Generally, there are two tax considerations when making a claim for expenses:
- Whether they can be deducted from trading income to computing profits chargeable to Income Tax or Corporation Tax (depending on whether incorporated), as discussed in HMRC’s Business Income Manual and Corporation Tax Manual respectfully.
- Whether they are an allowable employment expense, and therefore, if there would otherwise be a Benefit in Kind assessed for Income Tax, as discussed in HMRC’s Employment Income Manuals.
The purpose of this guide is to explain any specific rules relating to common expenses that are incurred by small businesses owners. Please contact us for advice relating to your specific circumstances.
S54 Corporation Tax Act 2009 states that expenditure cannot be deducted in computing trading profits unless it is incurred wholly and exclusively for the purposes of the trade, profession or vocation.
The day to day running costs of a business (e.g. staff wages, purchase of trading stock, rent of business premises, and so on) are referred to as revenue expenditure; and unless there is a specific statutory prohibition, revenue expenditure is allowable.
Capital expenditure (e.g. the purchase of business premises, plant and machinery used in the business process and so on) in practice is the opposite of revenue expenditure; unless specifically allowed by statute, capital expenditure is not allowable. However, in most cases, deductions can be claimed on this expenditure in the form of ‘capital allowances’.
HMRC do not ask business owners to submit records with a tax return, however, should HMRC make an enquiry into a tax return, they will require proof of the existence of an expense in the form of an itemised purchase invoice. If you are reclaiming VAT on the expense, then the purchase invoice must show a VAT number and split out the amount of VAT charged.
Note that card receipts, statements or bank entries will not count as proof of purchase, and should not be relied on for the purpose of making an expense claim; and likewise, the existence of a purchase invoice does not qualify an expense as having been incurred wholly and exclusively for the purpose of business.
Travel, Subsistence & Accommodation
In our experience, this is by far the most commonly claimed expense by small business owners; it is also the most complicated from a tax perspective. The rules governing expenditure of this nature is referred to as the 24-month rule – this is used to determine whether a place of work is deemed to be permanent or temporary in nature and therefore whether the expenses incurred in working at the location can be claimed.
Employees are entitled to tax relief for any costs incurred in travelling to or from a place they have to attend in the performance of their duties, provided the journey is not private travel or ordinary commuting to a permanent workplace.
HMRC use the ’24 month rule’ to determine whether a workplace is deemed to be temporary, and therefore, whether costs associated with travel can be claimed. This prevents a workplace from being deemed temporary where an employee attends it in the course of a period of continuous work which lasts, or is likely to last, more than 24 months.
Therefore if a person expects to work at a particular location for a period of 24 months or less then they can claim for travel and associated costs. Critical to this is the fact that it is based on the expectation of the individual, not the actual time at the location; likewise, it is based on time at a location, not the client you are contracted to. A likely time for expectation to form would be around the signing of a contract extension.
If a workplace is deemed a permanent, costs can still be claimed for travel to other locations provided the time spent at the site represents no more than 40% of the working time. If the individual only works at a single location for the entire duration of their company’s existence then that location becomes the de facto permanent workplace.
If you use your personal vehicle for business travel, you can claim a mileage allowance based on the number of business miles travelled. This is subject to compliance with the 24-month rule, described above. Mileage allowance is intended to cover all costs associated with motoring (fuel, insurance, wear and tear etc.). The below table sets out the statutory mileage rates set by HMRC, providing the rate paid per mile does not exceed those in the table no Benefit in Kind will arise.
|First 10,000 miles per tax year||Miles in excess of 10,000|
|Car||45p per mile||25p per mile|
|Motorcycle||24p per mile||24p per mile|
|Cycle||20p per mile||20p per mile|
Use of Home as Office
If you use any part of your home for activities related to your business, you will be able to make a claim for any additional variable costs incurred that relate to the business use. This would typically be additional electricity or gas as a result of being at home, costs that would be incurred in any case (e.g. mortgage & council tax) could not be claimed.
The most straightforward way of doing this is to claim £6 per week, or £26 per month (this was £4 per week prior to April 2020). Claims that are higher than this will come under scrutiny in the event of a HMRC enquiry and it will be down to the director of the company to justify that the equivalent expense has been incurred by the household any apportionment of costs has been reasonable.
An alternative to the flat rate claim is to rent a portion of your home to the company at the prevailing market rate for a similar rental in a similar location. If HMRC were make an enquiry into these costs they may require proof that any agreement has been made at arm’s length (i.e. at an appropriate market rate, if such a rental was made by an unrelated party). Under this method, any rents received would be treated as rental income received personally and taxed at your marginal rate (though costs may be deduced by apportioning household running costs). Additionally, renting a portion of your home for commercial purposes will affect your eligibility to claim Principle Private Residence relief on the subsequent sale of your home, possibly giving rise to a Capital Gains Tax liability in the future.
Our advice is that the flat allowance of £6 per week (or £26 per month) for Use of Home as office is cleaner and simpler to claim than it is to rent a portion of your home to your company.
Entertaining clients or potential clients where there is a commercial purpose (i.e. that you expect this activity to lead to future revenue) is a legitimate business expense and can be claimed from your business. However, when calculating your taxable profits (on which Income Tax or Corporation Tax is charged), the cost of client entertaining must be added back, thus preventing the business obtaining tax relief. If you operate your business through a limited company, then, in spite of corporate tax relief not being available on this type of expenditure, it is still worth this being claimed as it is paid from your pre-dividend income and so, in effect, personal tax relief is received.
Employee entertaining is deductible for tax purposes and relief will be given for the entire cost incurred. In order for an employee event to qualify as a tax-free benefit (and so, not be assessed for Income Tax or National Insurance), it must meet the following criteria:
- It must be an annual event that occurs on a recurring basis (such as a Christmas Party/Summer Barbeque etc.) rather than one-off events (such as a 25th anniversary etc.);
- It must be open to all employees to attend; and
- The aggregate cost per guest must not exceed £150 inc. VAT (if the cost comes to £150.01, the full amount will be assessed as a benefit).
- If partners are invited then only the VAT relation to the cost for employees can be reclaimed, assuming the business is VAT registered and able to reclaim VAT (i.e. are not using the Flat Rate Scheme).
Gifts to anybody that is not an employee are treated as being tax deductible, provided it meets the following criteria:
- It must not be food, drink, tobacco or vouchers;
- It must cost less than £50 per recipient per year; and
- The business name is prominently marked on the gift.
Trivial Employee Benefits (including Gifts)
It is possible to provide trivial benefits (including gifts) to employees (in addition to annual events) provided they meet the following criteria:
- Each benefit/gift must not exceed £50 in value (if the value exceeds this by just £0.01, £50.01 will be taxable);
- It must not be cash or vouchers which can be exchanged for cash;
- There must not be a contractual entitlement to the benefit; and
- It must not be a reward for an employee’s work or performance
Directors of’close companies’ (a company run by 5 of fewer shareholders) cannot receive trivial benefits exceeding £300 in a tax-year.
The fees associated with the preparation of business accounts and tax returns are a deductible expense when computing Income Tax or Corporation Tax. However, the fees associated with the production of a Self-Assessment tax return for a company director are classed as a personal expense and therefore should not be borne by the company.
As you are in business of your own account, you will not be covered by any insurance policies belonging to clients to whom you supply goods or services. It is therefore wise to have business insurance policies to safeguard your business. The common insurance policies that we are asked about are:
- Professional Indemnity – This is to cover your business for the cost of legal defence or damages awarded to a client in respect to professional negligence, poor advice, errors or omissions.
- Public Liability – This is to cover your business for claims coming from members of the public for personal injury or damaged property caused as a result of the services supplied by you.
- Employees Liability – This is to cover your business for claims brought about by employees working for your company.
- Employees Liability – This is to cover your business for claims brought about by employees working for your company.
- Personal Life Cover/Private Medical – Generally insurance of this nature, if claimed from the business, will be considered a benefit in kind on the part of the director/employee on the basis that ordinarily the cost of these would be met personally. Insurance premiums paid to cover loss of trading income on death/critical illness of key personnel, where the beneficiary is the event of a pay-out is the company, would be deductible against trading profits and would not be assessed as a benefit in kind.
There is a tax efficient life policy available to limited company directors, relevant life cover. Due to the way that relevant life policies are set up, via a discretionary trust, premiums are tax deductible for Corporation Tax (without creating a benefit in kind on the director) and benefits are paid from the trust which sits outside of the death estate (chargeable to Inheritance Tax).
Tax Liability Insurance
There are two types of tax liability of insurance policy:
- Those which covers the cost of fighting a tax enquiry, where a payout will cover additional professional fees such as legal and accountancy costs
- Those which cover additional tax liabilities or penalties arising from an enquiry where HMRC finds that the taxpayer has made careless or deliberate errors
HMRC deems neither form of insurance policy relate to the trade of a company and so expenditure on these premiums would therefore be disallowed when computing trading profits.
Payments to a registered pension scheme are a tax efficient method of extracting profit from a limited company, they are also treated as a qualifying deduction in calculating a deemed IR35 salary and so would mitigate tax liabilities resulting from a HMRC challenge.
HMRC’s guidance (BIM46035) indicates that director’s pension costs at a ‘commercial level’ will class as an allowable deduction from business profits – we interpret this to mean that the overall remuneration of a director (salary, benefits in kind and pension) should be comparable to that which would be offered at arms length to a third party to perform the same work. Whilst employer contributions are not restricted to an individual’s relevant earnings, we also interpret ‘commercial level’ to mean that a business should not be put into a trade loss position for an accounting period.
Pension contributions made from the personal funds of the director can be eligible to personal tax relief. Basic rate relief is claimed by the pension fund itself, so for every £80 paid into a pension fund personally, the pension fund will then claim £20 from HMRC which will be allocated to the fund making it worth £100 overall. Higher rate tax relief is then given via self-assessment for those whose income exceeds this level, this works by extending the higher rate threshold by the gross value of the contribution, meaning the taxpayer pays 20% on that portion of their income rather than 40% – saving a further 20% in tax. If a higher rate taxpayer makes a personal contribution of £80, the pension fund will increase by £100, and they would be able to claim a £20 refund via self-assessment.
For personal contributions the maximum contribution (gross) that can be made is the higher of 100% of the taxpayers earned income (salary, self-employed profits) or £3,600. Bear in mind that the net amount to pay to the pension fund in the case of a personal contribution is 80% of the gross value due to the reclaim made by the pension fund.
In both circumstances (company or personal) the maximum that can be contributed to a pension in a given tax year is £40,000 (gross), however unused allowances can be carried forward from previous years if a pension scheme was in place for the year being carried forward.
Alchemy Accountancy are not authorised by the Financial Conduct Authority to give advice about investment products, we suggest speaking to a Financial Adviser for more information about this.