It is common for businesses to encounter confusion arising from the tax adjustments made by tax agents during the preparation of income tax computation. For example, why are certain expenses eligible for deduction, while some are disallowed? How can one determine which expenses qualify for tax deductions and which are not? If you find yourself confused, let’s explore this article to gain a
better understanding of the criteria for deductible expenses.
General Rules for Deductible Expenses
Generally, businesses can only claim tax deductions for expenses that are wholly
and exclusively incurred in the production of gross income. Additionally, there are certain conditions must be met to justify whether an expense is deductible, including:
- Expenses for each income source are accounted for separately
Understanding which expenses are related to which sources of income is a fundamental step in determining deductibility. If expenses are incurred in the production of business income, they should be subtracted from the business source. Conversely, if the nature of expenses is related to the production of rental income, they should only be deducted against the
rental source. So, what if my company has incurred commonly used expenses for different business sources? In such cases, these expenses must be apportioned to the different sources on a reasonable basis. - Must be “incurred” NOT a “provision”
For expenses to qualify for a tax deduction, they must satisfy the definition of “incurred” and not a “provision”. An expense is considered “incurred” when the liability to pay has arisen, regardless of the actual payment made. Common examples include staff salaries, commissions, directors’ fees and utility bills.
On the other hand, an expense is considered as
a “provision” when the amount is uncertain and is based on estimation. In certain instances, businesses may record provisions for expenses, such as provisions for doubtful debt and the provision of bonuses in their accounts. However, for tax purposes, these provisions are not allowable for tax deduction.
- Outgoings and expenses
A tax deduction will be applicable for costs that satisfy the definition of outgoings and expenses. Outgoings refer to losses incurred due to theft and defalcation, etc. On the other
hand, expenses refer to any money spent or paid out to generate income or maintain day-to-day operations, such as salaries, upkeep, and maintenance, printing and stationery, etc.
- Wholly and exclusively
An expense must be incurred solely for income-generating purposes and directly related to the
business, while expenses that are personal and private in nature are not allowable for a tax deduction.
- In the production of gross income
To
qualify for a tax deduction, businesses must determine whether their expenses incurred contribute to generating business income. The incurrence of the expense must be for the purpose of earning income, but it does not necessarily mean that the expenditure must produce income in the same year it is made.
- Must
be revenue in nature
Only expenses classified as 'revenue in nature' may be eligible for tax deduction. Any expenses categorized as 'capital in nature' are disallowed to claim tax deductions. The key characteristics of 'revenue in nature' involve recurring, operational, and contribution to the furtherance or
maintenance of the business.
