Tax Insider Reports - Business Expenses: Timing of Deductions
When working out the profits or losses of your business, you can deduct any allowable expenses that you incur in running your business to arrive at the profit (or loss) figure before tax. The more expenses you deduct, the lower your taxable profit and the less tax you pay.
The following excerpt is from our popular How to Maximise Deductions for Business Expenses report and explores how the timing of deductions are important.
Where accounts are prepared on the accruals basis in accordance with GAAP, the general rule is that the expenditure is deducted in the accounting period to which it relates.
In many cases this will be the same period as that in which the payment is made. However, in other cases, some degree of apportionment may be necessary, for example, in the case of payments made annually, such as insurance premiums.
Example: Timing Of Deductions Under Accruals Basis
Henry prepares accounts on the accruals basis. He has a year-end of 31 March. He pays an annual insurance premium. The premium covers the calendar year.
On 22 December 2016, he pays a premium of £480 for the year to 31 December 2017 and on21 December 2017, he pays a premium of £540 for the year to 31 December 2018.
As regards the year to 31 March 2018, nine months covered by the 2017 premium year and three months are covered by the 2018 premium year.
The amount charged in the accounts and deductible in computing the profits for tax purposes is £495 (being (9/12 x £480) + (3/12 x £540)).
Where accounts are prepared on the accruals basis, the expenditure is allowed for tax purposes when it is recognised in the accounts (unless this rule is over-ridden by a specific statutory provision).
Timing Of Deduction Under The Cash Basis
Under the cash basis, expenditure is recognised when it is paid. It is not necessary to match
the expenditure to the period to which it relates – the relevant date is the payment date.
Example: Timing Of Deductions Under Cash Basis
Assume the facts are as in the example above illustrating the timing of a deduction for expenditure under the accruals basis, but that Henry prepares his accounts on the cash basis.
In the year to 31 March 2018, Henry pays (on 21 December 2017) the premium for the 2018 calendar year. Under the cash basis, the premium is deductible in full in calculating the taxable profits for the year to 31 March 2018, regardless of the fact that nine months of the period covered by the premium fall in the year to 31 March 2019. Likewise, the deduction for the premium for the 2017 year would be deductible in full in computing the taxable profit for the year to 31 March 2017, as the premium was actually paid in full in that year. Under the cash basis, the critical date for determining when an expense is deductible is the date on which the payment is made.
Tax Planning Considerations As Regards The Timing Of A Deduction
Rule 1: Secure a Deduction as Early as Possible
As a general rule it is best to secure a deduction as early as possible. This may mean accelerating expenditure to bring forward the deduction.
Example: Accelerating The Deduction
Tony prepares accounts to 31 December. He prepares accounts using the cash basis.
On 2 January 2018, he spends £2,000 on a new computer and printer. As the nature of the expenditure falls outside the limited disallowance for capital expenditure, he can deduct it in computing his taxable profits. As the expenditure was incurred on 2 January 2018, the deduction is made in computing the profits of the year to 31 December 2018 (falling in the 2018/19 tax year). However, had he accelerated the purchase by a few days, so as to fall on or before 31 December 2017, he would have been able to deduct it in computing the profits for the year to 31 December 2017 (falling in the 2017/18 tax year), and receive relief for that expenditure a year earlier.
Consider whether it is worth accelerating expenditure in order to receive relief sooner.
Rule 2: Obtain a Deduction at the Highest Possible Rate
The second general rule is that it is advisable to secure a deduction at the highest possible rate of tax. Where it is likely that the tax rate will be more in a later year than in an earlier year, it may be preferable to delay the expenditure to obtain relief at a higher rate.
Example: Deferring Expenditure To Benefit From Relief At A Higher Rate
Lilly is a sole trader. She is planning a business trip in spring 2019 to visit a supplier in India.
She expects the trip to cost in the region of £3,000. She prepares accounts to 31 March each year.
In 2018/19, she expects to be a basic rate taxpayer. However, in 2019/20, she anticipates that she will pay tax at the higher rate. By taking the business trip in April 2019 (falling in the year to 31 March 2020, taxable in 2019/20), she will obtain relief at 40%, whereas if she undertakes the trip in March 2019 (falling within the year to 31 March 2019, taxable in 2018/19), she would only obtain relief at 20%. Therefore, deferring the expenditure to obtain relief at a higher rate reduces the net cost of the trip from £2,400 to £1,800 – a saving of £600.
To maximise relief:
- obtain relief as earlier as possible; and/or
- at the highest rate possible.