Entertainment, petrol and the car: the three expenses most often struck out

Hook

What a tax audit strikes out most often is these three: taking people out to eat, petrol, and the cost of the car. By a distance. And most bosses understand these three as a yes-or-no question: deductible, or not deductible? Wrong. This episode covers how much of those three can actually be deducted, and what you have to prove it with.

Entertainment: half is the default

Entertainment first. LHDN has a public ruling written specifically about it. The rules can be pressed into two sentences. Note the order. Half is the default. The whole thing is the exception. Most bosses understand it the other way round — they assume entertainment is fully deductible in the first place, and feel wronged when it is cut. So which kinds are fully deductible? The three you meet most in practice: first, anything for employees. Meals, drinks, the annual dinner, staff trips, recreational activities — this category is usually fully deductible. Second, anything wholly related to sales. An event held to promote sales. Third, promotional gifts and samples given away free — subject to conditions. We said in the episode on expense claim forms that the "entertainment" column really has to be split into two. Now you know why.

But LHDN's first question is not "what percentage"

Now the most important part of this episode. When the auditor turns to your entertainment column, the first question is not "how much of it is deductible". It is this. Two examples and you will see it straight away. First: an insurance agent. His business is sustained by meetings and by relationships. Buying a client a coffee, giving a small gift, holding a client appreciation event — the connection between these and how he earns money is clear. So entertainment expenses in his books are entirely reasonable. The only questions left are whether it is half or the whole, and whether he has a record of who he hosted and what for. Second: a licensed money changer. The customer walks in, changes the money and leaves. And for security reasons they should not be lingering anyway. So if that money changer's books carry a large "client entertainment" figure — that is no longer a question of deducting half. The real lesson of this section is: your books have to look like your trade. The expense structure one industry should have is simply not the same as another's — forcing somebody else's practice onto yours is the easiest way to get into trouble.

What to keep for entertainment is more than the receipt

So what do you keep for entertainment? The receipt is the minimum standard. What is actually useful is the context. Who you hosted, from which company, for what, how many people. Writing it on the back of the receipt is enough — thirty seconds' work. Why does it have to be written down? Because three years later, when the audit asks about that meal, nobody remembers who was at the table that day. A receipt carrying only an amount and a date cannot prove it was entertainment, and cannot prove it had anything to do with earning money.

Petrol and the car: the private part was never deductible

Over to petrol and the car. What holds the whole thing up is two basic rules. Rule one: an expense is deductible only if it is incurred wholly and exclusively in the production of income. Rule two: private or domestic expenses are not deductible. So a car that both runs the business and carries the family has to be split, by definition. This is not LHDN making life difficult; it is where the rules start. And sole proprietorships and partnerships are handled differently from companies. Sole proprietorship, partnership: the car is usually registered in the boss's personal name — the approach is to strike out a proportion and deduct only the part used for the business. A company: if an employee or a director is using the company car, that may constitute a benefit in kind, dealt with on that person's individual income side. And one reminder in passing: the capital allowance on buying a car has a cap — it is not that the more expensive the car, the more you deduct. The amount is on the episode page.

So what percentage can you deduct? (the question at the heart of it)

I have to answer this one very carefully, because answering it wrongly does real harm. You may have heard something like "in such-and-such a trade you can only claim ten per cent". I have looked, and I cannot find a public ruling that says any such thing. But that saying did not come from nowhere. In practice, where private use is clearly on the high side, an auditor really will argue for a lower deductible proportion. That is not legislation, it is audit practice — and it varies case by case. So here is the crux: how do you prove it? Only one way is sound: a mileage log. Date, where you went, who you saw, how many kilometres. It sounds like a nuisance. But it is your only bargaining chip. And what happens without records? It becomes a negotiation — the auditor names a proportion he thinks is reasonable, and you have nothing in your hand to argue back with.

Three questions to put to any expense

Finally, something you can use yourself. For any expense you are unsure about, ask three questions. One: does this expense relate to how I earn money? If it does not add up — that is not a question of what percentage, it is the whole lot struck out. Two: is there a private element in it? If there is — split it first, do not throw the whole thing in. Whatever is split out and belongs in the director's account, move it there (a point we took apart in the episode on expense claim forms). Three: in three years' time, what will I prove this with? The receipt, the context, the records. Asking yourself these three questions first is far cheaper than thinking about them for the first time when the auditor asks you.

To close

One line to close: what I am telling you is not to claim less. It is to fix two things at once. What should be deducted, many bosses dare not deduct, and they pay more tax for nothing. What should not be deducted, many throw in whole and then wait to be chased. Fix both sides and your books will stand up. Want to know whether the expense structure in your trade looks right? Grab a coffee first and talk about your business. For the accounting, come to LTT. I am LTT, helping SME bosses get their accounts straight. Follow us, and see you next time.