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A Guide to Expenses for Contractors

As a contractor, working through your own limited company, one of the main benefits available to you is the ability to claim business expenses. Claiming expenses correctly can reduce your tax bill, it’s a vital part of running your company tax efficiently.

Matt Poyser from inniAccountsBy Matt Poyser, who now writes for Listentotaxman.com on matters relating to contracting and limited company taxes.

Matt is a previous contractor with a wealth of experience and the Director of Client Experience at inniAccounts (an accountancy service tailored for contractors, consultants and freelancers).

Have a question? inniAccounts are happy to help Listentotaxman visitors with any queries,
simply contact them here.

Many contractors believe that claiming expenses is a complicated and time consuming ordeal, 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 you with 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?

Simply put, a business expense is a payment made by your company for physical items, or services, that are essential for running the business and earning profits. The everyday running of a company leads to many expenses being incurred; such as travel costs, insurance, phone bills and internet fees.

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 businesses profits. This might seem counterproductive, as claiming expenses will 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 bill and 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 an important part of showing the independence of your business. Companies will naturally incur expenses and running costs. Marketing costs, professional fees, and asset accumulation, are all strong indicators that you are operating as a separate entity from your clients, which can form part of your evidence to support your IR35 status.

HMRC’s rules on business expenses

HMRC are clear in their guidelines; a business expense must be necessary and 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 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 second category is Non-tax deductible expenses. This type of expense is not deducted from year-end profits, and therefore does not impact on the company tax bill.

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 such as dry cleaning and supermarket shopping, must not form part of your expense recording. Many businesses have exposed themselves to scrutiny and penalties from HMRC by including personal expenses. If you are ever in any doubt, check the HMRC website for guidance.

By asking two simple questions you can identify the business expenses you need to be recording:

1. “Did I purchase this item or service because it’s needed for the business?”

If the answer is yes, then it is a business expense.

2. “Is the item or service used purely for business?”

This helps 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 running costs, personal vehicles used for business.

What can be classed as a valid business expense?

The best way to identify your business expenses is to think about what your business uses.

Products

This includes physical items like stationary, work wear, furniture, IT equipment, printing supplies. Any products you purchase for the sole use of the business is fully tax deductible. It is worth noting that shared use of the equipment e.g. using your laptop as the family computer at weekends, means it is not a deductible expense. Business equipment should be reserved for the sole use of the business.

Services

Your business will need support from other professionals, such as accountants, solicitors and tax consultants. You’ll also need to invest in marketing to promote your business and likely require professional insurance policies such as professional indemnity and business contents insurance. All these services can be claimed as a business expense and make up the core expense areas that HMRC look at when ascertaining your IR35 status.

Professional Subscriptions

As a part of your continued professional competence, HMRC recognises certain professional bodies 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

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 detailed information about how to calculate what you can claim as a business expense, take a look at INNI Accounts' 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.

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 and subsistence expenses can be claimed whilst working at a ‘temporary’ workplace such as a client’s site. After 24 months the workplace is classed as permanent and travel expenses can no longer be claimed. The rule also states that as soon as you are aware that you will be at a workplace for more than 2 years you must stop claiming travel related expenses straight away. You can read more about the 2 year rule on INNI Accounts.

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 back either.

Business start-up costs

Your 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. 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.

Claiming 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) and the receipts as well as any delivery/order documentation kept as an auditable record of the transaction. Keeping detailed records of your business expenses let’s you build a clear picture of your outgoings; so you can identify areas of concern and time regularly expense to smooth your cash flow and plan ahead.

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, 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. Many accountancy services offer scanning software so you can scan in your receipts and retrieve them wherever and whenever you need them, no more worrying about crumpled papers in your wallet.
  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 well as 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 the public sector, the 5% expense allowance does not apply. You can find more information on IR35 here.

Next steps

Your business expense receipts are tantamount to cash, you need to ensure they’re securely kept and properly recorded. Efficiently recording your expenses everyday will help keep your business finances healthy; allowing you to always know how much cash is available in your company and to minimise your tax liabilities.

Matt Poyser from inniAccountsBy Matt Poyser, who now writes for Listentotaxman.com on matters relating to contracting and limited company taxes.

Matt is a previous contractor with a wealth of experience and the Director of Client Experience at inniAccounts (an accountancy service tailored for contractors, consultants and freelancers).

Have a question? inniAccounts are happy to help Listentotaxman visitors with any queries,
simply contact them here.

This article was published in our Guides section on 13/11/2018.

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