Deductible Startup Costs that you can Claim
Business Startup Costs
Among the many hurdles that startups face, the primary concern for a majority of new businesses is a lack of cash flow, this even stops them from appointing specialist startup accountants, who would be able to sort many issues and claim a lot of reliefs discussed in this article, sometimes even enough to cover the initial cost of hiring that accountant. Businesses during their infancy incur a lot of sunk costs that cannot be recovered even if the business achieves success, it must therefore carefully devise a business plan which should enable them determine the resources required to operate successfully.
Part of the plan should be to take advantage of the expenses incurred to reduce tax either in the current year or future years, plus claiming all potential reliefs such as R&D Tax Relief, Patent Box Relief etc. Having a fair idea of what are the deductible business costs also adds a significant advantage. For a business to claim tax relief, it must be trading, and the expenses should be set off against the income it is generating. This, however, is not the case for startups and potential businesses which haven’t started trading yet, for which pre-trading expenses can be used for tax-related deductions.
What are the guidelines to claim these reliefs?
As they say, ‘ideas are easy, implementation is hard.’ Startups business in uk, which manage to cross the boundary of ideas and venture into the implementation domain, have a number of outflows to deal with. The business might need dedicated premises to operate from; a warehouse, maybe, to store products and other facilities depending upon its operations.
A whole set of expenses await potential entrepreneurs who possess the will but struggle with resources when it comes to realising them. All these expenses are not included in the organizational costs eligible for tax deduction until the business starts functioning.
HMRC’s Guidelines for Pre-trade expenses
As per the S57 Income Tax (Trading and Other Income) Act 2005, S61 Corporation Tax Act 2009, pre-trading expenditure is treated as incurred on the day on which the trading starts, i.e. it is included in the profit or loss calculation during the first accounting year. No separate claim for loss relief is required.
Let’s suppose that you start a business, and in the course of setting it up, you’re working just like an employee, hiring staff and sourcing suppliers. It is reasonable for you to draw a salary from the business. The withdrawal of a salary, i.e. at a fair rate according to the extent of work, is permissible by HMRC and will fall under the deductible startup costs This will be adjusted against the income of the business during its first year of trading.
The rules set out by HMRC allow expenses for up to 7 years before the date when trade commenced to be deductible which gives businesses plenty of time to set these off. In some cases, the businesses may take more than usual to take off, such as a construction business, but in that case, exceptions can be made by HMRC to remain fair. Conventionally, if a business doesn’t get stable and starts earning after a period of seven years, it could be due to the business model or other factors.
Video: Startup Pre-trade Expenses
Some expenses cannot be treated as per the rules of pre-trading expenses such as rentals for a post-trading period or other prepayments. Such payments should be dealt with the matching concept, i.e. expenses will be set off against the income of the same period in which the obligation arises. The expenses are, however, technically incurred before businesses can start trading, but as they belong to a post-trading period, they already fall in the ambit of tax deductible expenses. Therefore, there is no need to justify them as pre-trading tax deductible startup costs.
The Cost of Finance
The pre-trading expenses that a business incurs might also include interest payments. A startup can draw loans to finance assets, to pay employees or any license fee that is imminent to trade. The costs of raising this debt finance is termed as non-trading debits as they have been incurred before the business can start trading.
According to the loan relationship rules, which govern the pre-trading interest incurred by a company, companies can only use non-trading credit (income), e.g. interest received, to set off the non-trading debit for corporation taxes deduction purposes. It might take years for a business to generate non-trade credit income and to claim relief for the pre-trade interest expenses.
It can be the case that a company might not be able to generate non-trading credit (income) sooner, then non-trading debits can be elected to claim relief against trading income. The election will alter the nature of non-trading debits to trading expenses making them deductible startup costs during the first accounting period.
As per the CTA09/S330, the company can elect for non-trading debits if:
- the election has been made by the company within two years from the end of the accounting period in which the debt was taken
- the company commences trade within seven years from the period in which loan was drawn
- the expense would have been treated as a trading expense had it been incurred in the post-trading period
It will not be an exaggeration to say that startups act as small economic engines lifting the country’s overall economy through innovative products and infusion of new dynamics in the market.
Startups act as conduits of knowledge and ideas leading to technological breakthroughs; they have a flexible structure that aids the transformation of ideas into products at a faster pace compared to the bureaucratic setups of already existing organisations.
A successful startup might transform the host town or city into a business or a tech hub like Google has transformed the Silicon Valley in California or just like Infosys has transformed Bangalore in India, but supportive responses at multiple fronts are required to create a success story out of a startup.
Cash flow management is the most problematic area for a company that has yet to start its trading but is already incurring expenses. In the UK, the government and the HMRC have laid out specific guidelines for startups to use their pre-trading expenses for tax deductions. These expenses are treated as if they’re incurred on the first day of trading, thus reducing that period’s income and, ultimately, the tax.
Thao is a Senior Accounting Manager at Clear House Accountants. Her experience in the industry has led her to her current position in which she is responsible for a team of accountants, tax planners and bookkeepers.
Thao works with her team to help clients from a variety of industries, grow, save money and plan for the future. Thao holds a Bachelor and Masters degree in Accounting and Finance and is currently working towards her ACCA, she is also a Xero and Quickbooks Certified Advisor.
Thao’s expertise lies in high-level tax planning, management accounting and strategic business planning based on financial performance and business analytics. Her experience, expertise and knowledge make her an exceptional contributor at Clear House.
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