Exchequer Weblog

Where you run your business from your own home pressure can soon build up on your personal space. You may consider building an extension to your property, or installing a separate office in the garden, but there are significant tax implications.

The part of your home that is used exclusively for the business will not qualify for exemption from capital gains tax (CGT) when the whole property is sold. If the current area is used both for personal and business activities there is no problem with CGT as the area is not used exclusively for business. However, if the intention is to use the new extension (or garden office) entirely for business, you need to calculate the potential CGT bill on sale. The withdrawal of taper relief from 6 April 2008 means the net gain on the business part will be subject to CGT at 18%, assuming tax rates remain the same.

Where your business is run through a company there could be a ‘benefit in kind’ charge on you as director, if the company pays for the house extension. This can be avoided if you lease the part of the property used for business to the company for its exclusive use.

The building cost is also likely to carry VAT. Where your business is VAT registered it could reclaim the VAT as a business expense, if the cost of the whole building project is entirely born by the business, and HMRC are convinced that this cost relates to business rather than private use of the property. There is a potential VAT charge where the business use ceases or the house is sold. HMRC may demand VAT on the written down value of the office extension. If the value is close to nil then VAT is not usually a problem.

Many entrepreneurs are unhappy about the proposed withdrawal of capital gains tax (CGT) taper relief and its replacement with a flat 18% rate of CGT from 6 April 2008. Taper relief can result in an effective 10% rate of CGT where business assets are sold after two years or more, and an effective 24% rate of CGT where non-business assets are sold after nine years or more. These rates are halved for basic rate taxpayers. So someone selling a business, or an asset that has been used in a business, could see their tax bill jump by 80% if the deal is delayed beyond 5 April 2008.

Conversely an investor, who is planning to sell non-business assets, such as an investment property or quoted shares, will see their tax rate reduce to 18% from perhaps 40% if the sale is made on or after 6 April 2008. However, the tax rate does not tell the full story as indexation allowance, which compensated for the effect of inflation between 1982 and 1998, is also being withdrawn for individuals from 6 April 2008.

Where an asset has been held for many years the indexation allowance can significantly reduce the gain before taper relief, and this applies to both business and non-business assets. However, the deductions due to indexation allowance and taper need to be balanced against the 18% tax rate on the resultant taxable gain payable from next year.

Where the original cost of the asset is quite low, indexation allowance will have only a marginal effect on the final gain. If you are planning to make a significant sale in the next six months ask us to do the calculations to see if you should wait until 6 April 2008 or not.

The tax free personal allowances that will apply from 6 April 2008 have been announced, together with the rates and thresholds for National Insurance.

The main personal allowance for those aged under 65 will be £5435. This is the tax free amount you can earn in a tax year.

The personal allowances for those aged over 65 have increased by almost 20%, but the income limit which restricts the benefit of these allowances to those with relatively low incomes has only increased by 4%. This means some retired people may believe they will receive far more income tax free from April 2008, but in reality if their pensions have increased by the rate of inflation they are unlikely to benefit.

The rates of National Insurance remain the same with slight increases in the bands the rates are applicable to. If you run your own company you can pay yourself between £4,680 and £5,435 per year from 6 April 2008 and pay no NI, but still receive a NI credit towards your state pension.

The upper thresholds for NI class 1 (paid by employees) and class 4 (paid by the self-employed) have been increased to help bring them in line with the point where the 40% rate of income tax becomes payable. This alignment will not be complete until 2009. However, this increase in the NI upper threshold means more of your wages or profits carry NI at the main rate: 11% for employees or 8% for self-employed, so you are likely to pay more NI overall in 2008/09 than in 2007/08. NI at 1% is also due on all profits or wages received above the upper thresholds. So having income such as dividends that NI does not apply to will be even more beneficial.