A business expense is a cost of running the business, and it reduces taxable profit only if it passes two tests: it must be a revenue cost rather than a capital one, and it must be incurred wholly and exclusively for the purposes of the trade. The same two tests apply to sole traders and limited companies. For a company, every £1 of allowable expense saves Corporation Tax at 19%, 25% or, in the marginal relief band, 26.5% in financial year 2026; client entertaining, however business-like, saves nothing.
What counts as a business expense
In bookkeeping terms an expense is any cost charged against income in the profit and loss account: rent, wages, materials, software, insurance, bank charges, professional fees. For tax the question is narrower: the computation adds back anything the law does not allow, so correct accounts can still need adjustments before the tax return is right.
Money a sole trader takes out for personal use is drawings, not an expense. In a company the position differs: a director's salary is a staff cost the company can normally deduct, but a dividend is paid out of profit after Corporation Tax and is never an expense.
The two tests every expense must pass
- Revenue, not capital. For both income tax and Corporation Tax, "no deduction is allowed for items of a capital nature". Equipment, vehicles and premises improvements are relieved through capital allowances instead, or, for sole traders on the cash basis, most equipment is simply deducted when paid for;
- Wholly and exclusively. No deduction is allowed for "expenses not incurred wholly and exclusively for the purposes of the trade". Where a cost has a mixed purpose, the law still allows "any identifiable part or identifiable proportion" that is for the business, which is how the business share of a phone or a home office is claimed.
On top of these tests, some costs are specifically blocked. The main one is entertainment and gifts: no deduction is allowed for "expenses incurred in providing entertainment or gifts in connection with the trade", and "entertainment" includes hospitality of any kind. Entertaining your own staff falls outside the bar, which is covered in our guide to staff entertainment.
Sole traders and limited companies compared
| Point | Sole trader or partnership | Limited company |
|---|---|---|
| Core rule | ITTOIA 2005 ss33 and 34 | CTA 2009 ss53 and 54 |
| Accounting basis | Cash basis is the standard method (not available to LLPs or partnerships with a corporate partner); traditional accounting is optional | Accruals (generally accepted accounting practice); the cash basis is not available |
| Alternative to claiming costs | £1,000 trading allowance, instead of deducting any expenses | None |
| Records kept for | At least 5 years after the 31 January filing deadline | 6 years from the end of the last financial year they relate to |
| Tax saved by an expense | Income tax at the owner's marginal rate, plus Class 4 National Insurance (6% or 2% in 2026/27) | Corporation Tax at 19%, 25% or the marginal relief rate |
For the full list of costs a self-employed person can claim, and the HMRC flat rates for mileage and working from home, see what you can claim as self-employed. The trading allowance is all or nothing: if you use it, you deduct up to £1,000 instead of your actual expenses, so it only helps where real costs are lower than that.
Expenses paid to employees and directors
When a company reimburses an employee or director for business costs they paid personally, two questions arise: is the cost deductible for the company, and is the reimbursement taxable for the individual? Section 289A of ITEPA 2003 gives a statutory exemption for paid or reimbursed expenses where the employee would have been entitled to a matching deduction anyway. In practice, HMRC says you do not have to report routine items such as business travel, phone bills, business entertainment expenses, and uniform and tools for work, provided you either repay actual costs or pay a flat rate at an HMRC benchmark or approved bespoke rate.
Anything outside the exemption must have tax and National Insurance deducted and be reported to HMRC as normal, often on a P11D. Employers must keep expense and benefit records for 3 years from the end of the tax year they relate to, which is shorter than the company's 6-year general records period, so in practice keep them for the longer of the two.
Worked example: what an expense is worth
A single company with no associated companies has a 12-month accounting period starting 1 April 2026 and taxable profits of £42,000 before two late costs: £2,000 of specialist software subscriptions and £2,000 for a client hospitality day.
- Software. A revenue cost wholly for the trade. Profits fall to £40,000, which is below the £50,000 small profits threshold, so the deduction saves £2,000 × 19% = £380;
- Client hospitality. Blocked as business entertainment. It is a real cost in the accounts but is added back in the tax computation, so it saves £0 of Corporation Tax;
- Net effect. £4,000 of spending reduces the Corporation Tax bill by £380, not £760. The £50,000 and £250,000 thresholds are reduced for short accounting periods and for associated companies, so the saving would differ for a group or a short first period.
Between £50,000 and £250,000 of profit, marginal relief applies and, with the 3/200 marginal relief fraction, the effective rate on the slice of profit in that band is 26.5%, so a deductible cost there is worth £265 per £1,000. Our Corporation Tax rates guide sets out the calculation.
Records and evidence
An expense you cannot evidence is an expense HMRC can disallow. A company must keep "adequate accounting records", which the Companies Act defines as records that show and explain its transactions, including "entries from day to day of all sums of money received and expended". HMRC says a company can be fined £3,000, or its directors disqualified, if accounting records are not kept. Sole traders must keep records of business income and expenses to support their Self Assessment return.
Keep the supplier invoice or receipt, a note of the business purpose for anything that is not obvious, and a VAT invoice where both you and the supplier are VAT registered. From 6 April 2026, Making Tax Digital for Income Tax applies to sole traders and landlords whose qualifying income for 2024/25 was over £50,000, with the threshold falling to £30,000 from 6 April 2027 and £20,000 from 6 April 2028, so for many small businesses expense records now need to live in compatible software rather than a shoebox. Our guide to Making Tax Digital for sole traders covers what changes.
Primary sources: ITTOIA 2005 s34, CTA 2009 s54, CTA 2009 s1298, ITEPA 2003 s289A, Finance Act 2025 s14, HMRC's guidance on Corporation Tax rates, expenses and reliefs, the cash basis and employee expenses.
If you want your expenses recorded and categorised correctly through the year, our bookkeeping services team can take it on, and our accountants for small businesses can review what is and is not deductible before the year-end.