Allowable and disallowable trading expenses

If you run a business, it is important for you to understand the difference between allowable and disallowable trading expenses for tax purposes.  Improper understanding of them can result in you paying incorrect amount of tax.

Generally speaking, an expense is allowable for tax purposes if it is incurred "wholly and exclusively" for business purposes.  If you are running a fish and chips shop, the costs of the fish you buy and the employees you hire are allowable as they are incurred for the purposes of running your fish and chips shop.

What if a person is working from home and using it partly for business purposes?  If you can clearly distinguish the business element from the private element in the total premises costs, you can claim the business proportion of the expenses. 

If it is impossible to distingush the business element in your premises expenses, it is acceptable to claim a certain percentage of your premises costs as your business expenses, as long as the percentage you use is modest and reasonable (from HMRC's point of view).  For instance, in most cases,  it would be reasonable to claim 40% of your premises costs as use of home as office.

You can apply the same method to other business-private mixed expenses such as telephone and mobile expenses, motor expenses and travel expenses etc.

Of course, in real life, it is not always a black and white issue as to what you can and cannot claim as business expenses.  Below are the few usual suspects of disallowable expenses:

• Client entertainment (except for staff entertainment, in which case your staff may be taxed if the amount is excessive);
• High-valued gifts (exceeding £50 per person per year);
• Costs of business equipment (however you can claim capital allowances on the costs);
• Accountancy fees related to tax disputes (accountancy fees for the preparation of trading accounts and tax return are allowable);
• Legal fees related to the purchases of business equipment (however you can treat it as part of the equipment expenses and claim capital allowances accordingly);
• Personal and private expenses such as ordinary clothing, motor expenses incurred for private purposes (however you can claim the business proportion of the expenes);
• Late payment interest on unpaid tax;
• if you are working from home, capital repayment of your mortgage (however you can claim part of the interest element of your motgage payments);
• Depreciation you charge on your trading accounts (how you can claim capital allowances).

Generally speaking, to work out the taxable trading profit for your business, you deduct your expenses from your business turnover and add back all the private (if any) and disallowable (if any) expenses.  It is not as complicated as it might seem.