What we Can and Cannot claim
Business operators regularly make decisions on business expenses based on false assumptions and misunderstandings, resulting in a drastically different tax outcome than they expect.
Alot of people mistakenly think that buying a new vehicle or item of machinery will reduce their taxable profit by the amount they spend on the new item. However, this is not the case. In fact only a portion, the depreciation amount, is deductible off income.
What makes an expense tax deductible?
The General Tax Deduction Rule
Understanding one simple rule will clarify whether an expense is tax deductible or not in nearly all cases:
Expenses are tax deductible to the extent they are incurred to either:
- generate taxable income, or
- run a business that generates taxable income.
Items of stock for a shop are fully tax deductible as when the items are sold they generate taxable income. To be able to run the shop a premises must be rented. This cost is also a tax deduction.
Expenses we can Fully Deduct
The following examples are generally 100% business expenses, and therefore fully tax deductible.
- Cost of Sales – Buying a product, or paying for a service, for resale
- Rent – Business premises or equipment
- Wages or Subcontractors – Including related costs such as Kiwisaver contributions and ACC levies.
- Interest – Paid on money borrowed and used for business purposes. NB, repayments of loans are often a combination of interest and principal. Only the interest portion is tax deductible.
- IRD Interest – IRD charge Use of Money Interest on underpaid tax. NB, Interest that IRD pay you on overpaid tax (at a much lower rate than they charge you) is taxable income.
- Advertising – Newspapers, Facebook, website updates etc. The initial cost of a website is a capital item.
- Travel and Accommodation – On business trips. Entertaining customers while away will come under the entertainment rules below.
- Professional Development – Ongoing training to help with your current business is deductible. A degree or diploma to become a professional is not.
- Telecommunications – Business telephones and internet.
- Depreciation – As explained below, we can deduct for the cost of business assets such as business tools, equipment and vehicles, but the cost is spread over the asset’s life. Depreciation rates are provided by the IRD.
- Protective Clothing/Uniforms – a deduction for protective clothing such as gloves, boots, wet weather gear etc is allowed as long as they are used in deriving assessable income. Uniforms – a uniform for staff and clothes that advertise your business are deductible.
Expenses we can Partly Deduct
These expenses usually provide a business and a private benefit, so we can deduct the business portion.
- Home Office – When we live and work at the same place, we can deduct the business portion of shared expenses such as electricity, rates, insurance, rent or interest on mortgage payments, and maintenance on the overall property. The business percentage is generally calculated on a floor area basis.
- Motor Vehicle –If used for both business and private purposes, we must apportion ownership and running costs. A log book should be kept to ascertain the business percentage of usage.
- Travel and Accommodation – When combining a business trip with a holiday, we must apportion costs that relate to the whole trip, such as air fares, usually based on time spent on each. Usually an itinerary is required to be kept.
- Telephone – Telephone rental and data used for both business and privately.
- Entertainment – When entertaining staff or business contacts, the tax deduction is limited to 50% of the cost. This includes costs of functions, events, food and drink, holiday accommodation and pleasure craft. Limited exceptions allow a 100% deduction for overseas entertainment, promotional functions open to the public, and food and drink at seminars and training sessions. We discuss the entertainment rules in greater detail in a separate blog.
Expenses we Cannot Deduct
Tax deductions are denied on some expenses even if we feel they benefit our business.
- Clothes – Even if we buy a suit or dress solely for work, we cannot claim it.
- Hair and makeup – It doesn’t matter how good you need to look, none of these costs can be claimed.
- Health Costs – Doctor visits, gym memberships, glasses, hearing aids or massages. Even if they restore our health so we can work they are not deductible.
- Life Insurance – But income protection insurance is deductible.
- Fines and bribes – Whether incurred while doing business or not, most fines and bribes cannot be claimed.
- Income Tax – No deduction for tax payments. Income tax is the government’s share of our income, not a cost of earning the income.
- GST – For GST registered businesses, GST paid to suppliers, collected from clients and paid to IRD all fall outside our income tax calculations. GST is a tax collected by business on behalf of the government. For non-GST registered businesses, however, GST inclusive expenses are deductible as the GST forms part of the final cost.
- Tax Penalties – As with fines, tax penalties are non-deductible.
- Personal Kiwisaver contributions
Fixed assets, such as vehicles and business equipment, benefit our business over more than one year. We do not deduct the cost when we buy them but “depreciate” them by deducting a portion each year, thus spreading the cost over its expected useful life.
For example a vehicle cost $55,000. IRD allow us to deduct 30% of a vehicle cost in the first year, $16,500 for the full year. However, if the vehicle was purchased in the last month of the year so only one month depreciation of $1,375 ($16,500 / 12) can be deducted in that year.
Cost of Sales
In another attempt to tame a tax bill, a reseller may make a big stock order just before year end. The problem is, we can only deduct the cost of goods sold when we sell them. The cost of stock unsold at year end is carried forward to the following year.
Here’s a simple example for the 2017 year
The $24,000 of stock remaining becomes the next year’s “opening stock” and will be deducted in that year.
Bad business decisions are usually uninformed business decisions. While the outcome of many decisions involves some guesswork, the tax impact of our spending decisions does not have to be one of them. If unsure, get some advice before spending your money to get a tax deduction.