If you have an office at home, does it qualify as a home office for tax purposes? And if it qualifies, what expenses incurred in connection with the office can you get back from the taxman? We answer some questions.
Before automatically assuming that your office at home qualifies as a "home office" for tax purposes, you need to make quite sure that it is set up in such a way that the requirements for recognition as a home office, as prescribed by the Income Tax Act, have been met.
A home office must be a room in your home that is specifically equipped for the purposes of your trade and is regularly and exclusively used for that purpose. It is essential that all three requirements are fulfilled before any tax deduction will be considered at all.
What are "home office expenses"?
Some typical home office expenses include:
- Rent on the premises;
- Interest on the mortgage bond;
- The cost of repairs to the premises;
- Electricity;
- Water;
- Rates and taxes;
- Cleaning costs;
- Security; and
- Insurance.
When you claim a deduction in respect of these expenses, they need to be apportioned pro rata to the floor area of your home office in proportion to the total floor area of your home, unless the expense is directly attributable only to your home office - for example, repairs to the home office.
There may be other expenses you incur that are directly attributable to your home office and therefore are, in principle, deductible in full. They include wear and tear on your home office furniture, fittings and equipment, and telephone costs and stationery.
What does the law say about the deductibility of home office expenses?
In general, the tax treatment of home office expenses is governed by the provisions of three sections of the Income Tax Act: sections 11(a), 23(b) and 23(m). All the requirements of these provisions must be met in order for home office expenses to be tax-deductible.
Section 11(a) provides generally for the deduction from the taxable income derived from carrying on any trade of the expenditure and losses actually incurred in the production of that income, as long as such expenditure and losses are not of a capital nature.
Specific deductions are available for expenses such as legal costs, repairs and maintenance, and wear and tear on business assets.
Most home office expenses would ordinarily meet the requirements of this section, provided they are not of a capital nature. Section 11 does not distinguish employees and officeholders (such as a non-executive director of a company) from other taxpayers.
Section 11 must be read in conjunction with section 23(b), which prohibits taxpayers from deducting domestic or private expenses in relation to their home except in certain circumstances.
These circumstances are:
- The part of your home used as a home office must be occupied for the purposes of your trade;
- That part of your home must be specifically equipped for the purposes of your trade;
- Your home office must be regularly and exclusively used for the purpose of your trade; and
- Where you are an employee or an officeholder, you will only get a deduction for home office expenses where either:
* Your income from employment is derived mainly (more than 50 percent) from commission or other variable payments based on your work performance, and you work mainly other than in an office provided to you by your employer; or
* You work mainly at your home office.
The first three circumstances, bulleted above, provide the "general rules" applicable to all taxpayers in respect to a home office. In addition to these general rules, if you are an employee (or officeholder), you will be able to claim home office expenses only if you either earn mainly commission income or work mainly at home.
For example, if you are a salaried employee and work more than 50 percent at your employer's office, even if you have an office or study at home that you use for work purposes, you cannot claim your home office expenses.
What are the limitations on deductions by employees?
Section 23(m) limits the deductions that may be claimed by employees, and specifically salaried employees other than agents or representatives whose remuneration is normally derived mainly (more than 50 percent) in the form of commission.
Employees (other than mainly commission-earners) may only deduct certain expenses under section 11. The full range of deductions available in terms of the Income Tax Act is not available to them.
What is relevant to home office expenses is a significant, and most certainly a welcome, amendment that allows employees to deduct home office expenses under section 11(a) (general deductions) and section 11(d) (repairs) subject to the normal requirements with effect from March 1, 2005 (that is, the 2006 tax year).
In previous tax years, employees (other than those who earned mainly commission) with a home office were able to claim only wear and tear on assets used in their trade. They could not claim any other home office expenses against their income, even though their employers obliged them to work from home.
What is the bottom line?
The law distinguishes between the rules that apply to a self-employed taxpayer working from a home office and an employee or officeholder. Therefore, the tax treatment of home office expenses is primarily governed by the nature of your employment.
Bearing this approach in mind, the following framework for determining the deductibility of your expenses is recommended:
Step 1. Are you self-employed or an employee/ officeholder? If you are self-employed, the provisions of section 11 and section 23(b) must be considered.
If you have fulfilled all the requirements as prescribed by these two sections, you will qualify for a deduction in respect of your home office expenses - provided the home office is occupied and specifically equipped, and regularly and exclusively used for the purposes of trade.
Step 2. If you are employed or are an officeholder, determine whether you earn more than half of your income from commission and most of the work is done outside of an office provided by your employer. If so, a deduction for home office expenses may be claimed subject to the requirements in Step 1.
Step 3. If you, as an employee, do not earn mainly commission, determine whether you work mainly from home. If so, a home office deduction may be claimed subject to the requirements in Step 1.
Step 4. If you do not earn mainly commission income or do not work mainly from a home office, a deduction for home office expenses will be denied.
Essentially, if you are an employee, you will have to work mainly from home in order to claim a deduction for your home office expenses, but the home office expenses you can claim will no longer be limited to wear and tear.
If you earn mainly commission, you can claim your home office expenses provided you do not work mainly in an office provided by your employer.
Do I have to play by the rules?
It cannot be emphasised enough that, irrespective of the nature of your employment, final eligibility for a tax deduction rests on whether or not you comply with the "general rules" regarding home offices as outlined in section 23(b). Failure to comply with these rules will jeopardise your claim.
The onus of responsibility for justifying a claim for any tax deduction rests with the taxpayer.
What expenses must be apportioned?
Once you know whether you qualify for a deduction in respect of your home office, the next step is to distinguish between those home office expenses that must be apportioned and those that are deductible in full. In essence, the household expenses that relate to your property as a whole must be apportioned pro rata to the floor area of the home office.
For example, let's assume you run a home office and the total annual cost of securing your house amounts to R5 000 a year. If the total floor area of your house is 500 square metres and the area of your office is 20 square metres, the total cost of security that will be tax-deductible will be determined as follows:
Total cost of security x Area used exclusively for business
Total area of your residence
= (R5000 x 20 square metres) divided by 500 square metres = 100000 divided by 500 = R200
This can be replicated for other deductible expenses. The composite formula would be:
Total relevant household cost x Area used exclusively for business
Total area of residence
What about capital gains tax?
Unfortunately, capital gains tax (CGT) tends to have the last word. The implications of CGT are usually unfavourable, and when it comes to home offices this is no exception.
If you are operating a home office and you sell your home, the capital gain derived on the sale of your property will be apportioned with reference to the extent to which the property was used for business purposes. In other words, any part of the primary residence used for the purposes of trade (that is, for your home office) will not be covered by the R1.5 million primary residence exclusion.
Any tax tips?
- Make sure you do not use your home office for any purpose other than business. In other words, play by the rules. Don't let the South African Revenue Service (SARS) find that you are using your office for your own, or your children's, personal affairs.
- Keep an accurate record of all expenses incurred. SARS may well want to scrutinise your affairs.
- If you are an employee, document in your employment contract that you are obliged to use a room, or part of a room, on your property as an office.
- It is not necessary to set aside or build an entire room for use as a home office. SARS will allow you to set aside part of a room, provided that part is specifically equipped for trade purposes and is regularly and exclusively used for those purposes.
Click here for a flow chart that sets out how you can deduct your home office expenses from tax.
Example of a home office claim
Angela is a pharmaceutical representative who gets a salary of R125 000, a commission income of R20 000 and a travel allowance of R5 000 a year.
She is obliged in terms of her contract to work from home. Her employer has not provided her with an office. Does Angela qualify?
- She maintains an office specifically set up for work purposes;
- The office is used regularly for such trade purposes; and
- The office is used exclusively for such trade purposes.
Angela is a salaried employee whose commission income is less than 50 percent of her total income. However, her employer has forced Angela to maintain a home office.
- Forced to maintain a home office.
Therefore Angela is allowed to claim a deduction, which would be in respect of the following expenses:
She incurs interest of R15 000 a year on her household mortgage bond, and her rates and taxes for the year are R2 400.
The total area of her house is 100 square metres, and the area of her office is 10 square metres, so the proportion that will be tax-deductible will be 10 square metres divided by 100 square metres which equals 10 percent.
Her office is furnished with a computer costing R12 000, an office desk costing R1 600 and a chair costing R200.
Angela also incurs business expenses of R4 000 relating to cellphone and stationery.
Click here for a table showing Angela's tax claim.
- Moray Wilson is a manager of taxation services at Deloitte in Cape Town.
This article was first published in Personal Finance magazine, 3th Quarter 2006. See what's in our latest issue