it uses for its business, Jane would not be liable to tax on these items.