If you're a business owner or if you are planning on starting a small business – are you confident about what expenses are fully deductible from your business to arrive at a net profit (or loss)? Income tax, don’t forget, is based on your net figure.
It is a general rule in business that you have to spend money to make money. – The day to day expenses for running a business can be considerable - from buying large assets to buying postage stamps, it all has to be paid for. Things like wages for your staff, advertising and marketing are all business expenses that are offset against income to create your net figure.
Income is pretty clear (it’s why you are in business after all) – it is what you receive from your customers for your products and services; or any cash jobs, including the value of any transactions you may have swapped or bartered.
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So what are the standard Deductions against income and how does that work?
First of all, if you are GST registered and claim GST throughout the year, then you claim the net amount of the expense against your income tax. If you are not registered for GST, then you can claim the full expense (i.e. including GST) against your income tax.
Standard business deductions relate to the business operation and the costs to keep it going. They form the obvious group of; rent, repairs and maintenance, supplies and services (telephone, water, electricity), raw materials and insurances, ACC levies, accounting fees, work related travel costs etc.
Aside from the obvious, deductions also include interest on money borrowed for the business, and interest charged by the IRD for underpayment of tax and any Fringe Benefit Tax you’ve paid.
Business related legal fees from a NZ or Australian registered legal service of up to a maximum of $10,000 can be deducted in an income year.
The sort of things you can’t use for Deductions look like business expenses but are in the range of capital and personal expenses e.g. the cost of plant and machinery; loan principal repayments; improvements to equipment; private expenses, such as life insurance and interest on money borrowed for private purposes or your drawings from the business; plus legal fees over that $10,000 limit mentioned above.
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The three areas that can be deductible expenses but really need your input to work
1. Vehicle Expenses - Your car and how you use it for business – this is a claimable expense and worth looking at.
For example if you are self-employed or in a partnership you can currently claim back 77 cents per kilometre up to a maximum of 5,000 km of work related travel per year – the rate changes, sometimes from year to year so you need to keep up with this.
Over the maximum 5,000, you have to keep a record of actual vehicle expenses. Unfortunately you can’t claim for a motor cycle but the rate applies for petrol or diesel engines.
Calculating the business use versus private use is the key to this deduction and the recommended method is to use the logbook method.
With a 3 month logbook record you should be able to work out the average business use of your vehicle. By recording the odometer before and after the period, you can work out the percentage of vehicle expenses to claim as deductions. You can then use this breakdown for up to three years with a variance of less than 20%.
The default method – if you don’t want to use a logbook, is to claim up to 25% of vehicle running costs as a business expense. You will still need to keep records and you may be required to provide documents for the claimed amount.
2. Home office expenses - Your home and how you use it for business
Many sole traders conduct their business from their private houses. If they have an area with a desk and a computer, a telephone and storage that is all used for business purpose this can generally be claimed. As with all business expenses, the records you keep must be full and relevant. The calculation is based on the proportion of the area set aside for your office compared to the whole house and applied to the general household expenses (power, rates, insurance, and mortgage interest). So, if in a house, your floor area is 100sq m, 10sq m are set aside for your business, then 10% of the power costs would be claimed.
What about the telephone? If you have separate business and private lines going into your house, you can claim the full cost of the business line (none of the private). Remember not to use the business line for private calls as you will have to adjust for them. If you just have one line , and you run your business from home, you can claim a deduction of 50% of the telephone rental cost.
Mobile phones – if all the calls are work related, you can claim the call costs as a business expense. If you only have one mobile phone you cannot claim the entire phone bill as a deductible expenses. You have to work out the percentage relating to business calls, from your phone accounts.
3. Entertainment Expenses - Entertainment and Travel and how you use them for business
Entertainment expenses and travel expenses are often tied up together. If your business requires you to travel, (e.g. to see agents or clients) then food and drink that you may use doing that is fully deductible. Travel expenses by themselves, if they are all to do with business are deductible and for these expenses it is pretty essential to keep records. These should include all invoices plus travel details and time spent doing business and time spent not doing business.
Along with business travel entertainment, if you are supplying food and drinks at promotions or at some conferences then that is fully deductible as well.
Other entertainment expenses tend to be 50% deductible – these would include things like corporate boxes for activities taking place away from your business premises, or a corporate yacht plus the food and drink provided or consumed associated with these activities. The 50% rule also applies to a business lunch at a restaurant and to the Friday drinks on business premises, or somewhere exclusive to you and your staff for the purpose of boosting morale or goodwill.
It does not include everyday lunches provided at a cafeteria for staff or your morning Cappuccino and your lunch on the run – these are not entertainment expenses.
Remember – the most important thing is that you need to keep records of all your expenditure to prove your proportion deductions – everything must be able to be shown as a legitimate business expense. Maybe an investment in a good online accounting package to help you with this would be a sensible investment – oh and by the way, software is generally a business expense and could be deductible depending on your business!!