Tax Allowable Expenditure and Non-Allowable Payments for Directors

For incorporated businesses, understanding what expenses are tax-deductible is essential for protecting yourself from expensive and time-consuming tax enquiries. When it comes to directors' expenditures, it is necessary to distinguish between expenses that qualify for tax deductions and those that do not. Any costs paid by the company that are not business expenditures will be considered the directors drawings/income by the Taxman.

Tax Allowable Expenditure

Tax allowable expenditures are business-related expenses that a company can deduct from its taxable profits. These deductions reduce the company's overall tax liability, resulting in a lower tax bill. For these expenses to qualify as tax allowable, they must meet certain criteria set out by HM Revenue and Customs (HMRC); the basic rule is that the expense must be ‘Wholley, Exclusively and Necessarily’ for business purposes. Common examples of tax allowable expenditure include:

Business Travel: Expenses incurred during business trips, such as accommodation, meals, and transportation, are usually tax allowable. However, these expenses must be directly related to the business purpose of the trip; every day commuting to work or travelling for non-business purposes is not allowable.

Office and Premises Costs: Rent, utilities, and maintenance costs for business premises are generally tax-deductible. Many directors include a charge for using their home as an office in their company's accounts. The HMRC permits a flat rate of £6 per week, but if you can calculate a proportion of your household costs, this option can be more beneficial.

When doing this it's important to be aware of potential tax pitfalls, including losing some of the Director's Principal Private Residence relief for Capital Gains Tax on a sale of their home and business rates. Caution is strongly advised, and seeking professional guidance in this matter is advisable.

Business Supplies: Costs associated with purchasing necessary supplies and equipment for the business are tax allowable.

Professional fees for Accountancy and some legal fees relating to the protection of the business are allowable, e.g., debt collection fees. Fees for dealing with the directors’ personal income tax returns do not meet the business purposes criteria and are specifically not tax deductible for the business.

Non-Allowable Payments for Directors

Directors often fund personal expenses through their companies that are not eligible for tax deductions, and it's essential to distinguish between expenses that qualify for tax deductions and those that do not. Getting this wrong can be Costley to put right and lead to enquiries from the Taxman.

Common examples of non-allowable payments for directors include:

Non-Business Travel: Personal or leisure travel expenses are not tax allowable. Any portion of a director's travel expenses that cannot be proven to have a legitimate business purpose will not qualify for a tax deduction. This includes travelling to and from work.

Entertainment and Leisure: Costs for personal entertainment, such as theatre tickets, gym memberships, coffees, or dining at fancy restaurants, are non-allowable expenses. Please note that some businesses in the arts and entertainment sector may have a legitimate business purpose for Theatre and other entertainment activities if they relate directly to their work.

Personal Bills: Payments for personal bills, such as mortgage or rent, utility bills, and personal vehicle expenses, are typically non-allowable. Again, businesses operating in the Arts and Entertainment sector may also have a legitimate business purpose for some expenditure that may otherwise be considered personal, such as clothing, Hair, and make-up for the attendance of premieres and other business-related events.

Directors Loan Account

If a company pays for something that a director is not allowed to expense, it is considered as personal expenditure. Such expenses should not be recorded as business expenses. Instead, they should be noted in the director's loan account. This account maintains a record of all transactions between the director and the company. Personal expenditure is treated the same way as other withdrawals. This implies that it is regarded as an amount advanced to the director.

Please see my earlier ‘Back to Basics’ blog on directors’ loan accounts to find out how these operate and the taxation implications of having an overdrawn balance on these accounts. https://www.accountsaction.co.uk/blog/directors-loan-accounts

Benefits in Kind

If a personal item is not included in the Director’s loan account HMRC will treat this as the company providing the director with an un-taxed benefit. If this happens the company is required to report these benefits to the taxman by completing and submitting a P11D form. The company would also be responsible for paying Class 1A National Insurance on the value of the benefit and the director who received the benefit will also be liable for income tax on the benefit. This can be collected through their salary (Pay As You Earn - PAYE) or reported on their self-assessment tax return.

Conclusion

Understanding tax allowable expenditures and non-allowable payments is vital for compliance with tax regulations. It's essential for businesses to meticulously document and differentiate between business-related expenses that qualify for tax deductions and personal expenses that do not.

Directors should know what constitutes non-allowable payments and be prepared to repay these amounts to the company when necessary, either as additional dividends, salary income, or as a cash payment.

Staying informed and compliant with tax regulations helps businesses minimize tax liability and maintain good financial health. Consulting with a qualified accountant is the best approach to ensure that all financial transactions are appropriately categorized and reported.