In order to be deductible as a business expense for direct tax purposes the item must be ‘wholly and exclusively’ for the purposes of the trade being carried on.
This is a simple enough definition but has led to large numbers of tax cases over the years.
The key is to ensure that business owners claim as many legitimate expenses as possible while limiting risk of enquiry and challenge by HMRC for wrongly deducted expenses.
Some of the more common areas of confusion/areas which HMRC tend to look at closely are as follows.
Repairs and renewals
Expenditure incurred on restoring a business asset to its original state such as repainting an office or mending/servicing a piece of equipment used for the trade will be allowable.
On the contrary, expenditure incurred on creating an asset or improving an existing one will be disallowed.
For instance, if expenditure is incurred on an extension to an existing office block, this is capital expenditure and is not deductible against trading profits.
Depending on the circumstances, sometimes disallowed ‘capital’ expenses are deductible at a future point e.g. against proceeds when the asset is sold if a taxable gain arises.
Expenses incurred in advertising and promoting a business will generally be allowable.
This would include newspaper and television advertisements as well as internet advertisement (e.g. ‘pay per click’ advertising).
However, generally, third party entertaining (e.g. taking customers out to lunch) is disallowable despite the fact the argument might be that the lunch is only occurring in order to build and maintain an important business relationship.
The cost of business gifts are normally disallowable but can be allowed where the gift clearly includes the logo/information relating to the business.
However, it should be noted that the cost of gifts of food, drink or tobacco are always disallowed.
To be allowable, the cost of gifts to one person cannot exceed £50 in an accounting period.
Gifts to employees/staff are generally allowable but the separate ‘benefit in kind’ rules should be considered to determine whether there is an employment tax liability arising.
Legal and professional fees
The allowability of these should be considered carefully.
Typical legal fees to disallow include those incurred in acquiring and assets such as land and buildings (e.g. legal conveyancing costs). These would be treated as part of the cost of the asset rather than being an expense to deduct against profit.
As an example on the contrary, legal fees incurred in conjunction with a trade dispute either with a customer or supplier are generally allowable.
Unlike with normal accounting standards where expenses are deductible on an ‘accruals’ basis, pension contributions are deductible when they’re paid.
This can lead to an adjustment each year in the tax computation but does open up an opportunity to reduce the tax liability for a particular accounting period by making a pension contribution just before the end of the period.
There are other complications which need to be taken into account before making a pension contribution including:
- There are annual and lifetime limits for individuals in terms of the level of pension contributions which can be made and the ultimate size of their pension pot.
- The relief for certain very large contributions must be spread over several years rather than all being deductible in the year of payment.
- If the payments are for director/shareholder and are beyond what might be considered a commercial level, there is a small chance HMRC could seek to disallow this on the basis it’s not “wholly and exclusively” for the business.
Generally the costs of setting up a website are treated as disallowed capital items (don’t forget to consider whether capital allowances are available instead) but the ongoing work in relation to updating and maintaining a website is normally deductible against taxable profit.
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