When you are employed, tax is usually taken on the entirety of your wages. This is not the case for those operating businesses, where the income of the business is only the starting point. Tax is not based on this figure but on the lower figure of taxable profits. This is the amount left after deducting all your legitimate business expenses. It is therefore highly important to ensure you claim as much as you are legally allowed to in order to legitimately reduce the amount of tax you pay.
Whilst some of these will be expenses that you are simply incurring already, others allow opportunity for tax planning that could reduce your tax bill across multiple years.
Cash basis and flat rate expenses
For some business owners, keeping track of the accounting side of things can prove a daunting task. There are a couple of options that will simplify record-keeping for such businesses.
The first is the cash basis. Normally a business should account for income as it is invoiced to customers and expenses as they are incurred. This is regardless of whether cash has actually changed hands at the business year end. The cash basis allows a business to account for transactions based only on actual movements of cash. As well as being easier to track, this prevents a business paying tax on customer invoices that later go unpaid. However, a business that has good credit terms with suppliers will be delayed in claiming those expenses. This option therefore needs to be carefully considered.
Businesses with turnover up to £150,000 can start with using the cash basis. Once they are in the scheme, a business can continue to use this basis until their turnover reaches £300,000.
Expense recording can be further simplified by using flat rate costs. These provide a simple figure that will be accepted for certain costs without detailed records. Unsurprisingly, given the relaxed rules on evidence, these are not generous allowances. For most businesses, detailed expense records will produce a higher figure. The simplified expenses can be found here (tinyurl.com/y8umcp28)
Use of Home and travel expenses
A lot of small businesses will not be able to afford to rent office space. Accordingly, the day to day activity of the business will actually be conducted from the business owner’s own home. Since the business is effectively “renting” space in the home, an appropriate proportion of the household expenses (such as insurance and utilities) can be claimed as a business expenses. This is based on the area of the home used for this purpose, and how much of its total use is work-related. If you own your own home, then you should avoid any single room being used solely for your trade. This is because your home is normally exempt from capital gains tax, but any part used in this way risks falling outside that exemption.
Similarly, if your home is your office, then travel from there to a customer is a deductible expense, as is overnight accommodation on a work trip. If travelling by car you can claim either the business proportion of your total motor expenses or mileage as shown under simplified expenses above. However, care needs to be taken if you are at particular sites regularly. If a particular location is visited often enough, this will be considered another work base as well as your home. Travel between work bases is not deductible, and HMRC have taken a hard line on this in recent years. If in doubt, take expert advice on this point.
Some of the items that you buy for a business, such as plant and machinery, will be used for many years. Such items are known as capital expenditure. Whilst these are not deducted directly from your income in the same way as day to day expenses, there are still ways these can reduce your tax bill. These are known as capital allowances.
It should be noted that you do not have to claim all the capital allowances you are entitled to in any given tax year. Any capital expenses not claimed are carried forward to future years. This may be beneficial where the ordinary expenses are already bringing the profit below the personal allowance.
• Annual Investment Allowance (AIA)
This is the amount of capital expenditure you can claim in full in any given tax year. This amount has fluctuated over time, and currently stands at £200,000. Where your business has been running for less than a year, you can claim an appropriate proportion (e.g. a business only running for 9 months could claim 75% or £150,000)
Cars do not qualify for this allowance, though they may be eligible for the allowance below.
• Enhanced Capital Allowance (ECA)
In addition to AIA, there is a separate allowance for energy saving or environmentally friendly capital purchases. This means 100% of the cost in the year of purchase. As well as more conventional plant, ECAs are currently also available on certain types of environmentally friendly vehicles. (Electric and low or zero emission vehicles)
If a company creates a loss from claiming ECAs, it can generate a payable tax credit for the losses created from this investment. However, this only covers ECAs for equipment and not those arising from vehicles.
• Writing Down Allowance (WDA)
Any capital expenditure not claimed above, including all amounts brought forward from previous years, is claimed using WDA. Purchases will be split into two categories, with claims of 18% and 8% on the total depending on which category an item falls into. Any claim in the year is deducted from the total, with the remainder carried forward to future years.
The majority of plant and machinery will attract the 18% rate. The 8% rate applies to higher emission cars, assets with a very long-life and certain integral features of buildings such as electrical and hot water systems.
When a building is bought for business purposes, then there is no deduction for the cost of the building itself. However, as noted above, capital allowances can be available at 8% on certain integral features of the building. These can be hard to identify, and a joint election needs to be made with the vendor of the building before a new owner can claim them. It is therefore wise to take specific professional advice if considering such a purchase.
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