This article acts as a general guide to help you identify which expenses are deductible. The article focuses on unincorporated businesses, but the rules on deduction of actual expenses are broadly similar for companies.
A simplified approach?
Unincorporated businesses can choose to take advantage of two less complicated methods of claiming tax relief for expenses.
You can earn up to £1,000 in a tax year without needing to declare the income to HMRC – this is known as a trading allowance. If your gross income is more than £1,000, you can still claim up to that amount as a trading allowance, instead of having to claim for actual expenses. This will be beneficial if you don’t have many costs or if you have not got receipts. However, where your actual expenses are higher than £1,000, it will be better to claim those costs to reduce your profit or demonstrate that you have made a loss.
You can choose to use HMRC’s ‘simplified expenses’ rules which allow you to use flat rates for certain expenses, where it could be complicated to calculate actual costs. The flat rate charge is claimed instead of actual costs. You will still need to calculate actual costs for any other types of expense.
These rates apply to some costs associated with using a vehicle for business, working from home, and living in your business premises. There are conditions attached to these rules which we do not cover here but, broadly, all you need to do is keep records of the number of business miles you drive, the number of hours you work at home, and the number of people living at your business premises over the year and then you apply the following flat rates to that number:
| Type of expense | Flat rate | Applied to | Applied to |
| Cars or goods vehicles | 45p | Per business mile up to 10,000 per annum. | Actual costs of buying and running the vehicle, including insurance, repairs, servicing, and fuel. |
| 25p | Per business mile above 10,000 per annum. | ||
| Motorcycles | 24p | Per business mile | |
| Working from home | £10 | Per month in which you work 25-50 hours at home. | The business proportion of your household expenses. |
| £18 | 51 to 100 hours per month. | ||
| £26 | 101 hours or more per month. | The business element of telephone and internet expenses can be claimed separately. | |
| Living at your business premises (e.g. at a guesthouse) | £350 | 1 person living on the premises, per month | The amount is taken off your overall premises expenses – it saves you having to calculate a split of personal/business costs. |
| £500 | 2 people | ||
| £650 | 3 or more people |
HMRC provides a simplified expenses checker which you can use to see whether it’s beneficial for you to claim it.
Claiming actual costs
The rules are different depending on the accounting basis used by your business. Most businesses use the traditional accounting (accruals) basis where you record income and expenses according to the date when you issued your invoice or were billed by a supplier and those amounts are then apportioned between the different accounting periods to which they relate. However, small unincorporated businesses with turnover of £150,000 or less can choose to use the cash basis, where you simply record income when you receive it and expenses when you pay them. There are other implications in using the cash basis, and you should discuss the appropriate accounting basis for your business with your adviser but, for the purposes of this article, the main points to note are that it will affect the date on which you claim the expense and that some capital expenses are treated in the same way as revenue expenses.
It’s useful to understand whether your expenses are revenue or capital in nature as each type is treated differently. At the simplest level, think of revenue expenses as those which cover short-term running costs such as utility bills, consumables and maintenance costs; compared with capital expenditure when you spend a larger amount to acquire an asset such as a computer, a vehicle, tools or machinery which you expect to benefit your business for a reasonable period (at least a year, and probably longer). The deductibility of those expenses mirrors the benefit of the expense – revenue expenses can be deducted in full when incurred, whereas capital expenses may need to be spread over a longer period.
If your business operates on a cash basis, then your capital costs can generally be claimed as if they were revenue deductions, with some exceptions such as the acquisition of part of a business, education or training costs, or the purchase of cars. With the accounts (or accruals basis), you cannot simply deduct capital costs from your turnover. Instead, you may be able to claim capital allowances which, broadly, allow you to recover the expenses over a period of years. These rules are complicated and depend on the type of asset so, where levels of expense are significant or on unusual assets you may need to seek specialist advice.
In recent years, the availability of an Annual Investment Allowance of £1million has meant that most small businesses can deduct all their qualifying capital expenditure at once, but it’s important that you determine the nature of your expenses, as they are reported differently even if the end-result may appear the same. Please note that companies may be able to claim a super-deduction capital allowance and should get separate advice on this point.
If you write off a proportion of your capital expenses in your accounts (known as depreciation) you have to ignore this for tax purposes and claim capital allowances instead.
Turning to revenue expenses, the key point is that they will generally only be deductible for tax purposes if incurred ‘wholly and exclusively’ for the purposes of the business, so either when you (or your employees) are performing the trade or trying to attract more trade. Special rules apply where you are preparing to trade or where you incur expenses after ceasing to trade – these are not covered here.
In most cases it should be clear whether or not costs have been incurred for business purposes, but some expenses are specifically not deductible (such as business entertaining) and there needs to be an adjustment for any non-business element of an expense. In such cases, some or all of that cost must be disallowed – either by not including it at all or by adding back the private element to the total shown on the business tax return.
The table below is based on guidance from HMRC provided in their annual help sheet HS222 and shows the treatment of some of the most common expenses. Comments in italics are where there is a capital element so that capital allowances may be available for businesses operating on an accounting basis. Don’t forget that if you claim flat rate expenses, you cannot claim actual expenses as well.
| Cost - Cost of goods that you are going to sell or use in your production or service process. | Allowable expenses - The amount paid for the goods. | Disallowable expenses - The cost of goods taken for private use. |
| Staff costs | Wages, salaries, bonuses, pension contributions, employer’s National Insurance contributions, etc. for employees; agency fees. | Your own drawings, wages, pensions, etc. (in an unincorporated business). Any payments not related to the business carried on. |
| Repairs and maintenance of property or equipment | Business repairs and maintenance. For cash basis users, the cost of tools used (with exceptions) | Repairs of non-business assets. Costs of buying, improving, or altering premises Costs of buying property or equipment. |
| Motoring and travel expenses | Motoring costs including insurance, repairs, fuel, servicing, licence fees, hire charges, etc. Public transport fares. Hotel room costs and meals on overnight business trips | Purchase price of vehicles. Any private use element Travel costs between home and the business Other meals |
| Phone, fax, stationery and office costs | Most running costs, consumables and small office equipment. Trade journals and subscriptions. | Any non-business element although private use of telephones/broadband can be ignored if insignificant. Purchase costs of equipment |
| Advertising and business entertainment | Most advertisements and website costs | Entertaining clients, suppliers, and customers |
| Legal and professional fees | Most legal and professional fees. Most insurance premiums | Costs relating to buying property. Costs of settling disputes with HMRC |
| Interest on bank and other business loans | Interest on bank and other business loans. Alternative finance basis. For cash basis users, this is subject to a limit of £500. | Repayment of the loan, overdraft or finance arrangements. |
| Costs of working from home | The proportion of your costs which relate to business use (if flat rate not applied). The business proportion of your telephone and internet bills. | The proportion of your costs which relate to private use. The private proportion of your telephone and internet bills |
Record keeping
Having determined your expenses, it is important to ensure you keep proper records to ensure you can support your claims if HMRC launches an enquiry. You should ensure that you keep records of your income and expenses, such as invoices or bank statements, for at least five years from the 31 January following the end of the tax year.
You will generally report your expenses when you complete your annual tax return. In some cases, unincorporated businesses may only need to give the total figure rather than listing out different categories of expense, but it is good practice to record the different categories in any event for your own accounts and in case of HMRC enquiry.
If your business pays personal expenses on your behalf or those of your employees or provides them with non-cash benefits such as a company car, you will need to consider whether this needs to be reported via PAYE, either as earnings or a benefit-in-kind. .
Conclusion
Determining the level of allowable business expenses you have incurred can be a complex task and getting it wrong could cost you large sums of money. HMRC do try to provide support, particularly for new and smaller businesses, including videos on business expenses. However, it is always best to seek professional advice for your business and Lovewell Blake has a specialist team dedicated to SMEs and family businesses which can help with not only this, but also your accounting, payroll, and VAT.