If you’ve spent personal funds setting up your business, what scope is there to reclaim these costs from your limited company, once it has been incorporated or from you Sole Trader business?
Many small business owners, including contractors, may absorb a number of costs personally before their businesses are up and running. Many of these expenses will be incurred shortly before company formation. It may be that certain costs have to be paid for before your company bank account has become fully operational.
For example, you may need to travel to attend a client interview, pay for legal advice, or take out a business insurance policy if it is stipulated as part of a contractual agreement.
When is my business start date?
For tax purposes, HMRC are interested in your commencement of trade. Generally this is the point that you start supplying your product or services in return for money or other payment. The date the shop doors open to the public, the date of your first internet sale, the date you run your first course, the date of your first customer invoice.
The commencement of trade is the date that you will use for your first set of accounts if you a sole trader. For example, if you make your first sale on 11 October, then your first set of accounts will run from 1 October to 5 April (or 31 March). Every year after that they will be prepared from April to April in line with the tax year. You can choose a different year end date, but there are more complex issues involved in the first year, such as overlap profit.
Most limited companies use the company registration date as the commencement of trade date, unless there was a big time gap between registering the company and actually starting business. Unlike the sole trader, a limited company has it’s own financial year, not necessarily April to April. If a limited company started trading on 11 October then the first set of accounts will run for 11 Oct to 31 Oct next year (spanning just over a year). Then every year after that they will be prepared from 1 Nov to 31 Oct.
What counts as trading?
Sometimes the commencement of trade date is not so straightforward. Your commencement of trade could be before the first sale or invoice if there are preparatory activities that are required in order to make the sale itself. For example, for a training provider it may be the date that the first training course was delivered, rather than when the course was invoiced.
HMRC does not have a simple definition of trading, but uses a list called “Badges of trade”, to indicate when trading activities are likely to be taking place. They consider the circumstances on a individual basis and this is the best approach for you as well.
The commencement of trade should definitely be on / before the first invoice or money received date, but it can be before if that is appropriate to your circumstances.
I had to spend money before I made any sales, can I include it?
It is easy to start racking up business expenses before any sales have been made. Some types of business can have a long and expensive lead-in to the first sale. Don’t worry, most of these start up costs, known as pre-trading expenditure, can be included.
For both limited companies and sole traders, the pre-trading expenditure is treated as if it were incurred on the first date of trade (see HMRC BIM46355).
You can include expenses from up to 7 years prior to the commencement of trade, if they relate wholly and exclusively to the business and they are normal business expenses that would be allowed after the commencement of trade. In a property business pre-trading expenditure only applies 6 months before.
This means if you could include an expense after you start trading, then you can include it before, as long as it is wholly and exclusively business related.
If you become a VAT registered limited company, you will also be allowed to reclaim the VAT element of any products bought for the previous 4 years, and any services received up to 6 months before the date trading commences (see HMRC VIT32000).
Example – A sole trader business made its first sale on 11 October. However, there were bills for advertising, phone bills and internet hosting for the business in the 3 months prior to the first sale. The accounts will start from 11 October and all of the pre-trading bills will go into the accounts dated as 11 October.
Typical expenses for small businesses, in general, may include:
Domain names and web hosting.
Travel costs (e.g. travelling to visit recruiters, and potential clients).
Stationery, printing, postage, etc.
Business equipment (e.g. a PC, laptop, peripheral equipment).
Interest on business loan
Big ticket items: Equipment and Other Assets?
If you are planning any large expenditure on equipment prior to the commencement of trade, you really want to make sure that you can include it for tax purposes. Large items of equipment become assets in your accounts and the cost gets spread out over a number of years with depreciation. In the tax return, the depreciation is often spread on a different basis via capital allowances.
If large items of equipment (assets) were purchased prior to trading, wholly with the intention to use them to carry out your trade, then you can claim annual investment allowance (AIA) in the first year. This means you can claim 100% of the asset value against your business profit for the year.
You must claim the capital allowances on the trade commencement date, not the date you actually bought the item. The capital allowances legislation limits change quite frequently so it is important to remember that the limits and rules you need to use are the ones on your date of commencement, not your date of purchase.
What is not allowed?
There are some items that are not allowed as pre-trading expenditure and this is generally to do with whether they are considered to be capital or revenue expenditure. Capital expenditure adds to or improves the business (or it’s assets) whereas revenue expenditure is related to the actual day to day operation of the business.
Licences and Registration – you can’t include capital expenditure that is related to getting established in business. e.g. company registration, pub license prior to opening (but you can have the renewal costs).
Repairs and improvements – this whole area of capital expenditure can be quite complicated. The cost of repairs to a building before trading could be substantial but may not be allowable. Repairs that are required to make premises fit for the trade or improve the premises are not allowed as pre trading expenditure. However, small scale repairs that relate to general maintenance are allowable. This is a grey area and is worth getting further advice from your accountant, preferably before you spend any money.
Training courses – training has to update or add to the existing skills and knowledge used in your trade in order to be included as a revenue expense. Acquiring a totally new skill is considered to be a capital cost and is not allowed. This means that training courses can only be included once you have started trading and should broadly relate to your existing trade; the initial training for your trade is not allowed and training for totally new and unrelated trades is not allowed either.
Limited companies – for a limited company there may be issues in claiming substantial expenses prior to the company incorporation date, as legally at that point the company did not exist and any transactions were personal ones made with the director, not with the company. If this is an issue and the expenditure is large, it may be worth getting further accountancy or legal advice.
You cannot claim the cost of the company formation itself against tax, as this is treated as a one-off capital expense. Of course, if you paid for it personally as the director, you can reimburse yourself for this one-off expense.
You can only claim for expenses incurred “wholly and exclusively for the purpose of the trade”, e.g. specifically to help you carry on your trade as an IT contractor.
If an existing business (e.g. a current limited company) incurs costs related to setting up a new company, these costs cannot be legitimately reclaimed by the new company as it is a different entity.
Some costs cannot be claimed until you have started trading, including – significantly – training courses.
Summary & Further Information
For obvious reasons, you should keep accurate records relating to your pre-trading expenses, particularly so that you can demonstrate that any purchases have been made exclusively on behalf of the company you subsequently form, rather than for personal reasons.
Importantly, you must not make any purchases in the name of your company before it has been officially incorporated with Companies House.
Start up expenses can be included as pre-trading expenses if they would be allowed after you started to trade.
They are included as at your commencement of trade date.Large equipment can be included as an asset and for capital allowances as at the commencement of trade date.
Personal assets bought into the business are treated differently from items that you have purchased.
Capital expenditure (other than equipment) is generally not allowed
Talk to your accountant if you have any questions about reclaiming pre-trading costs, and expenses in general, as there are many ‘grey’ areas, which cannot be easily explained in a high-level article.