Limited company expenses not allowed

Question

A small UK limited company paid out money, but it is not allowed as expenses, either because receipts were lost, or the payment was made for things that HMRC doesn’t accept as valid expenses. That means obviously that the company’s profits are not reduced, and they lose money by paying more corporation tax.

However, the money in their bank account is now lower than it should have been. For example with £10,000 profit and £2,000 in expenses that were paid but not allowed to be deducted, the bank account contains £8,000 instead of £10,000.

Can the company get into trouble about this? Can HMRC claim they must have made some underhanded payments and someone evaded taxes, or is this situation legally fine? Would it help to keep proof of payments even if an expense turned out not deductible?

Answer 1

A company should always keep accounting books. In most jurisdictions (and I'm guessing the UK is not an exception), keeping books is a legal requirement for a corporation/limited company in order to not pierce the corporate veil.

Whether an expense is tax deductible shouldn't matter for bookkeeping. However, if audited, there may be some repercussions if shareholders discover that some money disappeared without proper trail/explanation. So if you can't deduct the expense because there's no proof it was ever made - you may have a legal issue on your hand, not just a tax issue.

Answer 2

I think you are confusing several things:

• A company can make non-tax-deductible payments. For instance it could buy Freehold land - that would be capital expenditure, not an expense. There are also restrictions on tax-deductibility for certain expenses, e.g. some types of entertaining, car lease costs, gifts to clients, most clothing, fines and penalties. No problem here. Many non-tax-deductible payments are not underhand at all; in fact if they have been properly declared in the corporation tax return they are the opposite of underhand. Underhand is attempting to deduct them for tax, when they aren't.

• A company must keep (and file) accurate accounts. Inter alia, that requires keeping track of expenditure.

• If a company does not keep proper accounts, or if filed accounts look strange, or if filed tax returns look strange, this might cause HMRC to investigate the company (which it can do for any number of reasons). Not keeping a track of expenditure or receipts is then going to make that investigation more difficult for the company.

• Having non-tax-deductible expenditure (for instance lavish entertainment of directors) might cause HMRC to check that the directors' personal tax returns declared this as a benefit in kind.

In general people trying to evade taxes want to declare tax deductible expenditure and 'forget' to declare taxable income (almost all income is taxable). So often the thing that doesn't go through the books is something that should be income of the company, but instead arrives in crisp fifty pound notes into the proprietor's pocket. Hence some companies like being 'paid' in cash (quotes because the proprietor is being paid for work the company did, no doubt still deducting cost of materials from their tax bill). Obviously this is illegal.