Trading Deductions

Adjusting the Profits for  Tax

There is a certain deal of freedom within accounting rules. There may be elements of subjectivity in the way certain transactions and positions are shown in financial accounts.  For policy reasons, certain types of deductions are not available or are limited or treated differently in the tax computation, in order to protect the tax base. For this reason, the financial accounts must be adjusted to ascertain the taxable profits.

Any expenditure which isn’t wholly and exclusively for the purpose of the business is not deductible. A self-employed trader isn’t able to eat lunch at home and claim the extra cost as a tax deduction. This is not wholly and exclusively for the purpose of the trade. Where expenditure has been partly incurred for a business, a proportionate amount may be allowed e.g. use of a car.

Appropriation from accounts such as business owner’s salary, interest on capital drawings is not allowed as a deduction. These in effect represent an appropriation of the income itself. Salaries in excess of certain amounts paid to family members are not fully deductible.

In general terms, expenditures are deducted in calculating trading profits only if they are incurred wholly and exclusively for the purpose of the trade. This contrasts with the test in respect of employment, which requires that the expenditure be wholly, exclusively, and necessarily for the purpose of the employment.

Expenditure that is for a business and non-business purpose may be apportioned. The private element is not allowed. In some cases, apportionment is not possible if the expenditure would have been necessarily incurred for personal reasons only.

Certain categories of expenditure are disallowed. Income included in accounts that is not taxable trading income should be deducted e.g. capital receipts on sale of assets.  Other forms of miscellaneous income such as savings and dividend income and exempt income will appear in financial accounts this will need to be deducted by way of adjustment. These categories of income and gains are taxed under different tax headings, but they are not part of the trading income calculation.

Capital expenditure is disallowed and allowed as a deduction in capital gains tax only. Accordingly, a distinction is made between expenditure on repairs and capital expenditure or improvement. Capital expenditure implies that which brings a permanent benefit to the business. Where capital expenditure is disallowed, fees and expenses relating to it are also disallowed.

Charges to income under accounts, by way of depreciation, are disallowed. These are notional write-downs of capital expenditure. Capital expenditure is only allowed in the limited context of capital allowances. They effectively dictate the manner and extent to which expenses relevant to capital may be deducted.

Expenditure on capital is not allowed as an expense. Capital profits and capital losses must be taken out of the financial accounts. Questions can arise as to the difference between revenue expenditure and capital expenditure in the context of repair.  Repair of assets will be revenue expenditure, but an improvement will not be. The initial cost of repairs for making assets usable is usually not deductible. It is deductible if the asset could be put into use before the repairs are carried out.

Provisions for future costs are allowable provided they are calculated in accordance with U.K. GAAP (accounting practice rules) and their estimation is sufficiently accurate.   A general provision is not otherwise deductible.

Capital expenditure is dealt with under a separate system. Depreciation in financial accounts is added back.  So-called “Capital Allowance” rules only apply.  See our separate note on capital allowances.  Many types of capital expenditure do not qualify for capital allowances e.g. purchase cost of offices.  Other types of allowances are allowed, at different times and differing amounts to the deductions in financial accounts.

The owner’s income, drawings, capital gains, and national insurance contributions are not allowed. They may be deductions from the profits of the business but are, in fact, an appropriation of income.

Provisions may be allowed if they are permitted in accordance with generally accepted accounting practice. They must be capable of being ascertained with sufficient accuracy. The provision must generally be specific, rather than general.

Certain costs in entertaining customers and gifts are disallowed. Gifts to employees wholly and exclusively for trade purposes, certain small gifts to customers (of not more than £50 per year per customer) in return for displaying advertisements. Gifts of trading stock to education establishments, charities, and community amateur sports clubs, small gifts to local authorities, and contributions to local enterprise agencies, councils, and regeneration companies are allowed.

Political donations are not generally specific enough to be allowed. Where it is for a specific purpose, it may, in principle, be allowed.

Fines and penalties are disallowed as a matter of public policy. Parking fines paid on behalf of employees on employer business may be allowed. If the payment itself is criminal, such as by way of bribery, then it is not allowed as a matter of public policy.

Interest incurred for trade purposes will be allowed. Premiums paid for leases of less than 50 years are allowed in part. See the section in respect of real property.

VAT paid, which is irreclaimable, is allowable provided the underlying expenditure itself is allowable.

Remuneration to employees is generally allowable, provided it is for genuine business purposes. Abnormal salaries to shareholders in the family may not qualify for this purpose. The remuneration must actually be paid to the employees within nine months of the end of the period of account.

Redundancy costs and compensation payable are usually permitted. This includes lump sums, contractual redundancy payments, statutory redundancy payments, and non-contract redundancy payments up to a statutory amount may be permitted.

The cost of travel within the business is generally allowed but not the cost of traveling to the place of business. Unincorporated businesses may use approved mileage rates in calculating expenses. No other expenses may be allowed in relation to the vehicle concerned.

Expenditure incurred in the seven years before the commencement of trading may be available as if it was incurred on the first day of trading, provided it is of a type normally allowed.

Amounts in respect of leasing expenses of cars are restricted if the emissions rating of a car does not meet certain criteria. This involves the disallowance of percentages of the payments if it is only applicable to leasing over 45 days.

Where stock is appropriated by the owner, it may not show as a sale. However, accounting practice would require the costs less the owner’s contribution should be credited to income at market value.

They are certain expenditure items which are specifically allowed or not allowed by tax law.  Expenditure for private purposes is not allowed. Where it is for a mixed purpose, it is apportioned.

Business entertainment expenses are disallowed.