Is it business, is it personal, or is it a mixture of the two
A business will have various running costs. You can deduct some of these costs to work out your taxable profits, as long as they are business related, or an identifiable proportion of the expense is ‘wholly and exclusively’ for the business.
Private expenses are never allowed for tax purposes. A private expense is where there is no separately identifiable business element. This will include taking cash out of the business to pay for private expenses.
The methods for dealing with these depend on whether the business is incorporated or not.
Sole traders and partnerships
For sole traders and partnerships where expenses are incurred that have no business purpose whatsoever they should be treated as drawings.
Where expenses are incurred that have a mix of business and private use an apportionment of the costs must be made. There are two ways of dealing with these:
- The whole amount can be claimed in the profit and loss account of the business with an appropriate adjustment to add back the private proportion in the tax return
- The profit and loss account can include only the business element with the private proportion being posted to drawings
The overall effect on the tax liability of the business is the same, regardless of which method you use.
It is thought, however, that HMRC prefer the former policy to be applied as it enables them to see more clearly what adjustments are being made in the accounts and tax return for private expenses.
Limited companies
For limited companies the treatment is different. The two ways of dealing with it are:
- Post the private element of any expenditure to the directors loan account
- Claim the whole expense in the profit and loss account and treat the private element of it as being a benefit in kind for the person concerned. This means that it is treated as additional earnings from employment for the individual concerned and will have to be declared on their P11D form. It also gives rise to a Class 1A National Insurance (NI) charge on the employer
For further information on any of the elements raised within this article contact us today.
In next week's article we will be explaining partial exemption.