Business owners and sole traders have a responsibility to calculate and file their total trading profits each year and to pay tax on that amount. A company’s tax liability can be reduced by deducting the cost of allowable expenses from your total trading profits.
What are allowable expenses?
Allowable expenses are essential business costs necessary for the running of the business. Qualifying costs are tax-deductable, which means the amount can be deducted from total trading profits prior to calculating a final tax bill.
It is important to understand what is classed as an allowable expense to avoid errors in tax calculations which could result in additional charges and fines.
Which expenses are tax deductible?
The rules on allowable expenses differ depending on whether you operate under the legal banner of sole trader or limited company.
Costs that may be included under your allowable expenses will also vary based on whether you work from home or conduct business from separate premises.
In all cases, allowable expenses must be “wholly and exclusively” incurred for the running of the business. This means, for instance, that you cannot claim the expense of a mobile phone, if that device is also used as your personal phone some of the time.
This means business money used to pay for private purchases would not qualify as allowable expenses.
Certain ‘pre-trading’ expenses are also allowable if they were necessary for the initial establishment of business operations. The rules concerning pre-trading expenses are slightly different to those for expenses incurred while carrying out trading activities or prospecting for business. Note that pre-trading expenses may only be included on the tax return which follows your first year of business.
Allowable expenses for limited companies
In most instances, the following business expenses are allowable:
- Accounting and bookkeeping costs
- Advertising costs, including brochures, photographs, filmmaking, business cards, flyers, and other publicity materials
- Minor repairs to business property, including fuses, locks, replacement keys, leads, plugs, and call out fees
- Consumable office items such as printer ink, paper, CDs, DVDs, memory sticks and hard drives
- Software license fees, web domain registration and hosting fees
- Courier costs and postage
- Purchase of stock
- Data protection costs
- Workwear
- Charitable donations
- Heating, lighting, property rental and equipment lease
- Landline telephone, mobile and internet costs
- Staff entertainment costs and prospect entertainment costs, typically not including food, drink, or alcohol
- Cost of re-training or educating employees where the skills being developed are essential to the job role, such as training materials or registration on approved courses
- Pension contributions may also be included as an allowable expense, though there is a cap on the amount that can be paid into a pension scheme annually.
As this list is by no means exhaustive, it is recommended to take professional advice to ensure you are applying the rules correctly.
Revenue expenses versus capital expenditure
Business expenses are either categorised as ‘revenue expenses’ or ‘capital expenditure’. The former category refers primarily to consumable expenses, such as ink cartridges or printer paper. The latter refers to expenses that represent more of a long-term investment for the business, for example, a computer or office furniture.
Smaller businesses which use ‘cash basis’ accounting (i.e. only including income and expenses that have been received or paid out within the accounting period) can typically claim most capital expenditure as part of their allowable expenses.
The “wholly and exclusively” rule applies to both revenue expenses and capital expenditure; any expenses that are utilised for non-business activities are not allowable.
What are incidental expenses?
Incidental expenses are one-off and typically minor expenses, usually associated with business-related travel.
These expenses are generally small enough to be paid out in cash and do not necessarily need to be documented with receipts, for instance, tipping a baggage handler or similar service provider would likely qualify as an incidental expense, providing the size of the tip is reasonable.
Business owners and employees should take care to ensure minor expenses do not fall under any other allowable expenses category before listing them as incidental. For example, taxi hire would be considered a travel cost, while payphone use would be considered a communication or utilities expense.
Allowable expenses for employees
Your employees can also claim expenses incurred during essential business activities, directly from HMRC, as tax relief. Alternatively, you may reimburse employees yourself and list the allowable expenses they incur on the company’s tax return.
If opting for the latter, it is good practice to have a detailed expenses policy outlining the type of expense which employees may claim, plus a maximum amount for each expense.
It is essential that your employees keep receipts for all expenses, as you may be required to submit them should HMRC wish to audit your tax return.
Ideally, companies should have an ‘expenses form’ which employees may use to submit and claim their expenses at the end of each month or quarter.
Self-employed allowable expenses
Whether you are registered as a self-employed sole trader or a limited company, you are eligible to claim allowable expenses. Any expense paid out which is wholly and exclusively necessary for the continuation of self-employed operations may be claimed as tax relief, to lower taxable profits and reduce your final tax bill.
It is often, though not always the case, that persons who are registered as sole traders (i.e. the business and the person are considered to be one and the same in the eyes of the law) incur fewer allowable expenses than limited companies (i.e. companies where the business and its shareholders or directors are considered separate entities).
The key consideration is that allowable expenses work similarly for both self-employed sole traders and limited companies. However, limited companies pay ‘Corporation Tax’ rather than ‘Income Tax’, which amounts to a lower percentage of total profits. In addition to being more tax-efficient, limited companies can claim a greater variety of allowable expenses than sole traders.
Working from home expenses
HMRC’S tax rules include provisions for small business owners who work from home and have higher household expenses as a result. When your business is partially or entirely conducted from your home address, you may claim a percentage of your household outgoings as allowable expenses. These expenses may include:
- Heating
- Lighting
- Council tax
- Mortgage interest or rent
- Water rates
- Council tax
- Telephone and internet
There are two permitted methods of claiming allowable expenses incurred by working from home. You may either calculate your expenses precisely based on how many rooms in your home are used for business purposes or use HMRC’s ‘simplified expenses’ method to claim a flat rate based on the number of hours per month you work at home.
The simplified method is undoubtedly easier and will not be scrutinised should HMRC wish to check your accounts; however, it often results in a lesser claim. Using this method, the amount you can claim while working from home is as follows:
- 25 to 50 hours – £10/month
- 51 to 100 hours – £18/month
- 101 or more hours – £26/month
Alternatively, use the following steps to calculate the exact portion of your household outgoings which can be claimed as allowable expenses:
Add up the all qualifying expenses paid out within the accounting period (e.g. rent, gas, electricity etc.) Divide this figure by the number of rooms in your house, not including kitchens and bathrooms. Multiply the resulting figure by the number of rooms used while working from home.
Tracking allowable expenses
Business owners are legally required to keep receipts and a record of all allowable expenses for six years. At any point within this six-year period, HMRC may decide to take a closer look at the expenses you have claimed. To make sure you are prepared for such an inspection, it is wise to use accounting software or a spreadsheet to meticulously track your expenses, by date, as they are incurred.
Legal disclaimer
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal or financial advice, nor is it a complete or authoritative statement of the law or tax rules and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert professional advice should be sought.
Author
Gill Laing is a qualified Legal Researcher & Analyst with niche specialisms in Law, Tax, Human Resources, Immigration & Employment Law.
Gill is a Multiple Business Owner and the Managing Director of Prof Services Limited - a Marketing & Content Agency for the Professional Services Sector.
