Jennifer Adams considers whether all expenses paid for by a business are tax-deductible.
Just because an expense is paid out of a business bank account does not necessarily mean it will be tax-deductible. The general rule for all businesses is that expenses are tax-deductible if they are incurred 'wholly and exclusively' for that business. The sole purpose must be for the trade as incurred for the benefit of the business.
Potential confusion
A typical situation where confusion may arise is where a business pays for a table at an annual charity quiz night for the industry; is this entertaining clients (not allowed), a donation (allowed), or advertising (allowed)? The answer is ‘not allowed’ as the split between business and non-business cannot be differentiated.
Travel expenses can also confuse. For example, for a sole trader or partnership whose business is based away from home, the costs of travelling (commuting) to the business base are not deductible as these are incurred to put the person in a position to work, rather than being incurred in running the business. However, if the business is based at home, the costs of travel from home to the premises of a customer or supplier are deductible. Where the business is run as a company, all travel costs met by the company are deductible in computing the company’s profits.
However, 'wholly and exclusively' also means no private use element. Should a company meet the costs of private travel of an employee or director (e.g., home-to-work travel costs), a benefit-in-kind tax charge may be levied on the employee and a Class 1A National Insurance contributions (NICs) liability on the company.
Identifying the purpose
It is important to appreciate that the existence of a non-trade or private purpose will preclude the deduction in full if it is not possible to identify each element separately. If it is possible to differentiate, a deduction may be permitted for the trade portion only, calculated on a ‘just and reasonable’ basis. However, it is not always easy to separate business from private, particularly if the business is home-based.
HMRC agrees that a home-based business incurs additional expenses (heating, lighting, water and internet, etc.). For the self-employed, there is a flat rate (both tax and NICs-free with no evidence required) that can be claimed depending on the number of hours worked (e.g., for up to 50 hours a week, the allowance is £10 a week). The amount for a director-employee is £6 a week with no hourly restriction.
Calculating the claim
However, with energy costs rising, a business owner should be looking at whether it would be more tax-efficient to use the alternative method of calculation – that of percentages. The business versus private use still needs to be considered when calculating any claim. For a more accurate figure, the total bills could be divided by the floor space for the room used or calculated as a percentage of the room’s use for work only. If the office is used for (say) ten hours a day, but two of those hours are not work-related, the claim can be for 80% work use for the room. Note that council tax, mortgage payments and rent do not count as expenses, because these are incurred regardless.
In addition, the exemption only covers additional costs; therefore if the cost is the same whether the person works from home or not, it will not be allowable.
Practical tip
In court cases brought by HMRC to determine whether an expense was 'wholly and exclusively' incurred, judges have confirmed that what matters is the purpose of the expenditure and not the motive. Therefore, it is not sufficient that the expenditure results in an advantage for the trade; the direct and immediate purpose of the expenditure is what matters.
