(By Kennedy Nakoonje Munyandi)
The COVID-19 pandemic has undoubtedly changed our way of life.
In the employment sector, for example, we have witnessed the Working From Home (WFH) revolution that a majority of employers have adopted. This phenomenon does not only imply that an employee works from his home as opposed to working from the employer’s premises. It also entails that the employee incurs additional costs in, among others, lighting, heating and cooling, water, coffee and tea, cleaning, Internet facilities and wear & tear on furniture (e.g. table) & equipment (e.g. water dispenser or coffee machine). On the other hand, the employer’s related costs would be reduced. What all this means in terms of the taxation of employment income is the issue of this article.
Income taxation mainly revolves around three items: taxable subject – who bears the tax burden; taxable income – what amount of earned income is taxable, taking into account any deductible expenses, allowances and exempt income; and the tax rate – what percentage of the taxable income forms a tax liability. In relation to taxable income, the question is: What would constitute a tax-deductible expense of an employee (in light of the COVID-19 pandemic and the advent of WFH)?
As indicated above, the taxable income of an individual is generally the total income earned, less any exempt income, the tax-deductible expenses and the tax allowances that an individual might be entitled to. Regarding deductions, tax laws usually contain a general deduction rule that sets out the qualification criteria for the deductibility of expenses. The law would further spell out what other expenses would be allowable (i.e. specifically allowable items) or disallowable (i.e. specifically excluded items) in spite of the general deduction rule.
In our Income Tax Act, the general deduction rule applicable to income arising from non-business activities (such as employment) is contained under Section 29(1)(b), which states as follows:
“29(1) Subject to the provisions of this Part –
(b) in ascertaining income from a source other than business, only such expenditure, other than expenditure of a capital nature, is allowed as a deduction for any charge year as was incurred wholly and exclusively in the production of the income from that source.”
Specific deductions would include wear and tear allowances, which are granted in lieu of a capital expenditure. In particular, and as an example, paragraph 7 of the Fifth Schedule to the Income Tax Act includes the term “employment” in the definition of “business” for the purposes of granting or claiming capital allowances on implement, machinery and plant. This means that an employee who has used own implement or machinery for the purposes of his business, in this case employment, could be entitled to claim capital allowances.
In terms of excluded expenditure, Section 44 provides (among others) that:
“44. No deduction is made in respect of any of the following matters:
(a) the cost incurred by an individual in the maintenance of himself, his family or establishment, or which is a domestic or personal expense”.
The above three provisos, therefore, mean that for an expense to be deductible against employment income: (i) it must not be of a capital nature; (ii) it must have been ‘incurred’ ‘wholly and exclusively’ ‘in the production’ of the employment income; and (iii) it must not be a domestic or personal expense. Further, capital allowances might be granted in lieu of a capital expenditure.
In the history of employment income taxation, the most contentious issue when it comes to deductible expenses had to do with travel expenses to and from the place of work. But that matter was resoundingly settled in a United Kingdom Court of Appeal tax case where Lord Denning famously ruled:
“Nowadays many people have only a very limited choice as to where they shall live. Business men and professional men cannot live over their work, even if they would like to do so. A few may do so, but once those few have occupied the limited accommodation available in Central London, there is no room for the thousands that are left. They must live outside, at distances varying from 3 miles to 50 miles from London. They have to live where they can find a house. Once they have found it, they must stay there and go to and from it to their work. They simply cannot go and live over their work. What is the position of people so placed? Are their travelling expenses incurred wholly and exclusively for the purposes of the trade, profession, or occupation? I think not. A distinction must be drawn between living expenses and business expenses. In order to decide into which category to put the cost of travelling, you must look to see what is the base from which the trade, profession, or occupation is carried on. In the case of a tradesman, the base of his trading operation is his shop. In the case of a barrister, it is his chambers. Once he gets to his chambers, the cost of travelling to the various courts is incurred wholly and exclusively for the purposes of his profession. But it is different with the cost of travelling from his home to his chambers and back. That is incurred because he lives at a distance from his base. It is incurred for the purposes of his living there and not for the purposes of his profession, or at any rate not wholly or exclusively; and this is so, whether he has a choice in the matter or not. It is a living expense as distinct from a business expense.” Newsom v Robertson (Inspector of Taxes) (1952) 33 TC 452.
Well, Lord Denning, I am sorry to inform you that nowadays people live over their work. Not that they have moved to their place of work. But the work has moved into their place of stay, their homes. It is now not about traveling expenses, but staying expenses. What sayeth thee now, my Lord?
Rather than wait for answers from his Lordship, who by the way might be dead, let us tick the boxes instead.
If an employee’s utility bills (i.e. water, electricity, Internet, etc. etc.) in a particular tax year have increased by an amount X as a result of WFH, would that amount be deductible against the employee’s emolument? Applying the earlier outlined deduction rules, it is clear that: the amount X isn’t a capital expenditure; the amount would have been incurred wholly and exclusively in the production of the employment income; and the amount cannot be said to be a domestic or personal expense. It therefore follows that the amount X should be deductible for employment income tax purposes. If the employee has to acquire a capital asset, such a workstation or an air-conditioner, the cost may be not deductible on account of being a capital expenditure but would qualify for capital allowances.
It is my conclusion, therefore, that expenses incurred by an employee as a result of having to work from home should be deductible for employment income tax purposes. Like any other tax deduction, these expenses must be quantified and ascertained to the satisfaction of the tax authority.
Currently, the only possible way to claim such a deduction would be through the submission of an annual income tax return. This procedure can be onerous for both the tax authority and the employees. There are two alternatives that the government could consider. The first one is that employees could be allowed to claim a refund from their employer, who in turn would claim this as a business expense. The second option would be for the government to emulate what the New Zealand has done. That country is reported to have introduced a tax-free allowance payable by an employer to an employee to meet the expenses of WFH.
There should be no denial that employees incur increased expenditure as a result of WFM. The employees need to be relived of this expenditure. They have a legal right to file tax returns and claim the expenditure. But leaving it to the employees to make a tax-deduction claim would pose a serious revenue risk in that there will be attempts to stretch the law to the very limit, let alone a high possibility of abuse. For example, if an employee rents a house, can part of the rentals be attributed to WFM? If they live in a self-owned house, can they make a partial capital allowances claim based on the value of the house? I do not see why this can’t be possible. The government can avert this risky by setting a clear rule and/or law.
The Author is the proprietor of Munyandi InterTax Advisory Xervices (MiTAX), an international and domestic tax law specialist firm. He can be contacted via e-mail ([email protected]), WhatsApp (+260 76 203 1514) or Facebook (www.facebook.com/MiTAX2021).