You’re probably aware that if you’re in business as a sole trader or a member of a partnership and your expenses outweigh your income, the tax rules allow you to use the loss, i.e. the excess expenses, to reduce tax you’ve paid on your other income. The rules for tax relief are especially generous where the loss arises in the early years of a business. However, where you run your business through a company and personally incur expenses, whether in the early years of trade or later, the tax position is far more restrictive.
Although the legislation includes rules for allowing tax relief for “employment losses”, the term is misleading. According to HMRC, employment losses aren’t, as you might expect, the result of job-related expenses exceeding your salary etc. (see the Trap below). The most common situation where an employment loss arises is where you receive income, e.g. a bonus, which subsequently becomes wholly or partly repayable.
Example – David forms a company, Acom Ltd, and is the main shareholder and director. He incurs various expenses in travelling and meeting potential customers etc. as well as paying for goods and services Acom needs to get up and running. This leaves David personally out of pocket. While he’s made a financial loss, he cannot use this to reduce tax on his other income.
Trap – The law only allows job-related expenses incurred by directors and employees to reduce the amount of employment income on which they are taxed. In other words, once income has been reduced to zero no further tax relief is allowed.
Tip – The expenses can be treated as a credit to the director’s loan account (DLA). This means they can draw the money without triggering tax or NI. However, care is needed with the bookkeeping entries and paperwork to ensure both the director and the company receive the correct tax relief (we can help you with this!).
Expenses or director’s loan account
We’ve seen many cases where expenses personally incurred by a director, especially in a company start up, have been credited to the DLA. Later, when the company can afford to, it repays the debt by settling a personal bill for the director. To summarise, the director incurs an expense for the company; it treats this as a loan which it later repays. All seems square, but in reality HMRC has just got away without giving tax relief for business expenses.
Trap – The lending and repayment through a DLA does not show in a company’s profit and loss account. What started as a business expense personally incurred by the director on behalf of their company, which of course should show as a deduction from its profit, has lost its character to become a loan repayment with no effect on profit.
Tip – Even if a company cannot afford to reimburse a director for an expense, they should include it on an expenses claim. This ensures the bookkeeper records the transaction as a deduction from profit as well as a credit to the DLA.