Why expenses matter more than contractors expect, and less than they sometimes claim

The tax benefit of a £1,000 expense through a personal service company is roughly £190 to £250 of saved corporation tax, depending on profit level. That is real money, but it is a fraction of what most contractors assume. The reason expenses generate disproportionate anxiety, and disproportionate errors, is that the rules shift sharply depending on two things: whether the contractor operates inside or outside IR35, and whether the client site qualifies as a temporary or permanent workplace. Get those two questions wrong and a whole category of costs becomes non-deductible, often with HMRC interest and penalties to match.

This guide covers the rules that apply to a limited-company contractor (a personal service company, or PSC) operating in 2026/27. It is structured around the areas where mistakes most commonly occur, starting with the 24-month travel rule that catches contractors every year, then working through the inside-IR35 restriction, the updated mileage rates, trivial benefits, and the far more powerful lever that most contractors underuse: the employer pension contribution.

The fundamental test: wholly and exclusively for business

Every deductible PSC expense must clear the same first hurdle. For a limited company, costs are deductible against corporation tax where they are incurred wholly and exclusively for the purposes of the trade. Where a cost has a dual purpose, only the business element qualifies. This is not a technicality; it is the rule that distinguishes a deductible broadband bill (used only for work) from a non-deductible one (shared household use that requires apportionment).

In practice, most professional contractors have a straightforward expense list. The common categories that clearly pass the test are accountancy fees, professional indemnity and public liability insurance, equipment and software bought for business use, legitimate business travel, use-of-home allowances for a genuine home-working arrangement, and employer pension contributions. The complexity lies not in whether these categories are allowable in principle, but in applying the rules to each contractor's specific circumstances, particularly around travel.

The 24-month rule: the most-misclaimed relief in contracting

Business travel to a client site is deductible only if that site is a temporary workplace. Under ITEPA 2003 ss.337 to 339, a workplace becomes permanent, and travel there becomes ordinary commuting, once a contractor spends or expects to spend more than 40% of their working time there over a period exceeding 24 months.

The rule has two distinct limbs, and missing either one is expensive.

The expectation trigger

The most commonly misunderstood aspect is that the 24-month test is expectation-based, not calendar-based. The relief does not run to month 24 and then stop. It stops at the point when it first becomes reasonably expected that the engagement will last more than 24 months at the same site. If a contractor is 14 months into a rolling engagement and the client confirms it will continue for a further 18 months, the expectation of a total stay exceeding 24 months crystallises at that confirmation date. Travel relief ends from that date, not 10 months later when month 24 arrives.

This matters because contractors who continue to claim travel expenses from the point they become aware the engagement will run long are over-claiming, often without realising it. The HMRC manual at EIM32000 onward is explicit on this: it is the formation of the expectation, not the passage of time, that governs.

The 40% rule

The second limb applies even where an engagement is not expected to exceed 24 months in total, if the contractor spends more than 40% of their working time at the same site. A contractor splitting time across three client sites but spending three days a week at one of them is likely over the 40% threshold at that site. Combined with any expectation that this pattern will persist for more than 24 months, travel to that site stops being deductible.

For contractors on rolling or open-ended engagements, particularly those who have been on-site consistently for more than a year, it is worth reviewing whether either limb of the rule has been triggered. Where it has, the PSC should stop claiming travel for that site and consider whether past claims need correction.

Worked example

A contractor starts an engagement at a single client site in September 2025. The initial contract runs for 12 months with options to extend. In April 2026, the client confirms the contract will run to December 2027 (a total of 27 months from the start). At that confirmation point in April 2026, the contractor's expectation changes: the total period will exceed 24 months. Travel to the site ceases to be deductible from April 2026 onward. The contractor can retain travel claims for the September 2025 to April 2026 period, when the site was still genuinely temporary.

Travel and subsistence inside IR35: the harder restriction

The 24-month rule applies to outside-IR35 contractors. For those inside IR35, the restriction is more fundamental and is not cured simply by keeping the engagement short.

Where an engagement is caught by IR35, either because the PSC self-assesses as inside under Chapter 8 or because a medium or large client has determined the engagement inside under Chapter 10, the client site is treated as a permanent workplace for that engagement from the outset. The post-April-2016 rules in ITEPA 2003 ss.338A and 339A restrict travel and subsistence relief for workers engaged through an intermediary under supervision, direction or control. In practice, inside-IR35 contractors cannot claim home-to-client travel and subsistence through the PSC as a deductible expense.

This is one of the most significant financial consequences of an inside-IR35 determination. A contractor commuting 40 miles each way to a client site and claiming those costs as a business expense while inside IR35 is making an incorrect claim. For a fuller picture of the consequences of an inside-IR35 determination, including the deemed-payment calculation and the options available, the inside IR35: what it means for your pay and tax guide covers the mechanics in full.

Outside-IR35 contractors retain the temporary-workplace relief, subject to the 24-month and 40% rules set out above. Status therefore determines the entire travel-expense position, which is why understanding your IR35 position before claiming travel is essential rather than optional.

Mileage: the 2026/27 rates and how to use them

From 6 April 2026, the Approved Mileage Allowance Payment (AMAP) rate for cars and vans rises to 55p per mile for the first 10,000 business miles in the tax year, and 25p per mile thereafter. The first-10,000 rate was 45p for 2025/26 and earlier. The 25p rate for miles above 10,000 is unchanged.

The AMAP rate is the maximum a company can pay to a director or employee for use of their personal vehicle without triggering a taxable benefit. If the PSC pays a mileage rate above 55p per mile, the excess is a taxable benefit in kind. If the company pays below 55p, the contractor can claim Mileage Allowance Relief from HMRC for the shortfall, though this relief is worth less than a company payment (it provides income tax relief rather than a corporation-tax deduction on the whole amount).

The practical implication for 2026/27 planning: a contractor driving 8,000 business miles in the year can now receive £4,400 from the company tax-free (8,000 x 55p), compared with £3,600 in 2025/26. For a higher-mileage contractor, the 10p per mile increase on the first 10,000 miles is worth £1,000 before any other tax savings are factored in.

Two conditions must be met for the AMAP rate to apply. The journey must be a genuine business journey: travel to a temporary workplace, between client sites, or to a business meeting. And ordinary commuting, travel from home to a permanent workplace, does not qualify regardless of the distance involved.

Keep a contemporaneous mileage log. HMRC expects to see dates, start and end points, the business purpose of each journey, and miles driven. A log reconstructed from memory at year-end is far weaker as evidence than one built in real time.

Other deductible travel categories

Beyond car mileage, contractors can claim the actual cost of business travel by public transport, taxis, and overnight accommodation and reasonable subsistence costs where the journey to a temporary workplace makes an overnight stay necessary. The key distinction throughout is temporary workplace (deductible) versus permanent workplace (not deductible).

If a client or agency reimburses travel costs, the reimbursement and the deduction cancel out from the company's perspective. The risk arises where contractors claim the cost in the company's accounts without accounting for reimbursements received, or where they claim costs for journeys that were not genuine business travel. Both patterns create reconciliation errors that can surface during an HMRC enquiry.

Professional and business costs

The following categories are deductible for most contractors with no real ambiguity, provided the cost is genuinely for business use.

Accountancy fees covering the annual accounts, corporation tax return, personal self-assessment return preparation, and ongoing business advice are wholly and exclusively for business purposes. Professional indemnity insurance and public liability insurance premiums are similarly straightforward. Legal fees related to trading matters (such as contract disputes or employment law advice) are deductible; legal fees relating to capital transactions, such as acquiring a business asset, are not immediately deductible but may form part of the asset's base cost.

Equipment and software

Computers, monitors, specialist software licences, and tools bought wholly for business use qualify for capital allowances. The Annual Investment Allowance provides 100% relief in the year of purchase for most plant and machinery up to the AIA limit, meaning a business laptop bought in 2026/27 is typically fully deductible in that accounting period rather than spread over several years. Finance Act 2026 also introduced a 40% first-year allowance under new CAA 2001 s.45U (effective for expenditure on or after 1 January 2026) for certain qualifying assets, though for most software and standard IT equipment the AIA route remains the simpler path to full immediate relief.

Where equipment has mixed personal and business use, only the business proportion is deductible, and that apportionment must be defensible if HMRC asks. A contractor who uses a laptop for work 80% of the time and personal browsing 20% should claim 80% of the cost, not 100%.

Phone and internet

A dedicated business mobile phone contract paid by the company is fully deductible. Personal phone bills with a business element require apportionment. Home broadband used partly for business is a dual-use cost; a reasonable business fraction (commonly 50% to 80% depending on usage) is acceptable where the contractor works from home regularly. The same logic applies to home utility costs where a use-of-home arrangement is in place.

Subscriptions and professional development

Annual subscriptions to professional bodies, relevant journals, and industry memberships that are wholly for business purposes are deductible. Training costs that maintain or update existing skills for the current trade are generally allowable; training that extends into an entirely new field of work is harder to justify as wholly and exclusively for the existing business.

Use of home as office

A PSC director who works from home can extract a use-of-home payment from the company in two ways. The simpler route is for the company to pay a fixed weekly amount that HMRC accepts as covering reasonable additional household costs (heating, lighting, broadband used for work). The more formal route is for the director to grant the company a licence to use a room as office space at a genuine market rate, with that rental income assessed on the director and the company claiming the rental as a deductible business expense.

The flat-rate approach avoids the complexity of a rental valuation and the administrative burden of a licence agreement, making it the preferred approach for most single-director PSCs unless the potential saving is large enough to justify the additional structure.

Trivial benefits: small perks, a real exemption

The trivial benefits exemption under ITEPA 2003 s.323A allows a close company to give the director small perks free of income tax and National Insurance. To qualify, a benefit must meet all of the following conditions: it costs £50 or less per benefit; it is not cash or a cash voucher; it is not a reward for employment services or contractually required; and it is not provided through a salary-sacrifice arrangement.

For a director of a close company (which almost all single-director PSCs are), ITEPA s.323B imposes an additional annual cap of £300 across all trivial benefits received in the tax year. This cap does not apply to employees who are not directors or to close relatives of directors (they are subject only to the £50 per-benefit limit).

The £300 annual cap means that over the course of a year a contractor director might receive, for example, six items each costing exactly £50, exhausting the cap. Common examples that fit within the exemption include a birthday or seasonal gift, a meal out to mark a work milestone, or a bottle of wine. The moment a single benefit exceeds £50 in cost, the entire benefit (not just the excess) becomes taxable. Keeping each occasion strictly at or below £50 is therefore essential.

Trivial benefits are a modest planning tool, not a significant tax lever. The £300 annual maximum is worth at most a few hundred pounds in tax savings at the top marginal rate. They are worth using correctly, but they should not distract from the tools that actually move the dial.

The real lever: why pensions outperform most expenses

Contractors sometimes focus intensely on expense deductions while underusing the one extraction route that genuinely changes the numbers: the employer pension contribution from the PSC.

An employer pension contribution is deductible against corporation tax on a paid basis, subject to the wholly-and-exclusively test. It carries no employer National Insurance (which at 15% on salaries above the secondary threshold would otherwise apply) and no employee National Insurance. And crucially, it is not taxed on the director as income when paid into the pension, provided it falls within the annual allowance. A contribution of £30,000 from the PSC in 2026/27 saves corporation tax at the company's marginal rate, triggers no NIC on either side, and adds £30,000 to the director's pension without it being assessed as income in that year. No expense deduction delivers the same package of reliefs.

The annual allowance for 2026/27 is £60,000, covering all contributions (employer plus personal) across all pension arrangements. It tapers where threshold income exceeds £200,000 and adjusted income exceeds £260,000, reducing by £1 for every £2 of adjusted income above £260,000 down to a minimum of £10,000. For a contractor well below those income levels, the full £60,000 allowance is available, and unused allowance from the previous three tax years can be carried forward to support a larger one-off contribution in a high-profit year.

For a PSC director with a low salary and dividend income, an employer contribution is also not constrained by the 100% of relevant UK earnings limit that caps personal contributions. Personal contributions are limited to the lower of the annual allowance and 100% of relevant UK earnings (predominantly salary). A director taking a salary of £6,708 and dividends of £50,000 has only £6,708 of relevant earnings for personal contribution purposes. The company-side employer contribution faces no such earnings cap, which is why the employer route is structurally the right choice for most PSC contractors.

The contractor employer pension contribution guide covers the mechanics, carry-forward strategy, and the money-purchase annual allowance trap for contractors who have already flexibly accessed their pension savings.

VAT and expenses: the interaction

How a contractor accounts for VAT directly affects the net cost of every business expense, and the effect is often overlooked.

A contractor registered for VAT on standard VAT accounting can reclaim input VAT on business purchases. A laptop bought for £1,200 including VAT costs the business £1,000 net after reclaiming the £200 VAT, and corporation tax relief then applies to that £1,000. The gross cost is lower, and the relief calculation uses a lower base.

A contractor on the Flat Rate Scheme does not generally reclaim input VAT on individual purchases (the flat rate accounts for this in aggregate). For a labour-only contractor, most of the time, this matters less because the main expense categories (professional fees, some equipment) are where the difference bites. However, the limited-cost-trader test, which catches most labour-only contractors and forces them onto the 16.5% flat rate, typically wipes out the FRS benefit anyway. Standard VAT accounting is usually more appropriate for a contractor with meaningful input VAT to reclaim. The flat-rate VAT and limited-cost trader guide sets out the comparison in detail.

The VAT registration threshold is £90,000 of VAT-taxable turnover in any rolling 12 months, frozen at that level since 1 April 2024. Many contractors register voluntarily below the threshold where their clients are VAT-registered businesses that can recover the VAT they charge, and where the contractor has meaningful input VAT to reclaim on business costs.

What contractors cannot claim

A clear list of non-deductible items is at least as useful as a list of deductible ones.

  • Ordinary commuting. Travel from home to a permanent workplace is personal commuting, not a business expense, regardless of distance. This applies to inside-IR35 contractors from the first day of the engagement, and to outside-IR35 contractors once the 24-month or 40% expectation threshold is crossed.
  • Personal clothing. Clothing that is not a recognisable uniform or specialist protective equipment is personal expenditure. A suit or smart office attire is not deductible even if worn exclusively for work.
  • Entertaining clients. Business entertaining, meaning hospitality provided to clients or potential clients, is specifically disallowed for corporation-tax purposes (CTA 2009 s.1298). The cost hits the profit-and-loss account but does not reduce the CT bill.
  • Fines and penalties. Any fine or penalty imposed by a regulator, court or public authority is not deductible.
  • Dual-use personal items without apportionment. Claiming 100% of a cost that is genuinely mixed-use overstates the deductible amount. The personal element must be excluded.
  • Travel and subsistence for inside-IR35 engagements. As explained above, the T&S restriction under ss.338A/339A means these costs are not deductible where the engagement is caught by IR35.
  • Benefits above the trivial threshold. A gift or perk costing more than £50 per occasion becomes a taxable benefit. Exceeding the £300 annual cap for a close-company director similarly triggers a charge.

The Chapter 10 context: what inside IR35 removes from the picture

For a contractor working with a medium or large client, the client determines IR35 status under Chapter 10. If the determination is inside, the fee-payer (usually the agency) operates PAYE and deducts employer NIC before paying the PSC. There is no 5% expenses allowance under Chapter 10: that allowance is a Chapter 8 feature, available only where the PSC self-assesses under the original intermediaries legislation (typically because the client is small or overseas). On a Chapter 10 inside-IR35 engagement, the 5% is not available, and the PSC receives income that has already had tax deducted at source.

For a contractor who holds a mix of engagements, some inside and some outside IR35, each engagement is assessed separately. The travel and expenses rules apply engagement by engagement: a contractor who is outside IR35 on one contract and inside on another can claim temporary-workplace travel for the outside engagement but not for the inside one.

Understanding which chapter applies to each engagement, and therefore which expense rules apply, is part of basic financial hygiene for a multi-contract contractor. The IR35 explained: the complete guide sets out the Chapter 8 versus Chapter 10 distinction and how to identify which regime applies.

Record-keeping: the practical minimum

HMRC expects records sufficient to substantiate every expense deducted. The standard retention period is six years from the end of the accounting period to which the records relate, though records relating to an open enquiry must be kept until that enquiry is closed. The minimum records for a PSC contractor should include:

  • Receipts or invoices for every expense item, including electronic copies where paper is not practical.
  • A contemporaneous mileage log showing date, start and end point, business purpose, and miles driven for each journey.
  • Bank statements showing the company account, reconciled to the accounting records.
  • Any contracts or engagement letters that support the business purpose of costs (such as professional indemnity policy documents).
  • Records of the dates and amounts of any use-of-home payments or trivial benefits provided.

Digital records are fully acceptable and increasingly standard. Accounting software that captures receipts at the point of purchase and tags them to the correct expense category reduces the risk of missing items and makes preparing the annual accounts faster and less error-prone.

Planning the expense picture for 2026/27

Three changes make the 2026/27 tax year worth reviewing specifically rather than rolling forward the approach from previous years.

First, the AMAP rate increase from 45p to 55p from 6 April 2026 means any contractor who had set a company mileage policy at the old 45p rate should update it. Paying below the approved rate leaves tax-free money on the table and requires the contractor to claim Mileage Allowance Relief separately, which is administratively unnecessary.

Second, dividend rates rose on 6 April 2026 under Finance Act 2026 s.4: the ordinary rate is now 10.75% and the upper rate is 35.75% for 2026/27. This makes the relative advantage of extracting profit as pension rather than as dividend more compelling for a higher-rate taxpayer contractor, reinforcing the case for employer pension contributions as the primary extraction lever ahead of dividends where headroom exists.

Third, the income-tax threshold freeze continues to 2031. The personal allowance is fixed at £12,570 and the higher-rate threshold at £50,270 for 2026/27, and that will not change for five more years. Fiscal drag means that as contractor day rates and project fees grow with inflation, more income falls into higher tax bands without any policy change. Pensions, which remove income from the tax calculation entirely, become more valuable in a freeze environment rather than less.

None of these changes alter the fundamental expense rules. The wholly-and-exclusively test, the 24-month rule, and the IR35 T&S restriction work the same way in 2026/27 as before. What changes is the context in which expense planning sits, and the relative payoff of pension contributions versus dividend extraction, which tilts further toward pensions.

Getting the expense position right

Contractor expenses are not a significant profit centre in their own right. The tax saving on most deductible costs is the corporation-tax rate applied to the expense amount, 19% for a small-profits PSC, 25% at the main rate. The cost still leaves the business; the tax saving merely reduces the after-tax cost. A £500 accountancy invoice saves £95 to £125 of corporation tax, not £500.

Where contractors go wrong is not usually in over-claiming legitimate expenses but in claiming costs that fail the temporary-workplace or IR35 rules and therefore should never have been deducted at all. Correctly applying the 24-month rule and understanding the T&S restriction for inside-IR35 engagements removes most of the compliance risk. Getting those two points right, and then ensuring the company pays the updated 55p mileage rate and uses the trivial-benefits exemption sensibly, covers the ground that matters most in practice.

The pension contribution deserves attention in a different category: not because it is an expense in the ordinary sense, but because it is the mechanism that most significantly reduces a PSC contractor's overall tax burden in a legitimate and HMRC-approved way. No collection of day-to-day expenses approaches what a well-timed employer pension contribution can achieve.

If you would like to review your IR35 position, your expense approach, or the case for an employer pension contribution in your specific circumstances, our team works with contractors across sectors and engagement structures. Visit our services page or check your IR35 status to start the conversation.