Probably the most frequent question we are asked by our newly (and sometimes not so newly!) self-employed clients is, “What are allowable expenses for income tax purposes?” In this post I will explain the basic principles that underlie the rules and give some practical examples to illustrate these principles in action.
What are allowable expenses?
- There is actually no definition of allowable expenses in the Tax Acts!
- The legislation only sets out what is not allowable.
- Disallowed expenditure must be added back to the profit per the accounts to arrive at the taxable profits.
As a general guide the following are allowable expenses for a business:
- Goods/stock purchased for re-sale;
- Wages, rent, rates, advertising, telecoms, repairs, lighting, heating etc;
- Running cost of business vehicle (fuel & maintenance);
- Accountancy/Bookkeeping fees;
- Interest on business loan (but not loan repayments);
- Lease payments on business vehicles or machinery.
If you are registered for VAT it will be the tax exclusive amount that is allowable.
What Expenditure is specifically disallowed?
- Expenditure not incurred wholly and exclusively for the purposes of the trade;
- Any capital withdrawn from i.e. drawings or introduced to the business;
- Expenses for domestic or private purposes. (Apportionment can apply);
- The rent of a private dwelling house;(Apportionment can apply);
- General provisions such as against debtors or stock. Specific provisions are usually allowed.
What about expenses which are partly for business and partly private?
Where expenditure relates to both business and private use, only that part which relates to your business will be allowed. Examples of such expenditure are rent, electricity, telephone charges etc., where the premises involved is used partly for business and partly for private purposes. These expenses will need to be apportioned to exclude the private use.
Case Study – Sole Trader
Rebecca is a sole trader who runs a small hair dressing & beauty salon in Dun Laoghaire. She employs two staff and rents her premises. She is married and owns her own home in Dundrum. She drives a diesel SUV and her typical day goes something like this.
Can I claim “Home Office” expenses?
Alarm 6.30am… Gets up and goes down to kitchen, opens laptop to check emails and bookings for the day ahead. She does this every morning (and evening!) and wonders whether she is entitled to claim some of the costs of running the home against her taxes?
Unfortunately sitting at the kitchen table and working will not make any of the costs of lighting and heating the kitchen allowable. If she converted a spare room into a home office then as long as this room was used wholly and exclusively for the business a claim for a portion of the running costs of the home can be made. If Rebecca rented her home she could claim a portion of the rent based on the size of the office as a percentage of the overall size of the house.
What motor expenses can I claim?
Due to an early appointment for a special client she skips breakfast and drives to Dun Laoghaire, stopping for diesel and some magazines for the salon reception. The receipt includes both items and she has always claimed the diesel and other motor costs as a business expense as she starts work at home before leaving for the salon and always checks her emails after arriving home in the evening. She also uses her car for business during the day, banking going to distributors etc.
As a general rule, travel between home and work, even if some work is carried out at home always carries the purpose of getting home – It facilitates living away from work. The duality of purpose, i.e. not wholly & exclusively for the business, renders the expense non-deductible. The exception to this rule is so called ‘itinerant ‘ traders where home is the only place new customers can contact them and where they store their tools etc. Therefore they go home to look for new work and so getting home is an effect of the journey not the purpose.
The element of motor expenses incurred after reaching the workplace is allowable as long as the trips were for the purposes of the business. In practice sole traders should keep a note of the proportion of their annual mileage that relates to business. In Rebecca’s case if 50% of her mileage is for business purposes then 50% of the total running costs of the car are allowable.
The magazines bought for the salon are deductible.
Are my skinny lattes allowable expenses?
At 10.30 Rebecca goes out for breakfast as she won’t be able to do any work until she gets some food. This is purely for fuel to get her through the next 7 hours and she uses the business credit card as she always does for her mid-morning lattes and muffin and her accountant has never disallowed them.
Well according to Revenue’s operational manual, humans eat to live, they do not eat to work! Therefore in nearly all cases expenditure by a sole trader on food and drink will be disallowed in computing taxable profits. The cost of meals incurred on a hotel bill when travelling for exclusively business purposes are allowable but other meals incurred while away are not allowable.
Surely I can claim for lunch with a potential client?
A film production company has started shooting a movie in the area and they are looking for a local salon to provide all the hair dressing and make-up services. A friend has introduced Rebecca to the producer and they have arranged to have lunch in the Royal Marine. Rebecca picked up the tab for the lunch and reckons it was money well spent out of the marketing budget. She also gave her a hamper of beauty products typical of the products that the salon uses.
The costs of entertaining clients and potential clients is disallowed for tax purposes and this would include meals, drinks, customer gifts and other forms of entertainment.
Trip to Wholesalers
In the afternoon Rebecca makes a trip to the wholesalers to collect an order of consumable items such as shampoos, conditioners, hair colour and some expensive new equipment for the salon. She also collects her new branded staff uniforms and protective gloves, aprons etc.
The consumable items are all allowable but the equipment is deemed a capital expenditure as it will be treated as an asset on the balance sheet and is not allowable as a deduction. A separate tax deduction called a capital allowance is granted for the equipment at a rate of 12.5% per annum over 8 years. The uniforms and gloves are a deductible expense as they are protective clothing.
Staff Night Out
One of Rebecca’s staff is celebrating a birthday and to celebrate Rebecca has arranged for the three of them to go see a movie and have some food and drinks afterwards. After all the add-backs incurred on food and entertainment during the day Rebecca won’t even try to claim this expense and uses her personal credit card to pay for everything.
Rebecca should keep the receipts because entertainment costs in respect of genuine staff are allowable expenses as long as they are reasonable and not incurred as part of entertaining clients.
To determine allowable expenses always apply these Two Key Tests:
- Is it “revenue” in nature?
- Has it been incurred wholly and exclusively for the purposes of the trade?
Please contact Robert Kelly FCA at firstname.lastname@example.org or on 01-5175211 if you would like any further information or have any tax planning or compliance requirements. We are a firm of Chartered Accountants based in Sandyford, Dublin 18 specialising in helping SME’s with all their tax and accounting needs.