Expenses – what you can and can’t claim

It’s very important that your business accounts and tax returns are correct, says Paul Howard. New penalty rules mean that mistakes – including claiming non-allowable expenses – can be very costly.

Tax legislation is complex, and there is very little guidance on what can and cannot be claimed as deductions for income tax or corporation tax purposes. So what can be claimed?

The starting point
To be allowable, expenses clearly have to relate to the trade or profession that’s being carried on. The wording in the legislation is that expenses must be incurred ‘wholly and exclusively for the purposes of the trade’.

Two important points to note are that payments which exceed a normal commercial rate are unlikely to be regarded as having been made wholly and exclusively for business purposes; and an expense incurred for more than one purpose will not be allowable unless a proportion can be identified as being wholly and exclusively for the purposes of the trade.

Capital and revenue expenditure – another important distinction
Capital expenditure relates to assets used in a business, such as vehicles or equipment. Tax relief for such expenditure is given by way of capital allowances, not a deduction in the Profit and Loss Account, so it’s important to distinguish capital and revenue expenditure. This is normally not too difficult, but there are some grey areas.

A guide
Having established two important principles that can help to identify whether an expense is allowable, you’ll be wondering about many common expenses. Most are allowable, some are not, and special rules apply to others. What follows is by no means exhaustive, and is for general guidance only. With tax law being so complex, there are many exceptions and special rules that you need to be aware of.

Administration
Starting with office related items, administrative costs (including printing, postage, stationery, telephone) are allowable, but it needs to be noted that private use must be separated off. A proportion of household bills – if work is done at home - (including rent, mortgage interest, council tax, gas, electricity and water, telephone and internet, insurances, repairs, maintenance and cleaning) can be claimed, based on the room(s) used, services consumed and time spent.

For those publicising a business, straightforward business advertising and marketing costs are allowable, but questions can arise in relation to sponsorship if the business owner or his family may receive some benefit or enjoyment. Small business gifts incorporating an advertisement and costing up to £50 per recipient per annum (except for food, drink, tobacco or vouchers) are allowable as are subscriptions to professional organisations or local trade associations and trade and professional journals.

Finance
As would be expected, the cost of accountancy is normally allowable, but additional costs of dealing with a tax investigation are not allowable if this results in extra liabilities for earlier years or a current year adjustment giving rise to an interest charge. Amounts that relate to actual bad debts written off, or provisions for specific doubtful debts can be claimed, but general provisions cannot.

Bank charges and interest (including interest on loans to finance the business or purchase business assets), are normally allowable, but interest may be partly disallowed if a sole trader’s or partner’s capital account becomes overdrawn. Charitable donations through Gift Aid are allowable as a charge on income rather than a trading deduction and other small donations to local charities may also be allowable. However, donations to political parties are not allowable.

Businesses need insurance, and most types of business insurance premiums are allowable. However, premiums for protection against the costs of dealing with a tax investigation are not allowable, and there are special complicated rules for ‘keyman’ insurance policies.

Finally, under this section, HMRC maintains that fines that are levied against a business for breaking the law – even parking fines – are not allowable. However, an employer who pays a fine that is an employee’s liability, such as a parking fine incurred when using their own car, can claim tax relief.

Tax
Tax is quite a thorny issue and in simple terms, an employer’s national insurance contributions are allowable whilst tax penalties, surcharges and interest are not; it’s the same principle as for fines above.

The VAT element of business expenditure is allowable for businesses that are not VAT-registered or that use the VAT flat-rate scheme. Payments of VAT to HMRC by flat-rate scheme users are deducted from sales.

Transport and premises
With rising oil prices and the increase in VAT rate, transport is now a serious expense. In terms of motoring expenses, these are generally allowable, except for travel between home and the normal place of business. There is a disallowance of 15% of the cost of long-term car hire, except for cars with CO2 emissions of less than 160g/km. Businesses with a turnover below the VAT registration threshold can, if they wish, use approved mileage rates instead of claiming all motoring costs separately.

The cost of using a car for business travel is allowed, but private travel must be disallowed. Further, travelling and subsistence expenses (including reasonable accommodation and subsistence costs in respect of business trips outside the normal pattern of day-to-day working) are generally allowable.

The costs of running business premises, including rent, rates, gas, electricity and water, repairs, maintenance and cleaning, are allowable as are repairs to premises, so long as there is no improvement to the structure.

Staffing
One of the biggest costs to a business is that of its employees. Wages (including bonuses, benefits in kind and pensions for employees and directors, and payments to subcontractors and agencies) are normally claimable, but amounts paid to, for example, family members must be at a commercial rate for the work performed.

Statutory redundancy payments are allowable, and other termination payments, including compensation for loss of office and payment in lieu of notice, may be allowable. If uniforms or protective clothing are required then these too can be claimed. Drawings, salaries and national insurance contributions of sole traders or partners: not allowable. Any payments made to agents or intermediaries are also allowable.

Finally the entertainment of staff is allowable, but entertainment of customers, suppliers or other contacts is not allowable.

Tax law is a total quagmire of different rules and regulations, some of which are obscure and open to interpretation. Good advice may be necessary if there is any doubt.

Paul Howard is tax director with BDO LLP