Managing expenses is an important part of running a limited company. In this guide you’ll learn what expenses are and what you can claim through your company.
Many freelancers, contractors and small businesses see claiming business expenses as an onerous task, but it doesn’t need to be. By understanding the HMRC rules and following some simple guidelines, you can ensure that you maximise the tax benefits and improve your balance sheet, quickly and efficiently.
If you have a contract that is caught by IR35 legislation, the expenses you can claim are restricted. Essentially allowable expenses will be the same as what a permanent employee would normally be able to claim. On top of a 5% expense allowance when inside IR35, you can also claim for professional subscriptions (subject to being on a HMRC approved list), pension contributions and Professional Indemnity insurance. From 6th April 2016 restrictions have been put in place that mean that travel and subsistence expenses cannot be claimed when a contract is inside of IR35.
Introduction to the 2 year rule
The 24 month or 2 year rule is a time period set by HMRC whereby travel and subsistence expenses can be claimed whilst working at a ‘temporary’ workplace such as a clients site. After this the workplace is classed as permanent and travel expenses can longer be claimed.
The rule also states that as soon as you have visibility of being at that temporary workplace for more than 2 years you must stop claiming travel related expenses straightaway, i.e. you cannot claim continuously for 2 years. For example, if you start with a 12 month contract and you secure another 12 month contract with that client, you must stop claiming expenses at 12 months.
What are business expenses?
In its simplest terms you should be looking to record any expense, paid by the business, by you, or by your employees that is for physical items or services needed to run the business. The HMRC rule is clear on this; a business expense must be necessary and that is wholly and exclusively incurred as part of the day to day running of your business. On the face of it, this definition appears simple, but what does it mean for you?
There are two main categories of expenses, and they are treated and recorded differently in your year-end accounts and tax returns:
- Tax deductible – the most common type of expense. Tax-deductible expenses are taken from company profits so your tax bill is reduced. These include travel, IT equipment and services like webhosting. For a full list click here.
- Non-tax deductible – this type of expense is not deducted from year-end profits and therefore does not impact on the company tax bill. The most common example of this expense is client entertaining where you can still record them but it won’t reduce your tax bill and VAT isn’t recouped.
So, if the expense is necessary and wholly incurred as part of the running of your business, it is a business expense. Personal items and expenses must not form part of your expense recording; examples include clothes (non-uniform), dry cleaning and supermarket shopping. Many businesses have exposed themselves to scrutiny by the HMRC by including personal expenses; they incurred penalties and additional administrative burdens. If you are in any doubt, check the HMRC website for guidance. Two questions you need to ask are:
“Did I purchase this item or service because I need it for my business?” If the answer is yes, then it is a business expense.
“Is the item or service used purely for business?” This helps you ascertain whether a proportion of the cost needs to be deducted for personal use. Examples of this are: mobile phones in your own name but used for business calls too, home-office space running costs, personal vehicles used for business.
There is some confusion around personal expenses and whilst some items appear obvious such as your weekly shop and clothes, others can appear to be in the grey area. Common queries are around company cars, gym membership and private healthcare for example. This sort of personal expense is seen as a benefit in kind, which means that there is no reduction in corporation tax, you can’t claim the VAT and you’ll need to pay income tax and National Insurance too: it just adds to your paperwork for no financial gain. We advise that you should not put personal expenses of any kind through your company.
Why is good expense management important to your limited company?
The majority of expenses incurred by your company will be tax deductible. This means that they are deducted from your profits and therefore reduce your tax bill. A lower tax bill means more working capital and you have more cash available, increasing the value of your company and maximising profits available for investment or drawing as dividends.
Good expense management gives you a clear view of how your company is performing and ensures that you have a true view of your financial position throughout the year. So many people fall into the trap of storing up receipts and invoices to deal with later. This makes claiming expenses an onerous task and means that the end of year accounts and tax bill can come as a shock. With inniAccounts, logging your expenses is quick and easy, a few minutes a week is all that’s needed to keep on top of things; plus you have a true picture of your tax liabilities and how well your business is doing.
What sort of things can be classed as a business expense?
The best way to identify your business expenses is to think about what your business uses:
- Products: physical items like stationery, work wear, furniture, IT equipment, printer supplies, tools.
- Services: IT support, webhosting, cleaning, accountant and legal fees, outsourced office functions.
- Utilities: Power, water, rates, mortgage/rent, telephony.
- Professional subscriptions: membership and subscription to HMRC-approved bodies.
- Client entertaining: whilst you can’t reduce your tax bill or claim the VAT back, it is a valid business expense for many companies.
Some expenses are simple to process as they are wholly used by the business. Others will require careful calculation because they constitute a benefit in kind (e.g. where a company vehicle is also used as a personal vehicle) or the service/utility is used by the wider household (e.g. your office is a space in your home). In these cases, you should give your account manager a call or refer to the HMRC guidelines on how to calculate what proportion constitutes the business expense.
Client entertaining is a valid business expense and can form a major part of business development for many companies. Keep in mind that entertainment expenses do not reduce your corporation tax bill and you can’t reclaim the VAT back either. Our software is aware of the tax rules for entertaining, all you need do is record the expense correctly. Simply select ‘entertainment’ as the expense category and we’ll do the rest to ensure that it your corporation tax and VAT returns are accurate.
Can I claim for business start-up costs incurred before I became a Limited Company?
Yes, business set up costs can be claimed as business expenses. Any expenses that are paid for using personal funds should be documented and claimed for when the company starts trading. You do need to remember a few rules when claiming this type of expenses:
- Does it meet the business expense criteria above?
- For corporation tax purposes the expense must be no more than 7 years and for VAT purposes no more than 6 months before you started trading. In reality, it would be best to concentrate on the expenses incurred 6 months or less prior to the start of trading.
Can I claim VAT back on expenses?
You can claim VAT back on certain types of expenses and the inniAccounts system calculates this for you. You’ll need to enter the VAT rate charged when entering the business expense. This is usually noted on the receipt, but if not, the main rates are below:
- Standard (20%): The VAT rate charged on most expenses.
- Exempt: Bank charges, postage, insurance, and mortgage interest.
- Zero: Train tickets, flights, books, newspapers, food (except hot prepared food to eat in or takeaway which is standard rated).
- Reduced (5%): Domestic fuel & power, energy saving materials.
Remember: VAT can’t be claimed back on business entertaining expenses.
If you use the VAT Flat Rate Scheme, VAT is not reclaimed on individual expenses; it’s calculated using the flat rate percentage for your business type and recording individual expenses won’t influence your VAT calculations and return directly. If you use the Flat Rate Scheme, only VAT on purchases in excess of £2,000 can be claimed.
How do I record my expenses in inniAccounts?
Entering your expenses is quick and easy in inniAccounts and we’d suggest that you set aside a few minutes a week to keep on top of them. There are two places to input your expenses, as how you paid for them is important to log:
- Quick entry – for expenses you paid for with personal money e.g. with cash or a personal bank account/credit card.
- Bookkeeping – for expenses you paid for using company funds i.e. from a business account or your company credit card.
When recording the expense just: enter the details, select the correct accounting category and check that the VAT rate shown matches the rate on the receipt. The inniAccounts system does the rest.
What receipts should I keep and how?
You need to keep a receipt/proof of purchase for all expenses that you claim for. This can be in the form of the paper originals, or electronic copies. It is worth noting that if you are keeping electronic copies, you should ensure that they are complete, legible, secure and backed up in more than one place. As with all receipts and HMRC required evidence, you need to make sure they are retained and available for inspection or you could receive an unexpected tax bill if you can’t provide the required proof of purchase.
- inniAccounts guide on allowable business expenses
- HMRC expenses guidance, a guide to your business expenses. http://www.hmrc.gov.uk/incometax/relief-self-emp.htm
- HMRC list of recognised professional bodies http://www.hmrc.gov.uk/list3/list3.htm
Download the complete list of allowable business expenses and much more in our most recent ebook.
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