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‘DC’, business owner with an annual turnover of £5.5m asked:  “Where would you suggest we go to be able to get a list of all the legitimate things we can claim against tax /profit for tax planning?”

Our Accounts Expert for the EBA, Simon Patterson, replies:

This business owner raises an interesting question when he asks for advice on compiling a list of legitimate things his company can claim against their profits to reduce his tax bills, or for tax planning ideas.

This seems pretty straightforward on the surface, but actually the question is more complex than might first appear. So I am giving a long and a short answer.

When preparing a company’s accounts and calculating the corporation tax, there are two types of profit to be calculated. Firstly, there is the accounting profit, essentially sales minus expenses. Then, the taxable profit is calculated after making a series of adjustments to the accounting profit. The adjustments which can legitimately be made will depend on whether the expenses comply with the existing tax legislation and case law. HMRC’s ‘wholly and exclusively’ guidance (BIM37000) is an excellent source of reference. This states that only expenses incurred wholly and exclusively for the purpose of the business are allowable for tax purposes.

So, expenses such as advertising, marketing and certain travel costs etc can only be included within the final taxable profits calculation if they are wholly and exclusively incurred for business operations. Contrary to most business owner’s perceptions, client entertaining is almost never allowable as a tax deductable expense. These costs might be used to calculate accounting profits but would then be added back to arrive at the taxable profits. Now this has been clarified, I can continue with the short answer to this question. What can legitimately be claimed depends on the purpose of the expense. Each Budget, the government any changes to the tax law including for example allowable expenses a business can claim against tax, some of which are more generous than others. One of the most important for business owners currently is the Annual Investment Allowance (AIA). This is a flat rate allowance that currently allows up £100,000 of any qualifying capital expenditure to be deducted against taxable profits.

Capital allowances are available on:

• the cost of most plant and machinery that your company or organisation uses for its business
• certain building works – for example converting space above commercial premises to flats for renting
• certain research and development.

It means up to £100,000 is allowable in the first year and, for investments of greater amounts, the remainder is proportionally deducted thereafter. Once the investment goes beyond the AIA threshold, a flat rate of 20% is applied to apportion the investment over subsequent years. So, if a firm buys £175,000 worth of new IT systems, it can allocate the first £100K of expenditure against the annual investment allowance and the remaining £75K would achieve tax relief at 20% a year on a reducing balance.

Being able to deduct £100,000 in the first year is currently a very generous relief. However be aware that this amount will be cut to £25,000 from 6^th April 2012, which was announced in the emergency budget. Therefore, if you are considering making any significant capital investments in the short to medium term, it would be advisable to do this as soon as possible.

There are a few other things to consider. Without seeing your company accounts I cannot tell if you are operating as a Group or have any Associated Companies, but if this is the case, the £100,000 limit for AIA would be across the group or Associated Companies. For companies with a group structure it is important to engage in careful tax planning to calculate the best way to allocate the allowance because it is possible to split the AIA amongst related business and indeed take advantage of other group reliefs to aid in tax planning

In addition to the AIA rules, capital investment in environmentally beneficial technologies may qualify for Enhanced Capital Allowances (ECA) and further tax relief in the first year of purchase. The qualifying criteria for such expenditure are very prescriptive and should be properly evaluated before any investments are made.

It should also be pointed out that expenditure on the repair/replacement of an asset would be treated as integral features where the repair/replacement costs in the last 12 months are greater than 50% of the total cost of replacing the asset. For example, if your business has spent £3,000 in the last twelve months replacing/repairing parts of their boiler system but the total cost of replacing a boiler system is £5,000 then the £3,000 of expenditure will be treated as capital expenditure and would qualify for AIA.

It may be that some of your business activities qualify under the research and development guidance and hence qualify for the enhanced R&D tax credits. Currently R&D tax credits mean that for every 100% of expenditure the company can claim 175% worth of tax deductions.

As you can see R&D tax credits are an extremely valuable relief and R&D can be found in many businesses that may not consider that at first blush they carry out R&D activities.

What else is allowable?

Company pension contributions on behalf of an employee are an allowable deduction and therefore very tax efficient. As are seminars and educational courses you might pay for employees to attend, provided they directly benefit the business of the company. There are some grey areas here, so for instance, an MBA for a director might not be allowable because this is an academic qualification, but professional training, for instance to gain professional body membership, is. Finally, if you are starting to plan your work Christmas party, when setting the overall budget, remember that only £150 per employee is tax deductable.

Ultimately, don’t let the tail wag the dog. It is rarely sensible to make a decision purely on the basis of it being tax efficient. After all, the most you are saving is the effective rate of tax you pay. It’s a bit like buying grocery items in the supermarket because they are offered ‘by one get one free’ – if you don’t need it, it’s not a bargain. The same principle applies to expenditure.

If you have an Accounts question for Simon, email it to experts@the-eba.com.