The importance of the “wholly and exclusively” principle for corporation tax
The “wholly and exclusively” concept is a cornerstone principle of UK corporation tax.
Not every expense charged in the income statement of a company is an allowable deduction for tax purposes. Broadly, an expense attracts tax relief to the extent that the cost has been incurred by a business wholly and exclusively for the purposes of the trade. The application of the wholly and exclusively principle can be complex, as evidenced by the substantial body of case law which has developed on this subject over the years.
This article shall provide colour and context with regards to the importance of the wholly and exclusively principle.
The “Wholly and exclusively” principles – the basic principles
The wholly and exclusively test can only be satisfied if the sole reason for incurring the expense is for the trade. If an expense has been incurred wholly and exclusively for the trade (and there is not a specific prohibitive rule denying tax relief) the costs can be used to reduce the taxable profits (and therefore corporation tax payable) of a company.
Examples of expenses usually considered as being incurred wholly and exclusively for the purposes of trade include salaries of workers, professional fees (legal and accounting compliance), maintenance and repair work, general insurance, and office-related expenditure.
The “wholly and exclusively” principles – complexities
In considering whether an expense has been incurred wholly and exclusively for the purposes of the trade, the following should be considered:
- Intrinsic duality - Where expenditure cannot be incurred wholly and exclusively for the trade as a matter of law, no deduction is allowed, even if there is also a legitimate trading purpose. Expenditure, where it is impossible to separate the trading and non-trading elements, is “intrinsic” (this needs to be extinguished from expenditure which has trading and non-trading purposes that are separable and quantifiable). As a result of this duality, the whole amount is disallowed for tax purposes. Common examples include ordinary clothing, living accommodation, medical expenditure, certain training costs and legal fees for avoiding conviction.
- Incidental benefit – An incidental benefit conferred on the business by an expense does not preclude the cost from being incurred wholly and exclusively for the purposes of the trade. Incidental non-trade benefits are ignored. For example, a director travels to the USA on business. In doing so, the director enjoys aspects of the US such as the scenery and weather. The additional benefits (weather, scenery etc) do not mean that the expenditure is not wholly and exclusively for the trade.
- Dual purpose expenditure - Incidental benefits differ from expenditure that is intended for dual purposes. Expenditure will only be wholly and exclusively for the purposes of the trade if all the reasons classify as business purposes. Thus, if one reason does not classify as business, the expenditure has not completely met the principle. In the example of the director travelling to the US above, if the director combined the visit to the client with a holiday with his wife, the expenditure is for a dual purpose (trade and private). In most cases, the total expenditure would be disallowable for tax purposes. However, in this case, and in many cases, it should be possible to identify elements of the expenditure that relate to being for the trade and elements that relate to private expenditure. A deduction may be permitted for the portion relating to business.
Common “wholly and exclusively” expenses?
- Legal and professional fees – Fees relating to revenue expenditure related to the trade are allowable. Examples include debt collection, employment issues and preparation of accounts. On the other hand, legal fees relating to capital expenditure are disallowable for tax purposes, further to the statutory provision which specifically disallows expenses which are capital in nature.
- Repairs and maintenance – General repairs and maintenance costs are allowable. On the other hand, capital expenditure including improvements are disallowable for tax purposes (although such costs may be deductible under the UK’s capital allowances (tax depreciation) provisions).
- Travel and subsistence – Such expenditure can be difficult to analyses, especially in cases where the expenditure appears to have a business and private element, as mentioned above in the dual expenditure section. If the trade portion of the expenditure can be identified, the facts must be considered in establishing whether a deduction should be available for the travel expense.
- Entertaining - Staff entertaining is allowable. However, client and other entertainment are disallowable for tax purposes.
- Donations and subscriptions – Donations to charities are allowable if for the benefit of the trade. Political donations are disallowable.
As a trader who is liable to corporation tax, what advice can be given to ensure that expenses are correctly identified using the wholly and exclusively principle?
Good record keeping - It is essential that both personal and business-related records are retained. Business owners should use accounting software programs for the recording of income and expenditure, including invoices. Having a record of all income and expenses should enable the identification of those items that are trade-related. Poor record-keeping may lead to business expenses posted to personal expenses and vice versa leading to a deduction for business expenses missed and as a result, paying more tax. Records should be retained for 6 years.
Separation of personal and business expenditures- As well as maintaining all records of personal and business expenditure, it is good practice to separate private from business expenses. This could be done by keeping a separate bank account for business expenses. To ensure that all relevant business expenditure is properly charged in the accounts, it is important to review the expenses claimed and consider whether all deductions are wholly and exclusively for the business.
Arnold Hill & Co has extensive knowledge with regards to assisting our clients with understanding what is allowable and not allowable, and we can help you in navigating the legislation and case law.
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