Pre-trading expenses for sole traders and partnerships
Understanding the rules for pre-trading expenses for sole traders and partnerships is vital. This is because these initial costs, incurred before your business officially starts trading, can have a significant on your tax liabilities and financial planning.
Overview
The UK tax rules offer an opportunity for you to claim these expenses. Moreover you can potentially reduce your tax bill and enhance the cash flow of your business. Therefore we'll cover what are regarded as pre-trading expenses, the tax rules, and how to claim these costs effectively, ensuring compliance and optimising tax efficiency.
Definition of pre-trading expenses for tax purposes
Pre-trading expenses are costs incurred by a business before it begins trading. It follows that those qualifying expenses are considered by HMRC essential for setting up and preparing the business to operate. Consequently, recognising these expenses is the first step in strategic tax planning for new businesses.
The tax rules for pre-trading expenses
The tax rules are covered here, though essentially they state pre-trading expenses for sole traders and partnerships are allowable as a tax deduction from trading profits, on the first day of trading where the following applies:
In order to qualify, it is necessary that the expenditure is not otherwise deductible from trading profits and would have been allowable when incurred, if the trade had commenced at that time.
Therefore, pre-trading expenses must have been incurred for the purposes of the trade. The tax rules only allow a deduction where the expense would have been allowable if, notionally, it had been incurred after trading commenced.
Essentially this means that any expenditure must have been wholly and exclusively incurred for the purposes of the trade. So no deduction is available for private costs.
If there is a specific rule which prohibits a trading deduction based on the nature of the expense, this will equally apply to limit or block tax relief on that expense. For example entertaining expenditure.
The tax rules do not allow relief for expenses that are otherwise deductible from trading profits. A typical example would be advance payment of rent relating to the trading period. These costs will be deductible under normal principles, when trading begins, usually applying the accruals basis.
Relief is not available for expenditure where the trade is abandoned prior to commencement. It should also be mentioned that the rules do not give relief to the extension of an existing trade, only the commencement of a new trade.
Capital expenditure
The tax legislation only allows a deduction for pre-trading revenue expenditure. Pre-trading capital expenditure does not qualify for tax relief. Examples of capital expenditure could include the purchase of equipment of the creation of a website.
the Capital Allowances Act 2001 provides that pre-trading capital expenditure is treated as incurred on the first day the qualifying activity is carried on (i.e. the trading start date) for capital allowance purposes. In other words, any relief for expenditure is treated as accruing from the first day of trading.
This is best demonstrated by the example below:
Example
Amos decides, on 1 March 2024, that he will start a new business later in the year running a private investigations agency. He incurs the following expenditure:
On 1 July 2024, Amos is ready to start trading and enters into a contract with his first customer.
The advertising, and insurance incurred by Amos represent pre-trading expenditure which is allowable. These items of expenditure qualify for relief as they would have been allowable had Amo’s trade commenced at the time each item of expenditure was incurred.
The purchase of the laptop and smartphone do not qualify for relief as they relate to capital items For capital allowance purposes, they are treated as being purchased on 1 July 2024, and capital allowances may be claimed at that point.
When does a trade start?
As the rules only apply to expenses incurred in the seven years before trade commences, it is important to determine the date of commencement.
The date that a trade commences is a question of fact. However The general rule is that a trade can only commence when the trader is in a position to provide goods or services which are, or will be, their trade to provide plus they provide those goods or services, or offer to do so, by way of trade.
What happens if I make losses?
Where substantial pre-trading expenditure is deemed to be incurred on the first day of a trade, it may result in a trading loss for that accounting period.
Losses arising from pre-trading expenditure may be relieved under the normal loss relief rules. Note that there is enhanced loss relief for losses arising in the first four years of a trade. This is known as ‘early years’ loss relief. This is a topic we will be covering in a separate article at a later date.
What's the VAT position?
You can register for VAT in advance of making taxable supplies. This can allow VAT to be recovered on pre-trading expenditure, subject to any specific restriction on VAT recovery applying. Input VAT incurred before registering for VAT can often be recovered under the specific pre-registration VAT rules.
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