Expenses can reduce the tax amounts that a company owes to HMRC if they are legitimate, are a genuine expense of the company and are allowed by HMRC.
Corporation Tax is calculated against the chargeable profits of a company: so for example, if a company makes £1,000,000 profit, Corporation Tax will be calculated in reference to that £1,000,000. It doesn’t matter that the company had £4,000,000 in turnover, the tax is calculated and chargeable on profit.
What are Legitimate Expenses?
Legitimate expenses operate to reduce the amount of Corporation Tax that a company has to pay by reducing the amount of profit that the company has made and therefore can be taxed on. Expenses for Corporation Tax purposes are generally defined costs that are attributable to genuine running costs of the business. There are, however, very complex rules set out by HMRC about what are allowable expenses or deductions from a company’s income for Corporation Tax and those that are not.
In addition, the expenses that are allowed in respect of “income” (for example a customer pays to a building company for their services) versus “capital gains” (for example the money made from a company selling its property) are different. While we won’t go into detail here about exactly what is and isn’t allowed as an expense for Corporation Tax purposes, it is useful to understand the rationale behind the rules.
Why can Legitimate Expenses Reduce Corporation tax?
Generally, if a company has received a certain amount of income during a tax year and it has had to spend a certain amount of money to achieve that income, you can see the rationale for why the amount spent should be taken into account when calculating the company’s Corporation Tax bill. The company has spent that money in order to run the business, so that amount should be deducted to calculate the company’s profit.
For example, if a bakery spends £15,000 on flour, that £15,000 should be deduced from the bakery’s income or turnover (along with other allowable expenses the bakery has incurred) to determine the amount of profit that the bakery has made in the relevant tax period. Corporation Tax will be charged on the profit (after allowable deductions), not the bakery’s total income or turnover (which would be likely, in this scenario, to be at least £15,000 more than the profit).
That is a very simple example because, without the flour, the bakery fundamentally would not be able to make the large majority of the products that they sell. Where it becomes more difficult is in situations where the expenses are not so clear cut. If the bakery’s expense was for the CEO to travel abroad for 3 weeks for a one-day meeting with a supplier, it’s unlikely to be an allowable expense as it is not a genuine running cost of the business.
Understandably, HMRC does not look kindly on companies that try to fraudulently reduce their tax bill by putting through false, inflated or unallowable expenses to reduce the amount of chargeable profit the company has made and therefore the Corporation Tax that needs to be paid. It’s very important that you operate within the rules otherwise, the penalties for the company and its officers can be very, very serious.
If your company is struggling to pay its taxes, you should take appropriate steps to address the situation. We have years of experience in helping to turn struggling companies around and negotiating with HMRC to come to an agreement about how the company can pay its tax debts. Do not try and use illegal fixes like fraudulent expenses to try and manage the situation. Call us on 08000 746 757 for a no-obligation discussion or use the live chat function below.