Business Expenses: Meaning, Types, Tax Deductible Expenses

When you start a business, what is the first question? What will be my capital and expected, or what is business income from this venture, right? However, apart from capital investment, what’s important is how you allocate funds and the different business expenditures. It's important to consider for two reasons- it affects the net profit and it can be claimed as deductions when you pay the taxes. So, let’s understand the business expenses in detail. 

What are Business Expenses?

Business expenses are the costs you incur to run your business and generate revenue. The business expenses list includes salaries, rent, utilities, supplies, advertising, and equipment. These expenses are subtracted from your total revenue to calculate your net income. Most business expenses are tax-deductible, which can reduce your tax liability. These necessary costs ensure your business operates smoothly and continues to grow, whether it's through daily operations or pursuing new opportunities. 

Types of Company Expense:

The different types of business expenses are as follows:

Revenue Expenses

Revenue expenses are the regular costs a company incurs to maintain its operations and generate income. These costs don’t create long-term assets for the business. Examples include maintenance, repairs, rent, and wages. They appear in the company’s income statement for the period they occur. Examples of revenue expenses include asset maintenance and repairs, utility bills, wages, sales commissions, rent, and lease payments. 

Variable Expenses

Variable expenses change based on business activity or production levels. They rise or fall in direct relation to sales or output. Common examples include raw materials, direct labor, and shipping costs.

Cost of Goods Sold (COGS)

COGS covers the direct costs of producing or acquiring goods sold by a business. It includes raw materials, labor, and other expenses tied directly to the production process. For instance, in furniture sales, COGS includes the cost of wood, labor, and additional materials like hardware.

Capital Expenses (Capex)

Capex involves money spent on buying, maintaining, or upgrading fixed assets like land, buildings, or machinery. These expenses are treated as investments on the balance sheet. For example, purchasing a building or investing in new technology falls under capex, as the benefit lasts over a year.

Fixed Expenses

Fixed expenses remain the same over a set period, regardless of business activity. These recurring costs are essential for operation, such as rent, insurance, and employee salaries not tied to production.

Recurring Expenses

Recurring expenses are regular costs that occur at fixed intervals, such as monthly or annually. Examples include utility bills, subscription fees, and loan repayments.

Interest Expenses

Interest expenses arise from borrowing money, including interest on loans or credit. These costs can affect a company’s profitability and cash flow.

Incidental Expenses

Incidental expenses are small, irregular costs that support business operations. Examples include minor repairs or one-time professional fees.

Similar to the direct tax paid by individuals, businesses are given the provision of tax-deductible expenses. There are a few expenses that can be deducted from the taxable income to reduce the final tax liability of the business. 

Tax Rules for Business Expenses:

Businesses and professionals can claim tax deductions on expenses that are revenue in nature. Sections 30 to 36 of the Income Tax Act 1961 cover specific costs such as rent, taxes, insurance, depreciation, interest, and employee-related expenses. These sections allow businesses to reduce their taxable income by deducting these costs. If an expense isn't covered under these sections, Section 37 comes into play. However, there are certain conditions and exceptions. 

• First, the expense must not be capital in nature. This means it should not create or acquire an asset or provide any long-term benefit for the business or profession.
• Second, the expense should not be personal. In other words, it must not be spent for the personal enjoyment or benefit of the individual or their family.
• Third, the expense must not be disallowed by other provisions of the Act, like sections 40, 40A, 43B, etc.
• Fourth, the expense should be incurred entirely for the business or profession. It must directly contribute to earning income from that business or profession.
• Lastly, the expense must be incurred during the previous year that corresponds to the assessment year in which the deduction is claimed. 

To claim these expenses as a deduction in tax, the business needs to be careful with the compliance and documentation of the business expenses. 

List of allowed expenses in income tax:

Some of the common business expenses deductible for tax purposes include the following:

Rent and Lease Expenses

The cost of renting or leasing office spaces, warehouses, or factories is usually tax-deductible.

Employee Salaries

Wages, salaries, bonuses, and payments to employees—whether permanent, temporary or on contract—are fully deductible as business expenses.

Professional Fees

Payments made to professionals like lawyers, accountants, or consultants for business services are tax-deductible.

Business Travel Expenses

Costs related to business travel, including accommodation, meals, transportation, and other related expenses, can be deducted.

Office Supplies and Equipment

Spending on office supplies such as stationery, software, and hardware, as well as leased or purchased office equipment, is deductible.

Advertising and Marketing Costs

Expenses from advertising or marketing, including digital campaigns, print ads, or sponsorships, can be claimed as deductions.

Employee Benefits

Contributions to employee benefits like health insurance, retirement plans (EPF), or education expenses are generally deductible.

Utilities and Communication Expenses

Costs for utilities like electricity, water, internet, and phone services, when used for business, are tax-deductible.

Depreciation Expenses

Businesses can deduct depreciation costs for assets like machinery, vehicles, or buildings over their useful life.

Scientific Research Expenses

If your business conducts scientific research, the expenses related to these activities may qualify for tax deductions.

Remember that each expense type may have specific rules or limits. Maintaining proper documentation is essential to support any deductions claimed. But are there any rules pertaining to the documentation of business expenses?

How to document business expenses?

Under the Income Tax Act, businesses must keep proper books of accounts and documents to help the Assessing Officer determine their taxable income. These books include the cash book, journal, ledger, and all bills and receipts issued or received. If a business's income or turnover crosses certain thresholds as per Section 44AA and Rule 6F, maintaining these books is mandatory. For instance, businesses with gross receipts over ₹1 crore and professions with receipts over ₹50 lakhs need to conduct a tax audit. The books of accounts should be filed electronically by September 30th of the assessment year. Additionally, cash expenses above ₹10,000 won’t be allowed as deductions under Section 40A(3). To avoid penalties or disallowances, businesses must carefully document their expenses and adhere to the Income Tax Act’s rules. 

Bottomline

Business expenses are not just meant to be incurred items on the P&L statement; managing business expenses is crucial for long-term success. Mismanaged spending can lead to cash flow problems, reduced profitability, and even financial distress. By keeping expenses in check, businesses can ensure financial stability, boost profit margins, and maintain a healthy cash flow. Additionally, well-managed expenses build trust with stakeholders, including investors, employees, and suppliers, enhancing the company’s reputation. Effective expense management also mitigates risks and keeps taxes in check. Overall, a strong expense management strategy is vital for driving efficiency, maintaining competitiveness, and ensuring sustainable growth in today’s dynamic business environment.

FAQs

Q1. What is an admissible expense?

Ans. Admissible expenses are costs that can be subtracted from a business's total revenue to calculate its taxable income.

Q2. What type of business expense is salary?

Ans. A salary can be a direct or indirect expense based on the job role. If it’s paid to a factory worker, it’s a direct expense since it's tied to production costs. But, if it’s paid to an office employee, it’s considered an indirect expense because it can’t be linked to specific goods.

Q3. How are fixed expenses different from variable expenses?

Ans. Fixed expenses are costs that stay the same, no matter how much you sell or produce. These include things like rent, insurance, and salaries. Variable expenses, on the other hand, change depending on your sales or output. For example, the cost of raw materials, utilities, and commissions will go up or down based on how much you're selling.