We accountants often use the expressions “tax-deductible” and “non-deductible”. Sometimes “tax-free” and “taxable” as well. But what do these words really mean?
Deductible and non-deductible costs
Let’s start at the beginning: every year a company pays income tax on its taxable profit. Exactly how the tax is calculated varies between different company types, but it’s always based on the taxable profit.
So what do we mean by “taxable profit”? Well, we start with the pre-tax book profit – that’s the profit you find in the company’s profit and loss statement, simply put revenue minus costs. The costs in your accounts are mostly deductible, but some are actually non-deductible. This means that, even if it’s a cost that decreases the company’s profit, it doesn’t decrease the company’s income tax.
Non-deductible costs can be e.g. representation/entertainment, penalty fees from Skatteverket/Bolagsverket or asset write-downs.
So to arrive at taxable profit, we take book profit and add back the non-deductible costs.
Taxable and tax-free revenue
There is also revenue that is not taxable, and this we have to deduct when we calculate the taxable profit. Examples of tax-free revenue are dividends and capital gains from unlisted companies (näringsbetingade andelar) and interest income from the tax account at Skatteverket.
But sometimes we also talk about deductible and non-deductible VAT, what’s that all about? VAT (value-added tax) is a bit different from revenue and costs. I’m assuming you know what VAT (or sales tax) is, but maybe not exactly how it works.
VAT – the basics
If you run a business that is subject to VAT (which most companies do) you add VAT when you sell something. This VAT is called “output VAT” (utgående moms) and this is money you eventually pay to Skatteverket.
And vice versa, when you buy goods or services from others you often pay VAT on these purchases. This VAT is called “input VAT” (ingående moms) and you eventually get this money back from Skatteverket, assuming your business is subject to VAT.
In practice you report output and input VAT in the same VAT return, and the net amount is paid/received to/from Skatteverket.
So what is then non-deductible VAT? Well, it may be that your business is not subject to VAT, e.g. if you’re a dentist, an insurance company, a bank, a holding company etc. Then you don’t add VAT when you sell something, but you don’t get to claim back the VAT on stuff you buy. Input VAT instead becomes a cost in your P&L statement.
Even if you are subject to VAT, some input VAT can be non-deductible. It could e.g. be when representing and only a certain amount is deductible, or if you purchase something but the receipt or the invoice doesn’t fulfill the legal VAT requirements. Here your input VAT becomes a cost as well.
Taxable and tax-free benefits
Benefits – the basics
Another area where the terms “taxable” and “tax-free” are commonly used is for benefits to employees (or owners). A taxable benefit is a benefit on which you pay income tax, while on a tax-free benefit you obviously don’t pay income tax – no surprises there.
When a benefit is taxable it’s included as income in the recipient’s income tax return and the employer pays social fees on the benefit amount. When the benefit is tax-free, neither income tax nor social fees are paid.
A taxable benefit is usually tax-deductible for the company, both the cost for the benefit and the social fees. However, VAT on the cost for the benefit is usually not deductible as VAT, only as a cost. For market-valued benefits the bottom-line effect is usually the same as paying extra salary to the employee. There is limited (or no) upside for market-valued benefits, in other words.
Even some tax-free benefits are tax-deductible for the company, both the cost for the benefit and the social fees. And you normally get the VAT back from Skatteverket. Common examples of tax-free benefits are coffee and snacks in the workplace, gym memberships, office massage etc. Tax-free and tax-deductible benefits are the most “beneficial” benefits for both parties.
Finally there are tax-free benefits that are non-deductible for the company, although nowadays this is rare. The most common example was when the employer pays for private health care or a private health care insurance, which until June 2018 was a tax-free benefit with no tax consequence for the recipient, no social fees for the employer, but a non-deductible cost for the employer. However, from July 2018 this is considered a taxable benefit just like any other taxable benefit, see above.
Non-deductible costs in aktiebolags
In limited liability companies (aktiebolag) and most other legal entities (handelsbolag excluded), the company’s taxable profit is not decreased by non-deductible costs. You can say that you’re paying with the company’s after-tax profits. But a non-deductible cost in the company is still more beneficial for the owner than taking the cost privately, assuming it’s not a taxable benefit. To transform the company’s pre-tax profit to after-tax income for the owner, costs in taxes from 37,6% (with dividends) up to 70% (with salary at the top margin tax and social fees). While a non-deductible cost in the company “costs” only 22% in corporate tax. This principle can be a bit hard to grasp, I know.
Non-deductible costs in enskilda firmor
So how about sole traders (enskil firma)? This is actually quite different – since the company profit is taxed directly by the owner, a non-deductible cost in the company is exactly the same thing as paying with private money. Good to know if you e.g. treat clients with an expensive dinner.
So that’s a primer on the terms deductible, non-deductible, taxable and tax-free. If you have questions, please leave a comment.