Whilst the concept of a ‘home office’ is certainly not new the unprecedented challenges of the COVID-19 pandemic has brought the concept and its terms and conditions firmly into focus. With many companies not able to return to full or partial employment until at least Level 2, employers have quickly had to formulate plans to get employees set up in their homes so that they are in a position to get to a productive capacity as soon as possible. The punitive cost of office space, traffic congestion and a changing work dynamic are all additional reasons why productivity conscious employers are looking at the ‘home office’ concept as a solution to such problems.
The onset of COVID-19 has pushed the need for employees to maintain a home office into a necessity. Overnight employees have been thrust into this new working culture. Employees have hurriedly had to set up a workspace to enable them to be productive and client-facing as soon as possible. In many of these cases the practicalities of such changes would have only been agreed after the fact, with the most important of these being the costs associated with the ‘home office’. Depending on the agreement reached with the employer in terms of who is required to pay such costs, the employee may need to familiarise themselves with the tax legislation in this regard. SARS allows such employees to deduct their home office expenses within the “Other Deductions” section of their annual Income Tax return. It is important to note that this is only allowed under certain specific conditions. Before explaining the legislation though it is important to understand that the situation is different for sole proprietors or independent contractors who also work from home. They can automatically deduct their home office expenses and do not need to work through the same stringent set of conditions applied to employees to see whether they qualify for a deduction. The relevant portion of home office expenses can simply be reflected within the “Local Business, Trade and Professional Income” section of their annual Income Tax return.
So, what are the requirements to deduct home office expenditure for a salaried employee?
- The employer must allow the employee to work from home. SARS requires that this fact be put in writing in the form of a letter or an addendum to the employment contract.
- The employee must spend more than half of their total working hours working from their home office.
- The employee must have an area of their home which is used exclusively for this purpose. For example, employees who meet clients in their dining room at home would not qualify. A separate office, which is used specifically for the employee’s work, must be maintained to qualify for the deduction. This is often a sticking point with SARS and could potentially be problematic, particularly with the flexible arrangements made to deal with the COVID-19 pandemic.
- The office must be specifically equipped for the employee’s trade, i.e., it must be specially fitted with the furniture, tools and equipment required for the employee to perform their work. A room utilised for multiple activities would not qualify.
What expenses can be deducted?
Firstly, one must look at the employee’s remuneration structure to confirm whether they:
- Earn more than 50% of total remuneration either from commission or some other variable income based on work performance; or
- Is a normal salaried employee with variable payments or commission making up less than 50% of their total remuneration?
The first group (i.e., commission / variable income earners) can claim pro-rated deductions based on rent, interest on bond, repairs to the premises, rates, cleaning, wear and tear, and all other expenses relating to their home. In addition, they can also take other commission-related business expenses, such as telephone, cell phone, gifts, stationery and repairs to the printer into account.
The second group (i.e., salaried employees with variable payments or commission making up less than 50% of their total remuneration) can only claim pro-rated deductions based on rent, interest on bond, repairs to the premises, rates, cleaning, wear and tear, and all other expenses relating to their home.
How to calculate the home office deduction.
First calculate the total square meterage of the home office in relation to the total square meterage of the home and then convert this to a percentage. Then, apply this percentage to the home office expenditure to calculate the portion that is deductible.
This calculation is best explained with an example.
James is a design engineer who works for Smart Engineering. His remuneration only consists of a salary. His company is happy for him to work from home due to limited office space and flexibility in terms of working hours. He has a separate office at home which is fitted with a desk, cupboard, computer and printer which he uses exclusively for his job. The computer and printer were purchased one year ago for R21 000. His office is 10m2 and the floor space of his entire home, including the office, is 100m2.
During the 2020 tax year he incurs the following expenditure:
- R100 000 interest on mortgage bond
- R42 000 rates and electricity
- R36 000 cleaning costs (including maids wages)
- R8 000 security and monitoring costs
- R23 000 cell phone expenses (business portion)
Based on the above information, James qualifies for a home office deduction. The square meterage of his home office (10m2) is 10% in relation to his entire home (100m2).
James’s home office deduction for the tax year can be calculated as follows:
10% x (R100 000 + R42 000 + R36 000 + R8 000) = R18 600
James would also be entitled to a R 7 000 wear and tear deduction on his laptop / printer (assuming a three-year SARS write-off).
As a ‘salaried employee’ James would reflect his home office expense / other claimable expenses claim within the ‘Other Deductions’ section of the annual Income Tax return (ITR12).
It is important to note that any deduction reflected in the ‘other deductions’ field will elicit a query from SARS. They will request details of the claim. The first thing to do is to clearly show the calculation of how the percentage of home office expenses were arrived at. It is advisable to have a detailed schedule reflecting the totals per expense item and then have the schedules of the expenses specific to the claim. It is not always practical to send every invoice to SARS so a schedule will allow them to choose specific expenses if necessary. With any home office submission to SARS you must include a copy of the letter / employment contract from your employer confirming the requirement to maintain a home office.
There is another tax issue that needs to be understood before going down the road of the home office. While people are eager to claim the home office tax deduction in order to reduce their taxable income (and ultimate tax liability), few people understand the negative tax impact a home office will have on the calculation of Capital Gains Tax when they sell their homes one day.
When taxpayers sell their primary residence, there is a primary residence exclusion of R2 million. This means the first R2 million of the capital gain (or loss) is excluded for the purposes of working out Capital Gains Tax. All individual taxpayers receive an additional R40 000 capital gains exclusion per year.
However, if the taxpayer worked from home and used part of the house as an office, the Income Tax Act requires the capital gain to be apportioned between primary residence use and business use. This apportionment must take into account the length of time that the home office was used as a portion of the entire period of ownership, as well as the size of the home office compared to the size of the entire property.
Before happily agreeing to the use of a home office there is some homework that the employee should do. The employee should compare the potential Capital Gains Tax implications with the annual tax saving from the home office deduction to decide which is more advantageous from a tax perspective. Whilst the Capital Gains Tax implications are unlikely to be material if only a small part of the home is used as a home office, it is still important to factor this consideration into the decision.
With the tax position now clear focus now needs to be put on the implementation process. Whilst we can all agree that we are working and living in unprecedented times, what we as humans often have problems with is communication. Disagreements abound because people battle with communication. There is no better place to see communication challenges than in the workplace. Factor in a money issue and there is sure to be unhappiness. When discussing a change in working conditions with an employee ensure that there is adequate consultation on the matter and that the applicable terms and conditions are put in writing. The employee must understand what the expectations of them will be and what equipment and facilities will be required in this home office. After explaining the tax position and successfully negotiating the specifics of the new working conditions employer and employee should be in a good position to take advantage of this remote working relationship.