Working out what to claim and what not to claim can be like walking on a tightrope with potentially painful consequences if you slip.
Tax can be an absolute minefield and ensuring that the correct income is declared is vital. However, the matter of what can be expensed is open to interpretation and misunderstanding. On the one hand you don’t want to miss out on valuable reliefs, yet on the other, you’ll not want to mistakenly claim for something that isn’t allowable and possibly give HMRC an excuse to conduct an investigation into your affairs.
Your accounts
The accounts you draw up are a summary of income and expenses, generally for a period of 12 months and are declared to HMRC on your tax return. Moving on to what can be claimed, it’s important to note that expenses are costs to a business which are incurred “wholly and exclusively” for the purpose of trade. As a result, these expenses can be deducted from your total income, allowing you to claim tax relief on them. If you trade via a limited company, then by definition these expenses are to be “wholly, exclusively and necessarily” for the purpose of trade.
However, not all expenses are allowed relief against your income. Your allowable expenses are the same as those whilst you are employed, as well as equipment; replacement of parts; professional indemnity insurance; professional subscriptions; course fees (in some cases); accountancy fees; advertising and marketing; printing; stationary and books; postage; use of home as office; mileage and business travel; subsistence; staff wages; and cleaning and laundry.
There are also partial allowable expenses which you can claim, at an appropriate percentage or reduced amount, in certain circumstances to account for private use. These relate to motor running costs; telephone; hire purchase (leasing) interest; and other loan interest.
Of course not all business related expenses can be claimed against your income, so it’s clearly worth seeking guidance from your accountant, making sure that you advise them of all of your expenses and let them guide you on the tax deductions that are permitted.
Expenses
An important part of the tax process is the need to keep full and proper records of all business income and expenditure. This means, in simple terms, retaining all receipts and invoices relating to business expenses as HMRC has the power to enquire into your affairs and may ask for evidence to support your claim. By law you are required to keep your records for a minimum of six years – note that penalties may be charged for failure to maintain or retain records.
Not everyone uses full-blown accounting software so at the minimum, consider using an Excel spread sheet, with references to the relevant documentation, to keep track of your expenses; your accountant should be able to provide you with a template.
The better the record-keeping, the easier it is to draw up accounts, and if using an accountant, the lower the bill for his service. The advice is that, where relevant, you retain income received summaries; bank statements, cheque book stubs, paying-in-books; bank loan statements; HP/ leasing agreements; expense invoices/receipts; and records of business and private mileage.
You must note the sources of all monies into your various accounts including non-business related income. Your records do not need to be sophisticated but you should keep a record of all transactions as they arise.
Income is taxed in the period in which it is earned, even though this is not necessarily the period in which the income is received. In contrast, expenses are recorded on earnings basis and are deducted in the period in which they relate to which may not be in the period they are paid.
Since April 6, 2013, self-employed individuals can generally opt to be taxed on cash basis where they are taxed on total income received, less expenses paid, within the relevant period. There is little distinction between capital costs (fixed assets) and revenue costs (recurring costs) here. Therefore capital costs paid in a given period, on which capital allowances would normally be claimable, are treated as normal business expenses, having been adjusted for private usage.
But to qualify for cash basis of taxation, certain conditions need to be satisfied. The single most important condition is that all receipts recorded for the period must be below the VAT registration threshold. If the total of receipts exceeds twice the amount of the VAT registration threshold at the time the year after, the business must leave the cash basis system of taxation. It’s worth noting that businesses do have the option to utilise cash basis taxation for their future tax years where there has been a change of circumstances. Your accountant should advise you first before joining the scheme – cash basis taxation is not necessarily the best option for everyone.
HMRC can investigate
In extreme circumstances HMRC may disallow expenses you’ve claimed for taxation purposes. Their reasoning for this could be that they believe the expense claimed is not incurred “wholly, exclusively and necessarily” for purpose of trade. A good example of this is where they consider the expense relates to a private trip.
If this is the case, HMRC would then seek to impose penalties depending on the behaviour of the tax payer. This could result in higher penalties imposed if they deem this to be fraudulent or negligent conduct, unless it is proven otherwise to be an error that arose innocently.
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