How to know if an expense is deductible

Many self-employed or entrepreneurs always want to know which expenses are deductible for their business and to be able to deduct them in their tax return such as VAT or personal tax (IRPF) or Company tax (IS). This will help you to pay less tax. There is always doubt because many times whether an expense is deductible or not is based on the tax authorities interpretation of that expense. Whether an expense is deductible is fundamental for a business.

Here are some rules to follow in order to take advantage of those expenses that may be deductible.

Study The Definition Of Tax Deductible Expenses.

Studying the definition of tax-deductible expenses is the first step in determining whether an expense is eligible. 

According to the tax regulations, all necessary and reasonable expenses incurred that are directly related to the generation of income from the Activity may be deducted.

On the other hand, deductible expenses are expenses that a self-employed person or company incurs in the course of its activity and which the tax authorities (AEAT) allow to be counted in tax returns so that you pay less tax.

The Inland Revenue then allows us to count these expenses as deductible for both VAT and personal income tax purposes, and this alone can make a huge difference to your business and your accounts.

If you are sure that your expense falls within this definition, then proceed to the next point.

Requirements to consider an expense as deductible

For the tax authorities, these are the requirements for an expense to be considered deductible:

1. They must be linked to the economic activity carried out. In other words, they must be specific to the activity.

The deductibility of an expense is conditioned by the principle of its correlation with income. This is very important because if, for example, you have a lot of costs but no payment and you apply for a VAT refund, the tax authorities may refuse to refund the VAT.

We recommend that you do not apply for a VAT refund and offset against other years. You have up to 4 years to apply for the refund.

  2. They must be appropriately justified.

Deductible expenses must be justified, as a priority, by means of the invoice.

However, without prejudice to the above, the invoice is not the only and privileged means of proof of the existence of the expense, and it is up to the taxpayer to provide evidence of the reality of the operations.

  3. They must be recorded in the accounts or in the books and records that taxpayers carrying out economic activities are obliged to keep. 

General rule for deductible expenses.

An expense is deductible when it is necessary and exclusive for the development of the business activity.

This concept of ‘necessary’ or ‘exclusive’ expense can be ambiguous so here it is best to think of deductible expenses as interpreted by the Inland Revenue:

An expense is deductible when it is necessary to be able to carry out the business activity and the product or service purchased can only be used for the development of the activity.
In other words, an expense must be unequivocally and unambiguously necessary and exclusive. If you have doubts as to whether or not an expense is necessary and exclusive for the activity, it probably is not. This example will make it clearer.

John is a real estate agent and he considers his appearance to be
very important for his profession. Therefore, he decides to buy branded clothes to give a better image to the client.

John is quite right, and his expenditure may be necessary, but it is not exclusive: he intends to use it for his work, but he could also wear it on any other occasion.

His wife Angela, however, runs a hairdressing salon and needs uniforms for her employees to work. In this case there is no doubt that those uniforms are exclusive and necessary for working in the hairdressing salon and cannot be worn on any other occasion.

In conclusion:

1. In Juan’s case the clothing is not a deductible expense because it cannot be considered an exclusive expense.
2. In Marina’s case, clothes are deductible because they are a necessary and exclusive expense. Clothes are essential for work and, a priori, it cannot be used on any other occasion.

An expense is deductible when you have an invoice or in some cases a receipt may be sufficient.

An expense is deductible if you have the invoice.

The rule of deductible expenses tells us that, in order to deduct an expense, we must keep an invoice that proves the purchase or service performed.

What are the requirements for an invoice to be deductible?

The invoice can be a full or simplified invoice, but it must always contain at least the following information:

1. Invoice number
2. Date of issue of the invoice
3. Details of the supplier: name, NIF or DNI and fiscal address.
4. Description of the good or service purchased 
5. Price of the good or service purchased free of tax (taxable base)
6. Percentage of VAT applied
7. Total to be paid

Our recommendation, ALWAYS ALWAYS ASK FOR AN INVOICE WITH THESE DATA in order to be able to deduct the expense, both from IRPF, IS and VAT.

Some companies allow you to ask for a monthly invoice, others give you a simplified invoice and you have to fill in your details.

Beware of proforma invoices

A proforma invoice is a document that you are given BEFORE you pay for what you buy, but a proforma invoice is not an accounting document and a proforma invoice is not used to deduct the expense. When you pay, ask for an official invoice.

But what if you don’t have an invoice? 

There are expenses that you do not have invoices for, such as monthly social security contributions, professional fees, insurance, IBI and some bank charges.
On other occasions, it is simply very difficult or impossible to ask for an invoice for the service provided, as is often the case with internet expenses and services, transport costs, train, bus, taxi, etc.

In these cases, you should at least keep a ticket or receipt that justifies the payment made. This way you will be able to deduct the expense in order to pay less IRPF or IS, but bear in mind that, as long as you do not have an invoice for the expense, you will not be able to recover the VAT.

Control your expenses with an accurate and detailed record of the total cost.

Remember: They must be recorded in the accounts or in the books that taxpayers who carry out economic activities are obliged to keep. 

Keeping accurate track of your expenses is the most important thing for a successful tax return. For this reason, it is necessary to keep a detailed record of all expenses incurred in your activity.

Each invoice or receipt should include the exact description and amount of the expense. This way you will be able to disclose the purpose of the item to the tax authorities and comply with regulatory requirements regarding tax deductibility.

Don’t undervalue small expenses that are real and considered necessary for your business.

The vast majority of self-employed people tend to neglect small items such as office expenses, equipment and transport. These are not so relevant when compared to many other expenses, such as marketing or loan repayments. But you should keep in mind that these small amounts can also add up in your favour for a better tax return.

Ask Your Chartered certified Public Accountant About Tax-Deductible Expenses Before You File Your Annual Tax Return

If you want to save on taxes, ask your certified public accountant about expenses that may be tax deductible. This will help you make informed spending decisions and also let you know in advance if an expense is considered tax deductible. Almost anything can be claimed as a deductible expense, from printer paper to business travel, so remember that all these little things count.