Whether you operate as a sole trader or via a limited company, there are some key principles to be aware of which help determine if the expenditure you incur is deductible against your income when calculating your tax liability
The ‘wholly and exclusively’ rule
For an expense to be tax deductible it must have been incurred wholly and exclusively for the purposes of the trade or business. This tends to be more of an issue for sole traders than for companies, where it is possible that some personal expenditure may be included within the expenses of the business. Where an expense is part business and part personal then sole traders may be able to claim for the business proportion, eg telephone costs.
Capital or revenue?
No deduction is allowed for items of a capital nature. Expenditure is capital if it is likely to be of enduring benefit for the trade, for example, fixed assets such as computers, printers, office furniture or business premises. Some alterations to business premises/assets can also be treated as capital expenditure – see the repairs section below. Tax relief for some of these items might be available by claiming capital allowances.
Typical business expenses
Below is some further guidance for common types of expenses businesses may incur.
Advertising Expenditure incurred advertising your products or services for sale is tax deductible. However, watch out for anything that might have a dual purpose such as a sponsorship package that entitles the business to attend events free of charge. HMRC considers that if there is a duality of purpose the expenditure should be disallowed.
Capital allowances/depreciation Depreciation charged in the accounts, which writes off the cost of a fixed asset, is not a tax-deductible expense. Businesses can, however, instead claim capital allowances on qualifying plant and machinery expenditure. Capital allowances are given at set percentages depending on the type of asset. In some cases, capital allowances will give 100% tax relief for the cost of an asset in the year it is purchased.
Entertaining and gifts The cost of entertaining clients, customers or third parties is specifically disallowed as a deduction for tax purposes. There is also no tax relief for the cost of making business gifts. However, there are a number of exceptions to this that are tax deductible:
• An item provided in its business in order to advertise to the public generally (eg a free sample)
• An item incorporating a conspicuous advertisement provided that it costs less than £50 and is not food, drink, tobacco or an exchangeable voucher
• Staff entertaining is an allowable business expense (although it can sometimes give rise to a benefit for the employee)
Legal and professional fees Fees relating to the structure of the business (eg for companies, reorganisation of share capital) will be disallowable. Fines and penalties and the payment of damages and costs will also normally be disallowable.
Remuneration Salary and redundancy costs provided for in the accounts are tax deductible as long as the amounts have been paid out in full within nine months of the year end. For a sole trader, note ‘drawings’ are not salary and are not therefore tax deductible!
Repairs and renewals Expenditure on restoring an asset to its original state is revenue in nature and therefore allowable. Expenditure on altering or improving an asset is capital. The use of modern materials does not itself mean that an asset has been improved if the function and other characteristics remain similar to before. If a whole asset has been replaced then the expenditure will be capital.