Disallowable expenses

Definition

Disallowable expenses are costs that appear in a company's accounts but cannot be deducted when calculating taxable profit, so they are added back in the tax computation.

In plain terms

Some things you spend money on — client entertaining, certain fines and penalties, depreciation — are real business costs but the taxman will not let you deduct them. They reduce your accounting profit but not your tax bill.

Why it matters for your company

Disallowable expenses are why your taxable profit is usually higher than your accounts profit. Knowing which costs are disallowed helps you budget the true tax bill and avoid a nasty year-end surprise.

In practice

Say a director takes clients for dinner to discuss a contract renewal, or the company sponsors a local sports team for goodwill. Both are recorded in the accounts as normal running costs and reduce accounting profit — but at the year-end tax computation, the accountant adds them straight back before working out taxable profit. Depreciation on a company van works the same way: it is charged every year in the accounts, then added back and replaced with the appropriate capital allowance instead.

For the finance function the practical effect is a small reconciliation step rather than a cash outflow — the expense has already been paid, so what changes is only how it is treated when arriving at the figure corporation tax is charged on. Directors who keep a simple running note of entertaining and similar costs through the year tend to find the year-end adjustment quicker and less contentious with their accountant.

Common pitfalls

The most frequent mix-up is treating staff entertaining and client entertaining as the same thing — one is typically allowable, the other typically is not, and lumping them together in the books makes the add-back harder to spot later. Fines and penalties are another blind spot: because they are paid from the business bank account and coded to an expense category, it is easy to assume they behave like any other deductible cost, when in fact they sit squarely in the disallowable camp.

A subtler pitfall is forgetting that a disallowable expense is still a genuine reduction in accounting profit and cash — it simply does not lower the tax bill. Directors sometimes read a healthy accounting profit and assume the tax due will track it closely, then find taxable profit — and the bill — comes out higher once the add-backs are applied, which is one reason it pays to budget for tax separately from headline profit (see how to budget for your corporation tax bill).