Increased Tax Deductions
Increase your tax deduction by £12,000
In this article I want to focus on sole traders and partners (i.e. self employed business owners) and an important car tax planning decision these individuals may have to make.
If you make the right choice you could enjoy thousands of pounds of additional tax relief every year.
You should also benefit from this article if you are a company owner, own your car privately, and also own rental properties. The taxman treats landlords much like any other self-employed business owner, so the more you know about self-employed tax treatment the better.
Let’s start with the basics.
Self-employed individuals who use their cars for business purposes are entitled to claim tax relief on a percentage of their motoring expenses.
Motoring expenses come in two forms:
- The cost of the vehicle itself
- The running costs
Tax relief is available for the cost of the vehicle in the form of capital allowances, generally 10% or 20% per year, depending on the car’s CO2 emissions.
Running costs include:
- Repairs and maintenance (servicing, MOT, oil, tyres, etc)
- Road tax
- Breakdown cover (AA, RAC, etc)
- Warranty cover
- Interest on a loan or other finance to purchase the vehicle
The percentage of motoring expenses on which self-employed business owners can claim tax relief is found by comparing the number of business miles travelled during the year with the total miles travelled.
Patrick, a sole trader, drives a total of 20,000 miles per year, 12,000 of which are business travel. He can claim tax relief on 60% of his motoring expenses:
12,000/20,000 = 60%
The Alternative Route
If your business turnover is below the VAT registration threshold (currently £70,000), you can ignore your actual motoring expenses and claim tax relief at the following fixed business mileage rates:
- 40p per mile (first 10,000 miles)
- 25p per mile thereafter
If you are a company owner and use your own car for business purposes you will be familiar with these mileage rates. They are identical to the ones used by company owners to reimburse their own business travel.
However, here we are talking about something completely different: sole traders and partners whose business’s total turnover is under £70,000.
Let’s say Patrick from the previous example is a self-employed consultant who earns fees of £65,000 per year. Instead of claiming 60% of his actual motoring costs, Patrick can claim tax relief as follows on his 12,000 business miles:
- 10,000 x 40p = £4,000
- 2,000 x 25p = £500
Patrick’s total tax deduction for the year will be £4,500.
If you want to calculate your motoring tax deduction using these business mileage rates, you cannot then claim either your actual running costs or capital allowances for the vehicle.
Whichever approach you adopt, you must apply it throughout the life of the car.
So the content of this article may only become relevant when you buy your next car and can choose a new tax calculation method.
As it happens, many business owners – especially rental property owners – do not claim any tax relief for their motoring expenses using either method. However, it’s never too late to start.
If you own rental properties and your gross rental income is less than £70,000 per year, you can claim a motoring tax deduction based on either your actual costs or the business mileage rates.
Those who own two unincorporated businesses (for example a regular trading business and a rental property business) can make two claims based on the amount of business mileage in each business.
Simplicity versus Tax Savings
So which approach is best: mileage rates or actual expenses?
Many self-employed business owners may opt to calculate their tax deduction using the 40p and 25p business mileage rates because this method is supposedly simpler: you don’t have to type up all your petrol receipts and other running costs or calculate capital allowances.
However, the amount of time saved may be exaggerated because you will still have to keep a log of your business mileage recording the date, purpose of the journey, start point, destination and miles travelled.
Maximising Tax Relief
The more important question is: Which method produces the biggest tax deduction, i.e. the most tax relief?
Sometimes your actual motoring expenses will produce the biggest tax deduction, sometime the mileage rates – it all depends on your personal circumstances.
The amounts at stake are potentially significant and could amount to thousands of pounds per year.
The two most important factors influencing your choice are arguably:
- The cost of your car
- The amount of business mileage
The more expensive your car is, the more important it is to claim capital allowances, which means you will also claim your actual motoring costs.
The more you travel on business, however, the more likely you are to benefit from using the fixed mileage rates.
Arthur is a sole trader with turnover of £60,000 per year. He buys a new car for £40,000. He only drives 5,000 miles per year, half of which is business travel. His total running costs are £1,940 per year. He sells the car three years later for £16,000.
If he uses the fixed mileage rates the total tax deduction over the three year period will be: 5,000 miles x 50% business x 40p x 3 years = £3,000.
If he claims his actual motoring costs, his capital allowances claim will be £12,000 over the three year period: £40,000 - £16,000 x 50%; and his tax deduction for running costs will be £2,910: £1,940 x 3 years x 50%. His total motoring tax deduction will therefore be £14,910.
By claiming his actual motoring costs, Arthur will increase his tax deduction by almost £12,000!
However, claiming your actual motoring costs will not always produce the most favourable tax outcome, especially if you drive a modestly priced car and do a lot of business mileage.
Terry is also a sole trader with turnover of £60,000 per year. He buys a new car for £10,000. He drives 25,000 miles per year, 75% of which is business travel. His total running costs are £4,484 per year. He sells the car three years later for £4,000.
If he uses the fixed mileage rates the total tax deduction over the lifetime of the car will be a sizeable £18,563:
10,000 miles x 40p x 3 years = £12,000
8,750 miles x 25p x 3 years = £6,563
If he claims his actual motoring costs, his capital allowances claim will be a paltry £4,500 over the three year period: £10,000 - £4,000 x 75%; and his tax deduction for running costs will be £10,089: £4,484 x 3 x 75%. His total motoring tax deduction will therefore be £14,589.
By using the 40p and 25p mileage rates, Terry will increase his tax deduction by almost £4,000.
Fly in the Ointment?
The 40p and 25p rates have remained the same for many years. Under the previous Government, this was a matter of deliberate policy, ostensibly as a ‘green’ measure to discourage business motoring.
Given the massive deficit which the new Coalition Government is attempting to reduce, it seems likely that the rates will continue to be fixed at the same level for the foreseeable future, perhaps even indefinitely.
Hence, whilst many people, like Terry, will currently benefit by using the fixed mileage rates, the number who benefit can be expected to progressively reduce over the years to come. Make the most of it while you can!
Calculating Your Own Motoring Expenses
Calculating your own potential tax deduction for motoring expenses is relatively simple.
All you have to do is add up all your running costs (fuel, maintenance, insurance, road tax, breakdown cover and warranty cover) for the period you expect to own the car, e.g. £3,000 x 3 years = £9,000.
You then calculate your capital allowances claim for the car (generally the purchase price of the car minus the expected sales price), e.g. £10,000 - £4,000 = £6,000.
Finally, you multiply the total amount (£15,000 in this case) by the percentage of your travel which is business travel, e.g. 50%:
£15,000 x 50% = £7,500 tax deduction.
You can then compare this tax deduction with the one you will receive using the 40p and 25p business mileage rates over the same period.
Remember, however, that whilst actual motoring costs are likely to increase in line with inflation, the fixed mileage rates are unlikely to be increased in the foreseeable future. Once you decide to claim the fixed mileage rates you will be committed to them for the life of your car; if that is likely to be many years, the impact of inflation may ultimately mean that you would have been better off claiming your actual costs.