Possibly the most asked question we get is… ‘can I put xyz through my business?’.
The answer usually is… maybe! Some business expenses are pretty black and white but for others, it all comes down to context.
There’s no list of what is and isn’t an allowable business expense. That’s because for one business owner, an expense can be allowable whereas for another business owner, the same expense may not be allowable.
To establish whether an expense is allowable or not, we have to consider the following guiding principles to determine the answer.
What Are Allowable Business Expenses?
Allowable business expenses are costs that are incurred "wholly and exclusively" for the purpose of running your business. These expenses can be deducted from your business income when calculating your taxable profit, which in turn reduces the amount of tax your business owes.
The Guiding Principles of Allowable Expenses
HMRC sets out clear guidelines to determine whether an expense is allowable:
Wholly and Exclusively for Business: The expense must be incurred entirely for business purposes. If an expense has a dual purpose (both personal and business), it can only be claimed for the business portion.
Necessary and Reasonable: The expense should be necessary for the operation of your business and reasonable in amount.
Not Capital in Nature: Allowable expenses typically cover day-to-day operational costs rather than capital expenditures, which are for purchasing assets like machinery or property. However, capital expenditures may qualify for capital allowances, a different type of tax relief.
Documented and Justifiable: Keeping accurate records and receipts for all expenses is crucial. HMRC may request evidence to substantiate any claims made on your tax return.
You could think of it this way… HMRC don’t care what you buy but rather why you bought it.
Common Allowable Business Expenses
Some common examples of allowable business expenses include:
Office Costs: Rent, utilities, office supplies, and equipment.
Travel and Subsistence: Business travel costs, accommodation, and meals during business trips.
Staff Costs: Salaries, pensions, and employer’s National Insurance contributions.
Marketing and Advertising: Costs related to promoting your business, including website expenses.
Professional Fees: Accounting, legal, and other professional services.
Allowable Expenses for Sole Traders vs. Limited Companies
While the principles of allowable expenses apply broadly to all businesses, there are important distinctions between how expenses are treated for sole traders versus limited companies.
1. Sole Traders
For sole traders, the business is not a separate legal entity from the individual. This means that any expenses must be personally incurred by the business owner.
Home Office: Sole traders who work from home can claim a portion of their home expenses, such as heating, electricity, and rent, based on the area used for business and the time spent working there.
Car and Travel Expenses: Sole traders can claim mileage allowance or actual costs incurred in running a vehicle for business purposes. If the vehicle is also used for personal travel, only the business portion is deductible.
Simplified Expenses: Sole traders can use simplified expenses, a flat-rate expense method, to calculate costs for things like vehicle use, working from home, and living on business premises.
2. Limited Companies
For limited companies, the business is a separate legal entity, so all expenses must be incurred by the company itself.
Director’s Salary: Payments made to the director as a salary are allowable, along with associated National Insurance contributions.
Employee Benefits: Limited companies can provide benefits to employees (including directors), such as pensions and health insurance. However, these benefits may be subject to additional tax considerations.
Dividend Payments: Dividends paid to shareholders are not allowable business expenses and must be paid from post-tax profits.
Home Office: If the director or an employee works from home, the company can reimburse them for reasonable home office expenses. These payments can be made tax-free if they fall within HMRC’s guidelines.
Travel Expenses: Travel expenses incurred by employees or directors on behalf of the company can be claimed, provided they are for business purposes.
Navigating the Intricacies of Business Expenses
Understanding the distinctions between allowable expenses for sole traders and limited companies is crucial for ensuring your business is tax-efficient and compliant. Here are a few additional points to consider:
Private vs. Business Expenses: Both sole traders and limited company directors must carefully separate personal and business expenses. HMRC closely monitors mixed-use assets and expenses, so accurate record-keeping is essential.
Capital Allowances: For both sole traders and limited companies, large purchases like machinery, vehicles, and equipment may not be claimed as an immediate expense but instead, qualify for capital allowances.
Expense Policies: Limited companies should establish clear expense policies for employees and directors to ensure that all claims align with HMRC guidelines.
The Grey Areas
Here are a few examples of common expenses where we need to think about the business expense principles when determining an allowable expense.
Clothing
Clothing is a common question, it’s fair to say that most of us wear clothes both for business and personal use (we hope!) which gives rise to the issue of dual purpose.
However, if the clothing items are embroidered with your business name or logo it can be justified as business apparel as the clothing enables you to represent and promote your business and brand.
Some non-branded items may also be justifiably considered business expenses such as hi-viz jackets, steel toe cap boots or other protective clothing provided that such clothing is necessary for your business.
An electrician for example would have no problem justifying the need for steel toe cap boots as an allowable expense whereas a beautician would struggle to do so which is why we must always refer back to our guiding principles.
Mobile Phones
There is a difference between Sole Traders and Limited Company owners regarding mobile phones.
Limited Companies can provide their employees (you) with one mobile phone tax-free, provided the mobile phone contract is with the company and not you the business owner. This makes mobile phone expenses relatively straightforward for both the cost of a handset and the ongoing usage.
For a Sole Trader, we have to deal with the issue of dual purpose. If you have two mobile phones and one is exclusively for business then it’s fine to treat the cost of the business phone as a business expense.
If like a lot of business owners, you use your phone for both business and personal use, you can only expense the business portion as an expense.
Given the way mobile phone contracts work with unlimited calls, texts and generous data allowances, it can be extremely difficult to assign a cost to your business and the potential tax saving may not outweigh the time and effort to try and establish a split between business and personal use.
Cars
Cars are another common area of confusion. As a Sole Trader, you and your business are the same (legally speaking) which means that dual purpose comes into play.
Generally speaking, the easiest method to apportion car-related business costs is to keep a mileage log and claim 45p per mile of business travel as an allowable expense (up to 10,000 miles).
If you have a works van for example that you use exclusively for your business, then the cost of the van could be treated as a capital expense and an apportionment of the cost could be expensed each year for the cost of the vehicle along with the associated costs such as insurance, servicing etc.
For limited company business owners, you can provide employees with a company car. The car is not completely tax-free however but can present itself as a tax saving option over owning a car personally.
In short, business expenses can be a bit of a minefield but if you assess any expense against the guiding principles outlined above, you shouldn’t go far wrong.
Better still, employ the assistance of an accountant to help guide you through those tricky business expense decisions.
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