What Are Tax Deductible Expenses?

Tax deductible expenses

The biggest benefit of being self-employed is that you don’t have to work for someone else! But what is the second biggest benefit? It is tax-deductible expenses. Why? Because it means you pay less tax!

How do HMRC define tax deductible expenses?

These are the expenses that can be set against your sales to lower the amount of tax you have to pay.

For business expenses to be tax-deductible, they must be “wholly and exclusively, but not necessarily, incurred for running your business”. So they can’t include expenses relating to your leisure time or family.

A PIZZA ANALOGY TO EXPLAIN TAX DEDUCTIBLE EXPENSES
Imagine a pizza parlour owned by Mario, called “Mario’s Pizza”. It sells the yummiest pizzas in Little Italy! However, Mario can only sell pizza in Little Italy, if he agrees to pay 20% of his profits to the Italian mafia (aka pizza protection money)!

Mario now has his first customer. It’s you! You decide to buy a whole pizza (it’s just one of those days!). The pizza costs £10 (it has 10 slices priced at £1 each). Mario says “help! I have to pay 20% of my profit on this pizza to the Italian mafia…how do I calculate this?”

Well you say: “You received £10 in sales for selling me the pizza. To calculate the profit, take away 1 slice of pizza for each £1 of costs that you spent to make and sell the pizza. You can only take away slices that symbolise costs that 100% relate to running your pizza parlour”.

There are 6 main categories of tax-deductible expenses for self-employed businesses:

1.    SALARIES & WAGES.

  • You can deduct: Wages, National Insurance and costs relating to employees or costs for hiring a self-employed person to do some work for you.
  • You can’t deduct. Your own wages or National Insurance.

2.    PREMISES

  • You can deduct: costs relating to business premises (heating, lighting, cleaning, water rates, rent, business rates), or costs relating to working from home (a proportion of home costs, including heating, lighting, cleaning, insurance, and general maintenance costs. You can also deduct mortgage interest if part of your home is used solely for business, but then you may be liable to Capital Gains Tax when you sell!).
  • You can’t deduct: the proportion of costs that relate to personal use of the home, or initial costs of purchasing/improving the building.

3.    EATING OUT

  • You can deduct: Subsistence costs when you’re working away from home.
  • You can’t deduct: Costs of entertaining actual or prospective clients! Or the cost of having dinner with your accountant!!

4.    TRAVEL

  • You can deduct: Travel and accommodation on business trips and between different places of work (e.g. between your work place (even if that’s your home) and where you have to do the work)
  • You can’t deduct: Travel between your home and usual work place

5.    ADMINISTRATIVE COSTS

  • You can deduct: Legal and consultation fees, accountancy fees, insurance costs, repairs.

6.    OTHER

  • You can deduct: Phone and mobile expenses, postage, stationery, advertising and marketing, cost of raw materials, bank charges, interest on work loan, pension contributions (limited to 100% of your self-employment profits)
So Mario takes 6 slices of pizza off the plate.

- the 1st slice represents the cost of employing the chef to make the pizza;
- the 2nd slice represents the cost of renting the pizza parlour, as well as for other bills like gas and electricity;
- the 3rd slice is for the cost of Mario’s hotel & food when he went travelling to Big Italy to source the best ingredients for his pizzas;
- the 4th slice is for the cost travelling to Big Italy for this business trip;
- the 5th slice is for paying his accountant and for buying the ingredients that were used to make the pizza;
- and the 6th slice is for Mario travelling to the pizza parlour everyday for work. Of course, you correct him: “you can’t take away the 6th slice, as you can’t deduct costs for travelling to your regular place of work”. So Mario puts the 6th slice back.

So there are now 5 slices left on the plate. Mario must give 1 slice (20% of the remaining pizza) to the Italian mafia! After he has given away this final piece, he is left with 4 pieces.

- The original 10 slices of pizza sold to the customer = sales
- The 5 slices Mario took off the plate that symbolized the costs of running the pizza parlour = tax deductible expenses
- The 6th slice that he wasn’t allowed to take off the plate = an expense that is NOT tax deductible.
- The 5 remaining slices (after taking 5 slices off the plate) = Mario’s pre-tax profit
- The slice paid to the mafia = tax paid to HMRC
- The 4 remaining slices left on his plate = profit after tax.

So there you have it. Tax-deductible expenses and pizza. If you like this post please share &/or like it on Facebook or Twitter.

Emma

P.S. Please feel free to post any questions that you have on tax-deductible expenses and your business. I will get back to you with an answer