As indicated in the “Determination of Income” section, the UK tax system calculates taxable profits by combining two elements: (i) the company's net income from each source and (ii) the net taxable profits derived from the sale of capital assets. This approach creates a particularly complex regime in terms of tax deductions.

In general, expenses must be directly attributed to the corresponding source of income, or, in some cases, to the total revenues or to the specific capital gain to which they are related. The rules that determine whether an expense is deductible vary depending on whether it is income or capital gains, and even within income categories, there are differences depending on the specific source.

For example, the tax treatment of expenses for companies that trade in real estate differs significantly from that applied to those that invest in them. In addition, the regime includes numerous special rules that regulate specific types of deductions and that, in the event of a conflict, prevail over the general rules applicable to each type of income.

Given the above, the general rule on commercial expenses, the most common category, is established as a starting point. Based on this basis, the most common exceptions provided for in tax legislation are analyzed.

General rule on business expense deductions

Companies can deduct, in general terms, expenses that have been incurred in a total and exclusive way for the development of their business activity, provided that they are not considered capital expenses and are reflected in the profit and loss account. However, there is extensive case law that determines whether an expense actually meets these conditions and whether its nature is capital or not.

As a general rule, the deduction is recognized in the accounting period in which the expense is accrued, although there are specific exceptions. For example, contributions to registered pension plans are only allowed if they have actually been paid, and certain contributions may be distributed over several years. In addition, deferred compensation and some personnel expenses must have been paid within nine months after the end of the financial year to be deductible; otherwise, your deduction is also limited to the time of payment.

This general rule is modified by multiple specific legal provisions. Some allow additional deductions, while others restrict them. A clear example is that representation expenses, such as meals or business entertainment, are often not deductible.

The UK tax regime also incorporates special rules on hybrid mismatches, in line with Action 2 of the OECD's BEPS plan, effective as of January 1, 2017. These rules seek to avoid situations in which an expense is deductible in one jurisdiction without corresponding income in the other, or where the same expense is deducted twice in different jurisdictions. Typical cases include hybrid entities (such as some US LLCs), financial instruments that receive different tax treatment depending on the party receiving them, or companies with dual tax residency. When such a mismatch is detected, it may be necessary to adjust or reject the corresponding deduction.

Depreciation and amortization

The UK tax system does not allow the accounting depreciation of fixed assets to be deducted as an expense. Instead, companies can apply specific tax breaks, known as Capital Allowances, on certain types of assets.

These deductions make it possible to deduct annually a percentage of the cost of acquiring the asset, depending on its category:

• Plant and machinery from the main fund: 18% annual deduction on a decreasing basis. As of April 1, 2023, new assets can benefit from the Full Expensing, a deduction of 100% in the first year. This measure, initially temporary, became permanent in 2024.
• Special-type plant and machinery: includes elements integrated into buildings (air conditioning systems, insulation, etc.) and long-lasting assets. Deduction of 6% per year, or 50% for the first year under the Full Expensing (does not include vehicles).
• Cars: The deduction varies between 100%, 18% or 6%, depending on CO₂ emissions.
• Research and Development (R&D): 100% deduction for assets used exclusively in R&D activities that meet the requirements.
• Structures and Buildings (SBA): 3% linear annual deduction for new commercial buildings, conversions or renovations after October 29, 2018.

In addition, most companies can apply a 100% Annual Investment Allowance (AIA) on the first £1 million of annual spending on qualifying assets, although this limit applies per business group.

Assets must be new and unused, and expenses must be reported on the tax return corresponding to the accounting period in which they were incurred, with no possibility of deferral.

The tax recovery of the applied deductions is carried out when the assets are disposed of. In general, sales value that exceeds the amortized tax value is taxed. In the case of immediate deductions (such as Full Expensing or the old super deduction), the entire amount received is usually taxable in the year of the sale.

When assets are leased, capital deductions usually go to the lessee and not the landlord. For leases to non-resident companies, deductions are restricted, often to 10% or even 0%.

Intangible fixed assets

Intangible assets, such as patents, brands, know-how or goodwill, are subject to a specific tax regime.

Royalties and other payments are generally deductible if they are recorded for accounting purposes.

The accounting amortization of intangibles is also deductible, except for certain assets acquired before March 31, 2002 or goodwill related to acquisitions after July 8, 2015, whose amortization is no longer tax-deductible. Since April 2019, certain intangibles acquired with admissible intellectual property can generate a tax relief.

Regarding software, if capitalized as an intangible fixed asset, the tax deduction is usually based on amortization. However, you can choose to exclude it from the intangible regime and apply the deductions corresponding to the plant and machinery regime. This option may allow an immediate deduction, provided that the expense is not considered to be of a recurring nature (income) for tax purposes.

R&D expenses are usually deductible and can benefit from additional incentives (see Credits and Tax Incentives section).

Management expenses

Holding companies and those with an investment activity can deduct certain management expenses, provided that they relate directly to the management of the investment business, and are not of a capital nature (i.e., they do not represent investment in assets).

Commonly deductible expenses include: auditing fees, director's costs, rents, city taxes and office costs. These expenses can be deducted from any type of income, including capital gains or financial income.

If the revenues for the period are insufficient to absorb all management expenses, the excess can be transferred to other entities of the group via Group Relief, or accrued without a time limit to be deducted against future income.

Action plans for employees

Employer companies can usually deduct the actual or estimated cost of offering shares or stock options to employees, depending on the type of plan and the accounting treatment applied.

This generally allows a subsidiary to deduct the expense when its employees receive shares or options from the parent company.

Financing costs

Financing costs (mainly interest and commissions) are, in general, deductible according to accounting accounts, even if they are capital in nature. However, this deduction is subject to certain restrictions, such as:

• Transfer pricing and undercapitalization rules (without explicit safe margins)
• Rules against hybrid mismatches
• Corporate Interest Deduction Limits
• Rules on financial instruments, derivatives and cross-border transactions

Traders often deduct these costs when calculating their trading income.

For loans not used in commercial activity, deductions generate non-business deficits, which can be offset against benefits for the same year, set back one year (against funding benefits for that year) or transferred indefinitely: against non-commercial benefits (if they arose before April 1, 2017) or against total benefits (if they arose since April 1, 2017)

As of April 1, 2017, and subject to a minimum of GBP 2 million per year, the CIR rules limit the deduction of net interest to the greater of:

• 30% of adjusted EBITDA in the United Kingdom
• The group ratio (for highly leveraged groups)

In addition, the group's interest deduction in the United Kingdom cannot exceed the net interest reflected in the global group's consolidated financial statements.

These rules replace the old global “debt cap” and often reduce the amount of tax deductions available to UK companies.

Bad debts, provisions and reserves

Provisions for future expenses are tax-deductible if they meet all of the following conditions:

• They correspond to eligible income expenses
• They are carried out in accordance with acceptable accounting practices.
• They do not contravene any specific legal rules regarding the timing of the deduction (such as the rules for personnel expenses)
• They were estimated with sufficient accuracy

These rules also apply to provisions for bad debts in accounts receivable. However, when it comes to debts related to financial income or costs, specific rules on loan relationships generally apply.

Even so, the key criterion remains the same: if an uncollectible debt can be identified with sufficient precision and the provision complies with UK accounting standards, it should in principle be tax-deductible.

Donations to charitable organizations

Most donations made by companies to charities are tax-deductible in the UK, provided they are made to registered charities and the corresponding legal requirements are met. These deductions apply when calculating profits subject to corporate tax.

Fines, Penalties and Bribes

Deductibles

• Legal costs in defending against fines or sanctions.
• Costs of compensating customers or others affected (even if the fine is not deductible).
• Compensatory (non-punitive) damages, such as defamation damages
• Breach of contract payments.
• Payments to employees for wrongful dismissals or similar compensation.

Non-deductible

• Payments that constitute a criminal offence, such as bribes.
• Fines and penalties imposed for violating the law
• Civil penalties, interest and similar charges (e.g. related to VAT).
• Fines for regulatory breaches.

Taxes

Local municipal taxes can be deducted from taxable income.

Payments to foreign subsidiaries

There are no specific rules for payments made to subsidiaries abroad. Therefore, their tax treatment is governed by the general deduction rules explained above.

However, transfer pricing rules apply if the agreed price does not match the market value. In that case, the price will be adjusted to increase taxable profits in the United Kingdom or reduce your tax losses.