A sole trader may incur costs before setting up their trade. Some of these pre-trading expenses are allowable for tax purposes subject to being ‘wholly and exclusively’ for the trade or profession.
Capital items purchased prior to trading may also qualify for capital allowances.
Expenses incurred up to 7 years before commencement of a trade are treated as incurred on the date trade starts.
The legislation provides relief in respect of certain expenditure of a revenue nature incurred for the purposes of a trade, profession or vocation before it is commenced. This relief is provided in section 57 of the Income Tax (Trading and Other Income) Act 2005 and confirmed in the HMRC Business Income Manual BIM46351.
The relief extends only to expenditure which:
Expenditure must be ‘wholly and exclusively’ for the trade to claim relief. No relief can be claimed for capital items using the provision above. For the purposes of claiming capital allowances there are special provisions in Capital Allowances Act 2001 to treat pre-trading capital expenditure as incurred on the date trading starts.
Capital allowances can be claimed on qualifying expenditure incurred before the start of the trade. Such expenditure is treated as incurred on the first day that the person who incurred the expenditure carries on the qualifying activity. Section 12 of the Capital Allowances Act 2001 and the HMRC Capital Allowances Manual CA23020 contain the relevant information including the following quirky example from the HMRC website:
Jubane and Gostelow decide to go into business as undertakers. They buy a hearse on 1 October 2018 and start the business on 1 January 2019. The expenditure on the hearse is treated as if it occurred on 1 January 2019.
Section 38A(4) of the Capital Allowances Act 2001 does not permit Annual Investment Allowance (AIA) to be claimed for pre-trading expenses. However capital allowances can still be claimed as explained above. Where assets have a value of £1,000 or less a full deduction is still possible leading to the same end result as claiming AIA.
Sometimes a person brings into use for the purposes of a qualifying activity plant or machinery that they received as a gift. When that happens the market value of the gift at the time that is brought into use for the purposes of the qualifying activity as the capital expenditure and treat the person as owning the gift as a result of incurring capital expenditure on it. This means that the market value of the gift is qualifying expenditure.
Horace receives a wig and gown as a gift in advance of being called to the bar. The market value of the wig and gown is treated as being incurred by Horace on the calling date (being the date the trade starts). These items are capital rather than revenue costs. However unlike normal business attire, they are treated as plant so qualify for capital allowances.
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