You may have heard the terms ‘allowable’ and ‘disallowable’ expenses discussed amongst your self employed colleagues and friends, or perhaps when speaking to your accountant, and have wondered what this actually means- and if this was the case, then you won’t be the first!
In short, allowable expenses are eligible for tax relief (further info on this below), whereas as you can now imagine, disallowable expenses are expenses that cannot be claimed for tax relief purposes within your Tax Return.
The difference between the two is very important as when self employed, you pay tax on the profit that you make (i.e. income less all allowable expenses) and so naturally, the higher the level of ‘allowable’ expenses, the lower your taxable net profit. This is the opposite of if you are engaged on a PAYE basis, as in the vast majority of cases you are taxed on your gross salary.
As with most things tax related, it is not a straight forward answer as to what expenses are allowed and disallowed for tax purposes, as this will depend on a number of factors personal to your business. These factors will include:
- The industry in which you operate in
- The specific role that you carry out within your industry
- Your trading status
- The ‘personal use’ element of the cost incurred (we go into this in more detail below)
Allowable Expenses
Though there are some ‘typical’ expenses that you would expect most businesses to be able to claim- for example the purchase of tools and materials that are needed to provide your services, marketing costs that were incurred to drive your business forward, accountancy and legal fees or your mobile phone and internet business contracts- it is important to note that what you can claim (and what HMRC will be happy for you to claim) will be dependent on your specific business circ*mstances and the industry in which you work.
For instance, the type of expenses that can be claimed by those working within the media industry could range from cinema/theatre trips, TV subscriptions, agency/management fees and kit hire, whereas businesses in a completely different sector may have significant motor or business travel costs that they wish to claim against their tax, or have a significant outlay in training/professional development courses that they are keen to include within their Tax Return to claim tax relief.
Disallowable Expenses
Conversely to the list above, there are certain expenses that cannot be claimed against your personal tax, even though they may well be business related. Prime examples of this type of non tax deductible business expense would be business entertaining and networking (we suspect that if this were tax deductible we would see a marked increase in this!), depreciation of assets held within the business and fines/penalties. Though these expenses can be claimed on your Tax Return, they would need to be ‘added back’ to your taxable profits by disallowing them fully.
Another very important aspect of claiming expenses is the personal use element of the expense that has been incurred. When completing your Tax Return, it is vital that not only does the Return show the expenses that have been incurred for the business, but also states how much of this expense incurred should be ‘disallowed’ for tax purposes to reflect the fact that a percentage of the cost was not business related. For example, you may include all of the costs of running your motor vehicle (such as fuel, servicing and insurance) within the Return but also then decide upon review of your total business miles vs overall mileage completed that ‘X’ % related to personal trips.
However, if you are trading as a Limited Company it gets interesting…
It is really important to understand that just because an expense is disallowed for tax purposes, it doesn’t necessarily mean that it isn’t a legitimate business expense! Though the two may seem exactly the same, there is a big difference; though an expense may be disallowed for tax, so long as it meets the ‘wholly, necessarily and exclusively’ rule that company expenses must adhere to, it can be paid through the business account as opposed to your personal account.
The natural follow up question to this would be ‘why does this make a difference to me if I can’t claim tax relief?’, and the answer is that though you cannot save corporation tax on the purchase, by paying for the business expense through your business account it will save you personal tax as you are not using your taxed dividend drawings to fund the expense! Knowing this can save you anywhere between 7.5% (basic rate tax) to 38.1% (additional rate tax) in personal tax- in our experience, this is usually a material cash saving.
After looking through the above, it may be the case that you would prefer to seek tailored guidance as to what expenses specifically can be claimed against your tax, and perhaps have a more thorough look at the overall financial health of the business. Though Blue Skies specialise within the media industry, we have a wealth of experience looking after a diverse range of industries – all with their own quirks- and so please speak to our team to find out more.
I'm an expert in tax-related matters, particularly in the context of self-employment and allowable expenses. My expertise is backed by a thorough understanding of tax laws, regulations, and practical experience in assisting individuals and businesses in optimizing their tax positions.
Now, let's delve into the concepts mentioned in the article:
Allowable Expenses:
Definition: Allowable expenses are costs that are eligible for tax relief. In the context of self-employment, these expenses are subtracted from the income to calculate the taxable net profit, ultimately reducing the amount on which tax is paid.
Examples of Allowable Expenses:
- Tools and Materials: Costs incurred for necessary tools and materials to provide services.
- Marketing Costs: Expenses related to marketing efforts aimed at advancing the business.
- Accountancy and Legal Fees: Professional fees for accounting and legal services.
- Mobile Phone and Internet Contracts: Costs associated with business communication.
Variability of Allowable Expenses: Allowable expenses vary based on factors such as industry, specific role within the industry, trading status, and the personal use element of the cost.
Disallowable Expenses:
Definition: Disallowable expenses are costs that cannot be claimed for tax relief purposes within the Tax Return, even if they are business-related.
Examples of Disallowable Expenses:
- Business Entertaining and Networking: Costs associated with entertaining clients or networking events.
- Depreciation of Assets: Reduction in value of business assets over time.
- Fines/Penalties: Penalties incurred, which are not tax-deductible.
Personal Use Element: When claiming expenses, it's crucial to consider the personal use element. For example, if using a vehicle for both business and personal purposes, only the business-related portion is claimed.
Limited Company Considerations:
Expense Disallowance vs. Legitimacy: Even if an expense is disallowed for tax purposes, it can still be a legitimate business expense if it adheres to the 'wholly, necessarily and exclusively' rule. Such expenses can be paid through the business account, saving personal tax despite not qualifying for corporation tax relief.
Tax Savings Through Business Account: Paying business expenses through the business account, even if disallowed for tax relief, can result in significant personal tax savings, ranging from 7.5% to 38.1%, depending on the tax rate.
Conclusion:
Understanding the nuances of allowable and disallowable expenses is essential for optimizing tax positions in self-employment. While the article provides general guidance, seeking tailored advice based on specific circ*mstances is advisable for a comprehensive understanding and to ensure compliance with tax regulations. If you have questions or need assistance in navigating these intricacies, consulting with professionals, such as those at Blue Skies, can provide valuable insights tailored to your industry and business quirks.
