Sarah Bradford outlines the rules governing whether an expense incurred by a self-employed trader can be deducted in calculating their taxable profit.
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No one wants to pay more tax than they need to. However, this is exactly what will happen if you fail to take account of all allowable expenses in calculating your taxable profit. It is important, therefore, that as a self-employed trader, you keep accurate records of the expenses that you incur in running your business, and you also understand what can be deducted – and what cannot.
The general rule
The basic rule is that a deduction is allowed for expenses incurred wholly and exclusively for the purpose of the trade. This means that as long as an expense is incurred for the purposes of the business and only for that purpose, a deduction is given.
Unlike the rule governing the deductibility of employment expenses, there is no requirement for it to be necessary to incur the expense for it to be deductible.
No deduction for private expenses
Not surprisingly, you can only deduct business expenses when calculating your taxable profit – a deduction for private expenses is not permitted. To ensure that you can tell whether an expense is a business expense or a private expense it is advisable to have a separate business bank account and a separate business credit card and use these for all business expenses. The business bank account and credit card should not be used for private expenses.
When preparing your accounts, it is important to check that no private expenditure slips through the net – it is very easy to mix the two (e.g., picking up a magazine at the same time as buying some office stationery and paying for everything together with the business debit card). Here, a deduction is only allowed for the stationery; care should be taken to exclude the cost of the magazine. Any temptation to put private items ‘through the business’ should be avoided.
Mixed expenditure
Sometimes, expenses will be incurred for both business and private purposes. The fact that a deduction is not permitted for private expenditure does not preclude a deduction for the business portion, as long as it is possible to identify the different elements.
The legislation provides:
‘If an expense is incurred for more than one purpose, this section does not prohibit a deduction for any identifiable part or identifiable portion of the expense which is incurred wholly and exclusively for the purposes of the trade.’
Where an expense is incurred for both private and business purposes, the extent to which any deduction is permitted depends on whether it is possible to identify the business portion.
Expenses that have a business and private element should be apportioned and a deduction claimed for the business portion. The apportionment should be done on a just and reasonable basis.
This situation may arise if a mobile phone is used for both business and personal calls. From an itemised bill, it will be possible to determine which calls are business calls and which are private calls and to split the cost accordingly. For example, if the annual bill is £800 and 72% of the calls are business calls, a deduction of £576 (72% of £800) would be permitted.
As a sole trader, you may have one car which you use for both business journeys and privately. Here it is easier to keep a record of business mileage and to claim a deduction using the mileage rates under the simplified expenses system rather than trying to identify and apportion actual costs. Under this system, a deduction is allowed at the rate of 45 pence per mile for the first 10,000 business miles in the tax year, and at the rate of 25 pence per mile for subsequent business miles.
Dual purpose expenditure
There is a difference between expenses with both a business and a private element, which can be separately identified, and expenses which have a dual purpose and in respect of which a split is not possible. An example of this is ordinary everyday clothing which is worn only for work. Despite the fact that the clothes are only worn for work, they also fulfil the private purpose of providing warmth and decency. As it is not possible to make an apportionment, no deduction is permitted in respect of the cost of the clothes.
However, as far as clothing is considered, this rule can be overcome by having a uniform which features the business name or logo, as this is an allowable expense. The key here is the logo or business name. The cost of a plain sweatshirt worn only for work is not deductible; however, the cost of a similar sweatshirt featuring the business logo is.
There are numerous examples where a claim for deductibility may fail as a result of duality of purpose, and it is important to consider this when assessing whether an expense is deductible. For example, if you need reading glasses to read work emails and to do your accounts and other paperwork, but you also use them to read the Sunday newspaper or a novel, the cost of the glasses cannot be deducted as a business expense as there is a duality of purpose. However, if a separate pair of glasses were purchased and used solely for business activities, a deduction will be permitted as there is no duality of purpose. It may pay to think ahead.
Incidental private benefit
In some cases, there may be an incidental private benefit to what is essentially a business expense, and where this is not significant, its existence will not prevent the expense from being deductible.
For example, if you travel to Spain to meet a supplier, the fact that you are able to enjoy nice weather while there does not stop the cost of the trip from being deductible.
Trading allowance
If your total trading income from self-employment is less than the £1,000 trading allowance, you do not need to report it to HMRC. In this situation, you do not need to work out your profits or deduct expenses as there is nothing to report and no tax to pay. Any profit you make is tax-free.
If your trading income is more than £1,000, you can still benefit from the trading allowance. Rather than claiming a deduction for your actual expenses, you can instead opt to deduct the £1,000 trading allowance instead. This will be advantageous if your actual expenses are less than £1,000 as it will reduce your taxable profit. It is also less time-consuming.
Simplified expenses
Using simplified expenses will save work. As noted above, simplified expenses can be used to claim a deduction for vehicle expenses by reference to a mileage rate for business mileage.
Where the business is run from home, simplified expenses can be used to determine the deduction for the business use of the home. The deduction is at a flat rate depending on how many hours the home is used each month for the purpose of the business. This is far less work than apportioning household bills between private and business use.
If you live in your business premises, as may be the case if you run a bed and breakfast establishment, you can also use simplified expenses to determine the disallowance for private use.
Typical expenses
A business may incur some or all of the following expenses, which can be deducted in calculating its taxable profit, as long as the costs are incurred wholly and exclusively for the purposes of the business:
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Office costs, such as stationery and printing costs and phone bills.
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Travel costs, such as fuel, train, taxi and bus fares, or parking.
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Uniforms bearing the business’s logo or name (but not ordinary everyday clothing).
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Goods purchased for resale.
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Raw materials.
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Costs related to the business premises, such as rent, light and heat.
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Insurance.
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Advertising or marketing costs.
Practical tip
To ensure that you do not overlook deductible expenses, make sure that you record all business expenses, and also that you understand what can be deducted.
