What does tax deductible actually mean?

Kirsty Young Expenses, Tax

When speaking about your business with an accountant, you may have heard the phrase ‘tax deductible’ presented as a Very Good Thing.

Well, the good news is, this part is true. It is a Good Thing!

If a particular type of expense is tax deductible, it will help reduce your tax bill. The common misunderstanding with it is – how it actually works.

Often business owners take the phrase to mean if they spend say £1000, they will reduce their tax bill by £1000. However, it doesn’t work like that.

Here’s an example for a small, limited company, where the tax rate is 19%:

People think…
Business Profits £52,632
Tax Bill @19% £10,000
…spend £10,000 £10,000
= £0 Tax to pay
WRONG

The reason this is wrong is because the tax you pay is a percentage of your profits. Spending money reduces your profits, which then reduces your tax bill, so long as the expenses are tax deductible.

Here’s how the maths should look:

It actually works like…
Business Profits £52,632
…spend £10,000 £10,000
Business profits now £42,632
Tax Bill @19% £8,100 Tax to pay
Tax saving £1,900
RIGHT

From this example you can see that if you spend £10,000, rather than saving the whole £10,000 in tax, you actually only save £1,900.

This is because you are reducing your profit by £10,000 before the tax is calculated.

The effect is, that you are saving 19% of the £10,000. This equally applies to any tax deductible expenditure you make.

 

What are tax deductible expenses for a business?

Sadly, there’s not a definite list, the general rule is that any expenditure that is ‘wholly and exclusively’ for your use in your business is tax deductible.

So, you will commonly see tax deductible types of expenditure such as:

  • Wages for your team
  • Stationary
  • IT equipment
  • Insurance
  • Telephone costs
  • Business rent
  • Accountancy
  • Software

However, like the famous piratical code in “Pirates of the Caribbean”, these are “More what you’d call “guidelines” than actual rules”.

 

Summary – don’t spend money just to save tax

Whilst tax deductible expenses are a Good Thing with regard to saving tax, remember that spending money should not be your primary way to save tax.

As we’ve demonstrated, spending £10,000 would save you £1900. So, unless you really need something, that doesn’t sound like a great plan?

However, if you do need to refresh your equipment or invest in tax deductible expenses, then you get tax relief for doing so.

Considering this point before the end of your tax year is a great planning point to help impact your next tax bill.

 

I’m still confused about tax deductions

Ask your accountant or book a consultation with us to help you. We offer a paid 1 hour, 1-2-1 consultation so you can ask us simple questions, to get the help, when you need it.