Alternative tax break for homeworking

Homeworking and tax

Directors and employees who work some or all the time from home are entitled to obtain a limited tax and NI-free reimbursement from their employers for their homeworking costs. The tax and NI-free amount is £6 for each week worked at home. If no reimbursement is received they can instead claim a tax deduction. Theoretically, there’s no limit to the tax and NI-free payment or tax deduction other than it cannot exceed the household costs that exclusively relate to business use.

HMRC practice

In practice HMRC severely limits tax relief for homeworking expenses. For example, even if part of your home is exclusively devoted to business use, HMRC has not (since 2007) accepted that a corresponding portion of interest paid on your mortgage (or rent) qualifies for tax relief.

Alternative deduction

The good news is that there’s an alternative which allows your company to pay you more tax and NI-free expenses. It can be used by any employee with agreement from their employer, but more realistically it’s probably only suitable for directors and very senior staff. Tip. The idea is simple in principle. The director or employee charges their employer rent for the use of the part of their home they use for work purposes.

How does this save tax?

Although the rent you receive from your employer is taxable, you’re entitled to reduce it by deducting household costs you incur relating to the part of your home you let. Because the rules for tax deductions from rental income are less restrictive than those for employment income, e.g. you can claim a proportion of mortgage interest, the arrangement allows your employer to pay you an amount for homeworking tax and NI free.

Example. John, a higher rate taxpayer, is a director of Acom Ltd. He lives in a six-room rented house for which he pays £2,100 per month. He uses one room, which occupies a seventh of his home’s floor area, exclusively for his work for Acom. Under the employment expenses rules HMRC is only likely to accept that Acom can pay John a tax and NI-free amount of up to £6 per week (£26 per month). If instead John lets the room he uses for work to Acom for a rent equal to a seventh of the rent he pays plus, say, £60 per month to cover a proportion of his other homeworking-related overheads, e.g. energy bills, i.e. a total £360 per month. That’s an extra tax saving for John of just over £1,600 per year (£360 - £26) x 12 x 40%).

Acom can claim a tax deduction for whatever it pays John, whether that’s £26 or £360 per month.

Practical issues. There are a number of hurdles you need to clear before entering into a rental agreement with your company, e.g. obtaining agreement from a landlord or mortgage lender, including for any joint property ownership, reporting the rental income and expenses on your tax return and possible capital gains tax consequences.