Tax-Deductible Expenses: What Is Accepted and Why Items Get Disallowed

There is a gap between money you have spent and money that reduces your taxable income, and every year it proves expensive. This is written for owners and accountants who need to know what an expense must satisfy to survive an assessment, which items are excluded outright, and what evidence to assemble when the entry is posted rather than a year later.

The three general tests

Article 147 of the Direct Taxes Act sets the framework. An expense is deductible when it is:

• Within reasonable limits — proportionate to the size, nature and volume of the business.
• Supported by documentation — a valid invoice, contract, payment record and proof the goods or services were received.
• Related exclusively to earning the entity's income in that fiscal period — not to the owner personally, not to another period, not to activity outside the company's scope.

To these is added compliance with prescribed ceilings; certain costs, such as staff welfare items, carry annual limits that are issued each year.

The accepted categories

Article 148 contains a long list. Rather than memorising clause numbers, it helps to see it in working groups:

Two of these generate most of the disputes. Depreciation must follow the class and rate in the issued schedule and relate to assets owned by the entity — the rules are in the fixed asset depreciation guide. Bad debts are accepted only where the claim is established, was previously booked and legal recovery steps were taken; an estimated provision alone does not qualify.

What is not accepted

1. The entity's own income tax.
2. Tax penalties and fines paid to government or municipalities — contractual penalties between commercial parties are treated differently.
3. Personal expenses of shareholders and directors — family travel, private vehicles, household costs.
4. Costs relating to exempt, zero-rated or lump-sum taxed income.
5. Undocumented expenses or those supported by fictitious invoices.
6. Depreciation arising from a revaluation surplus.
7. Estimated provisions without a defined legal basis.
8. Costs belonging to another fiscal period that do not meet the statutory exception.

Point four matters more than it looks. A company with both exempt and taxable income must allocate shared costs on a documented and consistent basis. Without one, the assessor will apply their own, and the outcome is rarely in your favour.

The formal conditions

Payment route. Deductibility of payments above the statutory threshold — where settlement is not by offset — depends on payment or settlement through the banking system. A large cash payment puts the expense at risk even with a valid invoice. Check the current threshold in the latest rules.

Withholding obligations. Where a payment carries a duty to withhold tax or social security contributions, failure to do so both exposes the expense to challenge and attracts a separate penalty. Payroll without filed lists, rent paid without the prescribed deduction, and contractor payments made without meeting the obligations are the three recurring cases; the framework is in withholding tax obligations.

Books and document quality. An expense not recorded in the statutory books, or supported by a voucher with no narrative, no attachments and no authorised signature, cannot realistically be defended.

The annual reconciliation

Accounting profit and taxable income are two different numbers, and the difference is normal. The right practice is a documented reconciliation that starts from book profit, adds back non-deductible items and deducts exempt income to arrive at taxable income. Build it during the year, not in the final week before the filing deadline. Having it ready is the difference between a documented defence and a verbal explanation when the file is examined — see tax assessment and defence.

Eight questions for every expense

1. Is there a valid invoice or contract in the entity's name?
2. Is there proof the goods or services were received?
3. Was payment made from the entity's account through the banking system?
4. Were withholding or insurance obligations met at the time of payment?
5. Does the cost belong to the current period and was it recorded there?
6. Is the amount proportionate to activity and within any ceiling?
7. If you have exempt income, have shared costs been allocated?
8. Does the voucher carry a clear narrative, full attachments and authorised approval?

Any item answering no to one of these is a known risk. It is better to add it back yourself in the reconciliation than to have the assessor find it.

Key takeaways

• The three Article 147 tests — reasonableness, documentation and exclusive connection to the period's income — govern everything.
• Article 148 lists what qualifies, but each item still depends on evidence and ceilings.
• Payments above the statutory threshold must go through the banking system.
• Costs relating to exempt income are not deductible; allocate shared costs on a documented basis.
• Build the reconciliation of book profit to taxable income throughout the year.