Costs will almost always be incurred in setting up a business and getting it ready to trade. These may vary considerably depending on the nature of the business. However, regardless of the amount of the expenditure, the possibility of obtaining tax relief for pre-trading expenses should not be overlooked.
It is possible to claim relief for expenses incurred in setting up a business, as long as they were incurred no more than seven years before the date on which the business commenced. In determining whether a deduction is available, the same rules apply as to expenses incurred while the business is trading, namely:
- the expense must be wholly and necessarily for the purposes of the business; and
- the expenses must be revenue in nature.
No deduction is given for expenses that do not pass this test, even if they were incurred in the seven-year relief window.
Expenses treated as incurred on day one
Relief for pre-trading expenses that pass the `revenue’ and `wholly and exclusively’ tests is given by treating the expenses as if they were incurred on the first day of trading. In this way, a deduction is given for pre-trading expenses in computing the profits of the first accounting period.
A business may well incur capital expenditure in setting up a business, for example, by investing in the plant and machinery necessary to run the business. As this expenditure is capital rather than revenue in nature, relief is not available as a deduction against profit under the pre-trading expenses rules. However, all is not lost as similar provisions apply for capital allowances purposes, which deem pre-trading capital expenditure incurred in the seven years before the commencement of the trade as being incurred on the first day of trading. Consequently, relief is given in the form of capital allowances. Where the expenditure is of a type that qualifies for the annual investment allowance, a 100% deduction can be claimed against the profits of the first period.
Although a business which sells good will need to buy stock in advance in order to be in a position to start trading, relief is not given as a pre-trading expense as the cost of stock is deducted as part of the cost of sales once trading has started.
Martin starts a business delivering fruit and vegetables. He buys a refrigerated van for £7,000 and spends £400 on advertising. The advertising costs are treated as incurred on the first day of trading. He cannot claim a deduction for the cost of the van, but capital allowances, including the annual investment allowance, can be claimed as if he had bought the van on the day that he started trading.