Accounting vs Tax Profits: What’s the Difference?

Two profits, two jobs

Your accounting profit is the figure in your accounts. It shows how the business traded over the year: every sale, every cost, everything you spent keeping the lights on. Its job is to tell you, your bank, and Companies House how the business is doing.

Your taxable profit is the figure used to work out how much tax you owe. HMRC doesn’t simply tax the profit in your accounts. It takes that number and makes two sets of adjustments to it. Get those adjustments right, and the tax is right. Get them wrong, and you’re either overpaying or storing up a problem.

The two adjustments are disallowable expenses, which are added back, and capital allowances, which are deducted.

Disallowable expenses: the costs HMRC won’t count

Some things are genuine costs of running your business, but HMRC won’t let you use them to reduce your tax. The rule is that an expense is only allowable for tax if it’s “wholly and exclusively” for the purposes of the trade. Plenty of real business spending doesn’t clear that bar.

The usual suspects are client entertaining and most business gifts, depreciation, and things like fines and penalties. They’re still perfectly good costs to run through the business, but when the tax is calculated they get “added back”, which pushes your taxable profit up.

In practical terms, this means the lunch you bought a client is a legitimate business cost in your accounts, but it won’t shave a penny off your tax bill.

Capital allowances: the ones that work in your favour

The second adjustment goes the other way, and this is the one people find genuinely confusing, so here’s the example we often use.

Say you buy a computer for £900. In your accounts, you don’t take the whole £900 as a cost in year one. You spread it over its useful life as depreciation, perhaps £300 a year for three years. That’s good accounting, but HMRC doesn’t allow depreciation as a tax deduction at all.

So we add the depreciation back, and instead we claim a capital allowance. For most small businesses, the Annual Investment Allowance lets you claim the full cost of qualifying equipment in the year you buy it, up to £1 million a year. So that £900 computer, spread over three years in your accounts, can often be fully allowed against tax in year one.

The rates, pools, and allowances behind all this change regularly, so the specifics for your business are worth a conversation rather than a guess. The gov.uk capital allowances guidance is the current source of truth on the numbers.

So why put disallowable costs through the business at all?

Good question, and one we get straight after the first one.

Because your accounts aren’t only a tax calculation. They’re the record of how your business actually performed: what it earned, what it cost to run, where the money went. Leaving out real costs would give you a tidier tax figure and a useless set of accounts. And if you’re a director and shareholder of a limited company, putting genuine costs through properly can also work in your favour on your director’s loan account.

In other words, accounting profit tells you the truth about your business. Taxable profit tells HMRC what it’s owed. You need both, and they’re rarely the same number.