Starting a business? Remember to claim relief for pre-trading expenses
When starting a business, whether as a sole trader, a company or in partnership, there is inevitably a preparatory period before trading commences during which expenditure is incurred in setting up the business. Depending on the nature of the business, the set-up period can be long and complex and the expenditure incurred during this phase may be considerable. It is therefore important that opportunities to claim relief for pre-trading expenditure are not overlooked.
When does trading commence?
To identify any pre-trading expenditure, it is necessary to determine when trading starts and whether an expenditure is incurred while trading or prior to trading. The point at which a business starts to trade will not always be clear cut – the transition from set-up to trading may be very gradual, such that it is difficult to pinpoint the exact point at which trading commenced.
HMRC take the view that a trade cannot commence until the trader:
- is in a position to provide those goods or services which it is, or will be, his or her trade to provide; and
- does so, or offers to do so, by way of a trade.
Whether or not a trade has commenced, is a matter of fact in each particular case. It is important to note that for trading to have started, the trade does not need to be on a large scale, although the production of a small number of items as a trial run will not necessarily mean that the trade has commenced.
Typical pre-trading expenses
Although the specific expenses that will be incurred in the preparatory period will depend on the nature of the business, typical expenses when setting up a business may include:
- expenses incurred in securing business premises, whether rented or purchased;
- computer expenses (hardware and software);
- website costs;
- marketing and promotion;
- purchase of stock;
- legal and professional fees;
- purchase of plant and equipment; and
- travel expenses.
It is important to distinguish between expenses incurred for the purpose of the business and those which are a private expense or which have a mixed-use element. It is also vital to identify whether the expense is capital or revenue in nature as this affects the way in which relief is given.
Relief for expenses
Once the business has started to trade, relief is given for revenue expenses as a deduction from profits to the extent that they are incurred wholly and exclusively for the purposes of the business.
As far as capital expenditure is concerned, the mechanism for giving relief depends on whether the trader prepares accounts under the traditional accruals basis or using the cash basis. Where the accruals basis is used, relief for capital expenditure is given in the form of capital allowances (to the extent that the expenditure is qualifying expenditure). By contrast, where accounts are prepared under the cash basis, capital expenditure is deducted in the computation of profits unless the capital expenditure is of a type for which a deduction is expressly prohibited; land, buildings and cars fall into this category.
Expenses incurred pre-commencement
The rules for determining whether a pre-trading expense qualifies for relief mirror those for determining whether relief is available for an expense incurred once trading has begun; an expense incurred prior to the commencement of trading will qualify for relief, if it would have qualified for relief had it been incurred once trading had commenced. Therefore, for a pre-trading expense to be deductible, it must have been incurred wholly and exclusively for the purposes of the trade. In addition, the expenditure must have been incurred in the period of seven years before the trade commenced; no relief is available for expenditure incurred prior to this. Where the set-up period is likely to belong, this should be borne in mind.
Care should be taken, particularly where the accruals basis is used, in relation to expenses paid in advance, such as rent or insurance paid prior to the commencement of the trade which relates to a period after the trade has begun. Under the accruals basis, such expenses would be relievable as trading expenses once the trade has commenced, and consequently do not count as pre-trading expenses. Likewise, no relief is given under the pre-trading expenses rules for stock purchased before the start of the trade, as the cost of stock is deducted in calculating profits once the trade has started.
The relief is available for both income tax and corporation tax purposes.
How relief is given
Relief for qualifying pre-trading expenses incurred in the seven years prior to the start of the trade is given by treating the expenses as if they were incurred on the first day of trading. In this way, the expenses are deducted in computing the profits of the first accounting period.
Availability of capital allowances
As noted above, where accounts are prepared using the accruals basis, relief for capital expenditure is given by means of capital allowances. Where accounts are prepared in this way, any capital expenditure incurred in the seven years before the start of the trade which is of a type that qualifies for capital allowances is treated as having been incurred on the first day of trading. Capital allowances (whether the annual investment allowance or writing down allowances) can be claimed for the first accounting period.
The necessity of keeping good records
In order to maximise the relief for pre-trading expenses, it is necessary to know what those expenses are when they were incurred. Good record keeping is therefore essential. If you are thinking of setting up a business, keep a record of everything that you spend. You should also keep invoices and receipts to back up the expenditure. Setting up a separate business bank account as early as possible is also a good idea to keep expenditure on the business separate from any private expenditure.
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