Continuing with our recent line of click-baity titles – here is a new one!
Now, when you are running a business, I’m sure you have had a lot of well-intentioned (some maybe not so) friends who have told you to simply claim stuff as expenses to your business. Because, if we recall an earlier lesson in this blog, expenses offset your income which reduces your profit. A smaller profit equals less tax and believe me when I say I have met business owners who are happy that they made a loss because it meant that they don’t have to pay taxes! (No, you should never be happy if you are making a loss. I mean, why are you even in business in the first place??)
Anyway, you want to be able to claim the correct expenses. Correct expenses here mean expenses which relate to the running of your business. Most of the time, expenses are pretty clear cut. If you are paying for rent on your business space – it’s an obvious business expense. If you are paying for your children’s swimming lessons, it’s not a business expense (unless if you are running a pearl diving side hustle where you use your own kids as child labor – which I’m sure you are not).
However, with certain expenses it can get tricky. Say for example, you work from home (like many small business owners do) and you use the internet connection at home to get work done. Can you claim the internet bill for your house as a business expense?
The short answer is Yes, but only a portion of it which relates to your business. You determine this portion by doing a series of calculations which we won’t cover in this article.
This article is going to teach you one (1) simple trick to determine if you can claim your expenses or not.
Ready?
Ok.
It’s called the Nexus to Income test. If you have an expense you want to claim, but you’re not sure if you can claim it, ask yourself, does this expense have a nexus to my income? Nexus to income here means proximity to income, which in simple English means a relationship or direct causal effect to income.
Basically, the question you should ask yourself is:
“Does my spending money on this thing help me make more money for my business?”
If you can answer yes, then, by all means, claim it and chuck it in your financial statements. If you answered no, then do not record it under your business, file it away under your drawings or personal expenses.
Let’s look at some examples:
You pay your team member a salary for the work they have done for the business.
Is it an expense? YES.
Your team member works hard for the business, they generate value and ultimately keep the business running. So heck yeah, they relate to your ability to generate income.
You pay a subscription for the accounting software (I happen to really like Xero) you use for your business work.
Is it an expense? YES.
You need an accounting software to run your business effectively, leaving you free to focus on making money for the business. So it defo relates to your ability to generate income in the business.
You pay for a trip for you and your family to go to Langkawi (bit of a plug for Malaysian Tourism here) because, hey, you deserve a break from all the hard work you put into your business!
Is it an expense? NO.
Sorry bub, but a family trip constitutes a personal expense. Even if you try to spin it as ‘mental health well-being which relates to your ability to clear your mind and run your business more effectively,’ it still won’t sit well with the tax authorities. Simply put, taking a family trip for yourself won’t affect the business’ ability to generate income.
There are plenty of other examples out there. Some can be quite tricky like entertainment expenses for clients and team members (In NZ the general rule is that you can only claim 50% of entertainment as a business expense). But it all basically boils down to asking yourself:
“Does my spending money on this thing help me make more money for my business?”
And that’s it. Have a great rest of the week!
If you want to read more about this subject, my good mate Jimmy Ling has a cool write up on claimable expenses on his blog over here.