Business expenses: a contractor’s guide to what you can and can’t claim.

*Please note the information in this article may be out of date

One of the main benefits of trading as a Limited Company contractor is that you can claim back business expenses for anything you purchase for your business, and in turn, claiming for these expenses can lower your tax bill.

Sun, 20 Oct 2019

Many contractors believe that claiming expenses is complicated and time consuming, but it doesn’t need to be. By understanding HMRC’s rules and following some simple guidelines, you can ensure you’re maximising the tax benefits for your company. This guide will arm youwith all the information you need to understand what you can and cannot claim, how expenses will affect your tax bill, as well as detailing the process involved in making a claim, and the importance of keeping relevant records.

What are business expenses?

A business expense can be anything that you purchase that is deemed necessary for the everyday running of your business. This could be travel expenses, phone and internet bills, and in some cases even a proportion of your utility bills if you work from home.

Why should I claim business expenses?

The majority of the expenses you’ll incur will be tax deductible, meaning you can deduct them from your business’s profits. This might seem counterproductive, as claiming expenseswill eat into your company’s profits, however these expenses are deducted pre-tax and VAT, so they’ll improve the financial health of your company. You’ll come away with a lower tax billand more actual cash in your business (increasing the value of your company and maximising the profits available for investment or drawing dividends).

Many contractors fall into the trap of storing up receipts and invoices to deal with later. This makes claiming expenses a hassle and often results in your tax bills coming as a shock. Good expense management gives you a clear view of how your business is performing, and ensures that you have an accurate picture of your financial position throughout the year.

Claiming your business expenses not only helps your company’s financial health, it’s also animportant part of showing the independence of your business if you are working outside of IR35. With IR35 being such a hot topic at the moment,things such as marketing costs, professional fees and asset accumulation are all strong indicators that you’re operating as a separate entity from your clients, which in turn supports your IR35 status.

HMRC’s rules on business expenses

HMRC are clear in their guidelines; a business expense must be necessary, wholly and exclusively incurred as part of the day to day running of your business. It seems simple enough, but what does this really mean for you as a contractor?

When looking at tax efficiencies and how HMRC views the expense, there are two categories, and they are treated and recorded differently in your year-end accounts and tax returns.

The majority of expenses are in the first category - tax deductible expenses. These include business-related travel, IT equipment and services like accountancy and web-hosting. Tax deductible expenses are taken from company profits, so your tax bill is reduced. The secondcategory is non tax deductible expenses. This type of expense is not deducted from year-end profits, and therefore does not impact on the company's tax bill.

Personal items and expenses such as dry cleaning and supermarket shopping, must not form part of your expense recording. Many businesses have exposed themselves to scrutinyand penalties from HMRC by including personal expenses. If you are ever in any doubt, check the HMRC website for guidance, but ultimately, you only have to ask yourself two things:

What can be classed as a valid business expense?

The best way to identify your business expenses is to think about what your business needs and uses on a daily basis.

Goods

Goods are physical items and include stationary,  furniture, IT equipment, printing supplies and many more. Any goods purchased for the sole use of the business is fully tax deductible.Remember, anything that is used by you personally as well as by the business should not beclassed as a wholly deductible expense.

Services

Any services you require to run your business count as a deductible expense. This may include professional services such as accountants, solicitors, tax consultants, marketing professionals and even insurance services for things such as professional indemnity and business contents insurance. The fact that these types of expenses are incurred should be considered in any assessment of status under IR35 and can indicate that you are running anindependent business.

Professional Subscriptions

As a part of your continued professional competence, HMRC recognises certain professionalbodies and personal development tools, such as business publications as a necessary business expense. It is important to ensure that the professional body subscription/membership fee is allowable by HMRC. You can check that the professional body is recognised by visiting HMRC’s recognised bodies list.

Utilities

In certain circumstances and if you spend a significant amount of time working from home, then you can also claim for utilities such as a landline, mobile or broadband fees, heating and lighting and cleaning. While certain utilities will be solely for your business use, others may have shared use if you work at home. It is important to only claim for the proportion used by the business. For more information on home office expenses, take a look at Intouch Accounting’s blog on working from home and what you can claim for. Guide to claiming for home office expenses.

Travel Expenses

If you use public transport to travel to meet a client or work at a temporary place of work (e.g. your client’s office), simply retain the receipt and you can claim for your fare. Claiming for your mileage in a personal vehicle is slightly more complex as it’s based on the number of miles you travel rather than a flat cost.

HMRC publish a fixed rate for mileage which you can claim without having to pay tax – for a car this is 45p per mile for the first 10,000 miles per year, and 25p per mile after this. The mileage allowance is designed to cover the car’s running costs and the fuel costs. Cycle to your client’s premises? You can claim for mileage on your bike too (20p per mile).

Mileage claims soon add up so claiming for all work-related journeys can make a real difference to your tax liabilities - just make sure you’re noting your mileage down after every journey.

Note: contractor’s commuting to their client’s site must comply with HMRC’s 24 month / 2 year rules to be able to claim travel expenses. Travel expenses to a ‘temporary’ workplace can be claimed for up to 24 months. Should your contract be longer than 24 months, this is then deemed a ‘permanent’ workplace and you can no longer claim your travel expenses. Should you know the contract will last more than two years when you take it up, you should not be claiming any travel expenses for that job at all.

It is also important to be aware that working on site for a period longer than 24 months could compromise your IR35 status, so be sure you are not being treated like a permanent employee in any other way, otherwise this could encourage HMRC to investigate. You can find out how to stay outside of IR35 by reading Intouch Accounting’s guide to IR35

Entertainment

Client entertainment is a necessary expense for many companies, however, it’s important to note that entertainment expenses do not reduce your corporation tax bill and you can’t reclaim the VAT either. Client gifts, on the other hand, can be claimed for if they are under £50 - but this does not include food, alcohol or anything that promotes your business.

While client entertainment won’t lower your tax bill, you’ll be pleased to here you can claim for employee entertainment such as staff christmas parties. A tax exemption of £150 per head on social events runs on an annual basis, so although Christmas parties are often the biggest social events for companies, the exemption can be used for other festivities such as summer parties. The allowance applies to even the smallest Limited Companies, so even if you’re a one-person band, you can still let your hair down.

Business start-up costs

Your business set up costs can be claimed as an expense. Any expenses that are paid for using personal funds should be documented and claimed for when the company starts trading. Remember, these expenses need to meet the standard business expense criteria. For corporation tax purposes the expense must be no older than 7 years and for VAT purposes no older than 6 months before you started trading.

If you’re ever unsure if your expense is a valid business expense, you can refer to the HMRC guidelines for a list of the types of expenses that can be claimed. You can also visit the HMRC website for detailed examples of allowable and non-allowable business expenses.

Charitable Donations

Donations can be claimed as a business expense as long as it is done through Gift Aid. This is to ensure the donation is going to a registered charity and the business isn’t offsetting costs through private ‘non-profit’ organisations. You also cannot claim for donations made to any political party.

What is not a tax-deductible business expense?

While the rules can be blurry for some types of expenses, there are also certain expenses that under no circumstances could be classed as tax-deductible. These include shareholder dividends, some legal fees and any fines or penalties. For more information on what you canand can’t claim, you can visit the HMRC website.

How to claim your business expenses

It’s important that you maintain auditable proof of your business expenses. Business expenses must be recorded correctly including the date of the expense, overall cost, item and type details, the VAT and the associated project if you’re planning to bill a client for the expense.

Receipts as well as any delivery/order documentation are also worth keeping as a record of the transaction. Keeping detailed records of your business expenses lets you build a clear picture of your outgoings so you don’t get any nasty shocks when it comes to paying your tax bill.

You must keep a receipt/proof of purchase for all expenses that you claim for. Receipts and other items of proof need to be retained for at least 6 years. This can be in the form of the paper originals, or electronic copies. It is worth noting that if you are keeping electronic copies (as long as they’re complete, legible and secure) as with all HMRC required evidence, you need to make sure they are retained, backed up and available for inspection.

Tips for easy expense management

1. Track and record as you go. Small expenses can get lost in the pile of papers, especially if it’s a train ticket or subsistence items while working on site. Deal with them daily or at least weekly. That way the information is fresh and you are less likely to lose the receipt.
2. Make sure you keep the receipts safe and filed chronologically. Most contractor accountants will have an online system for recording expenses and an automatic means of calculating mileage expenses.
3. Ensure that you use your business bank account to pay for the majority if not all of your expenses; there is a better separation of your expenses from your personal spending as wellas a more robust audit trail.

What about Contracts inside IR35?

If you have a contract inside IR35, 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, pension contributions and Professional Indemnity insurance. Travel and subsistence expenses cannot be claimed. Please be aware that if you’re working inside IR35and for a client in the public sector, the 5% expense allowance does not apply. You can find more information in our IR35 guide for contractors.

Next steps

Start documenting your expenses immediately. Make sure you have your business bank account set up and start to keep hold of all your receipts for business purchases. While keeping on top of your expenses may not be your first priority when running your business, itabsolutely should be. You can enlist the help of a contractor accountant who will be able to keep track of your expenses and give you advice on what is and what isn’t a tax-deductible expense, to help you keep your business running smoothly.