Tax-deductible expenses are expenses you can legally deduct from your total profits. This reduces your gross profits and hence the amount of tax you pay. In general, if an expense is necessary for the running of your business it is very likely to be tax-deductible.
What does tax-deductible mean in practice?
If you’re trying to work out what expenses are tax-deductible, then you need to determine what expenses are necessary for the running of your business. This is generally straightforward, with a bit of practice. It may, however, require you to shift your mindset to some extent.
For example, if your sales team meets potential clients in restaurants, you can only claim tax deductions for your employees’ meals. This is because, as an employer, you have a duty of care towards your employees. If they are away from both their home and their regular place of work, you need to make sure that they get fed.
You have no such obligation to your clients. This means that client entertainment is not (usually) a legitimate tax-deductible expense. The client’s employer, by contrast, might claim the cost of their employee’s meal as one of their own tax deductions. This is because, like you, they have a duty of care towards their employee and this can extend to feeding them on work trips.
Another point worth noting is that both payroll costs and payments to contractors qualify for tax deductions. Dividend payments, however, do not. This is because employees and contractors are working on behalf of the business. Shareholders, by contrast, are enjoying the (post-tax) profits of the business. The fact that certain employees may receive a lot of their income in dividends is irrelevant.
Are charitable donations tax-deductible in the UK?
Tax deductions and employee expenses
In most businesses, the majority of tax-deductible expenses will probably be managed centrally. For example payroll, rent, bills and the purchase of supplies will typically all be coordinated by someone or a team with responsibility for finance.
Some businesses, however, will need or want to allow their employees a certain level of flexibility with purchases, especially small ones. For example, if an employee wants an app costing a few pounds, there’s unlikely to be a justification for going through a significant process before the purchase. Employers may also need to allow mobile employees to make purchases “on the road”.
Keeping track of tax-deductible expenses
Many of these purchases are likely to qualify for tax deductions so it’s important to keep track of them. One way to do this is to issue employees with business credit cards and ask them to keep receipts as well. This belt-and-braces approach should make sure that tax-deductible expenses are captured one way or another. There are, however, three potential snags with this approach.
First, not all employees will qualify for business credit cards, as they may not have an acceptable credit score to qualify for one. Second, employees may not feel comfortable about having to pay for business expenses out of their own funds. This could be because if an expense reimbursement is delayed, or an expense isn’t approved, then the employee becomes personally liable for it. Third, paper receipts can easily be lost.
One way to deal with the first and second snags is to issue employees with prepaid debit cards. One way to deal with the third snag is to have them take photos of all paper receipts as soon as they get them. Make sure your employees understand that these photos have to be clear as HMRC may want to check them.