Understanding What Qualifies as a Business Expense: Types and Categories

Do you know that human labour alone can account for up to 70% of a company’s total spending? This highlights the importance of understanding what qualifies as a business expense, especially since many of these expenses are tax-deductible. 

Properly managing and categorising business expenses impacts your budget and helps reduce your taxable income, which is crucial under corporate tax laws.

According to British Business Bank, British startups spend around AED 1,11,000 in their first year on setup and administrative costs, excluding payroll. In the U.S., 28% of small businesses report spending over AED 36,000 annually on taxes and legal fees. These statistics show how vital it is to track and categorise your business expenses accurately, as every cost—from office supplies to employee travel—impacts your bottom line.

Given how crucial it is to track and categorise business expenses accurately, it’s no surprise that the global business expense management market is expected to reach USD 12.05 billion by 2029, growing at a CAGR of 9.2%. Automating expense tracking and using accounting software can streamline processes, save time, and boost profitability by correctly categorising every cost.

This guide will explain the different types and categories of business expenses, explain tax-deductible and non-deductible expenses, and show you how to maximise tax deductions. You'll also learn to track expenses effectively, helping you manage finances better and boost profitability.

What are Business Expenses?

Business expenses are the costs incurred during a company's normal day-to-day operations. 

Any cost directly related to running your business – whether incurred by you, your employees, or the company itself – should be recorded as a business expense. These costs are fundamental to your business's operation and, ultimately, its financial reporting and tax payments. 

In the UAE, with the recent introduction of corporate tax laws in 2023, understanding and managing business expenses has become even more critical. Businesses must track and categorise their expenses accurately, as some may qualify for tax deductions.

For example, if you own a design agency, billing AED 120,000 yearly does not mean you’ve earned that much profit. You will have spent some of that income on various business expenses like employee salaries, office rent, digital subscriptions, and more. These are business expenses.

 Unlike systems such as the IRS in the United States, which divides expenses into categories like “ordinary” and “necessary,” the UAE's Federal Tax Authority (FTA) focuses solely on whether expenses are tax-deductible or not. We will explore this in detail later.

Here are some common examples of business expenses:

• Advertising and marketing: Costs related to business promotion, such as online ads, billboards, and marketing campaigns.
• Business travel: Fuel, airfare, taxis, accommodation, and other travel-related expenses incurred while conducting business.
• Employee costs: Payroll, salaries, insurance, and employee benefits.
• Employee equipment: Laptops, monitors, phones, and other tools needed for employees to do their work.
• Legal fees: Payments to lawyers or legal consultants for advice or representation.
• Office space rent and utilities: These are the costs of renting an office and paying for electricity, water, internet, and other utilities.
• Software subscriptions: Monthly or annual fees for essential software like Zoom, Figma, or Adobe.

While this is not an exhaustive list, it highlights the most common expenses that businesses typically encounter. By categorising these expenses correctly, companies can better manage their finances and take advantage of potential tax deductions.

Types of Business Expenses

Understanding the different types of business expenses is essential for developing a budgeting plan and maintaining control over your company’s financial health.

In the UAE, businesses often categorise business expenses into three key types: fixed, variable, and periodic. Each type affects the budgeting process differently, so finance teams must diligently track and forecast these costs.

1. Fixed expenses

Fixed expenses remain constant and occur regularly, such as monthly or annually. They are predictable and easier to budget for, as they rarely fluctuate. Fixed expenses are crucial for businesses because they form the foundation of their financial commitments.

Examples of fixed expenses include:

• Rent
• Employee payroll/salaries
• Utility bills
• Insurance

2. Variable expenses

Variable expenses fluctuate depending on the business's activity level, such as production or sales volume. These costs rise or fall based on how much the company produces or sells at any given time. Managing variable expenses can be challenging since they are often the largest portion of a company’s expenditure and can be less predictable.

To calculate variable costs, businesses use the formula:
Total variable cost = Total quantity of output x Variable cost per unit of output

Examples of variable expenses include:

• Shipping expenses
• Sales commissions
• Raw materials

3. Periodic expenses

Periodic expenses are infrequent or semi-regular and do not occur on a consistent monthly basis. They could be quarterly or annual costs or unexpected expenses. Budgeting for periodic expenses can be difficult, as they may come as a surprise and impact cash flow if not adequately planned for.

Examples of periodic expenses include:

• Maintenance and repairs
• Merger and acquisition costs
• Major equipment purchases

By categorising expenses into fixed, variable, and periodic, businesses can create more accurate budgets and better manage their finances throughout the year.

Tax Deductible Expenses

Tax-deductible expenses play a crucial role in reducing your company's taxable income, allowing businesses in the UAE to lower their overall tax bill under the newly implemented corporate tax laws. 

Tax-deductible expenses are typically those incurred for business purposes and not of a capital nature. These are costs directly related to generating taxable income. Only expenses that meet this criteria can be deducted, ensuring businesses don’t misuse deductions by claiming non-business-related expenses.

How Do Tax Deductions Work?

UAE corporate tax law focuses on deducting business expenses necessary to produce income. By subtracting these expenses from the company’s gross income, the taxable income is reduced, lowering the final tax payable. Keeping clear records and receipts is essential to ensure compliance with tax regulations.

Common Examples of Tax-Deductible Expenses:

1. Business use of a car: Mileage or actual expenses related to business travel.
2. Home office expenses: If part of your home is used exclusively for business.
3. Salaries and wages: Payments to employees (excluding owner withdrawals).
4. Interest: Costs related to business loans or finance charges.
5. Rent: Costs associated with leasing business premises or equipment.
6. Advertising and marketing: Any cost spent to promote the business.
7. Utilities: Payments for services like electricity, water, and internet used in business operations.

Tax Deductions for Businesses in the UAE

Here are some specific tax deductions under the UAE corporate tax law.

• Interest Expenses: Interest on loans, Islamic financial instruments, or lease payments. Interest from transactions before December 9, 2022, is not deductible, and financial institutions are exempt from certain capping rules.
• Charitable Contributions: Donations to qualifying public benefit entities are deductible, provided they serve the public interest and align with business goals.
• Entertainment Expenses: Under UAE corporate tax laws, up to 50% of entertainment costs, such as client hospitality, can be deducted.
• Fines and Penalties: Fines that compensate for contract breaches and other illicit payments are not deductible.

Use the UAE Corporate Tax Calculator to find out how much corporate tax your company would be liable to pay in the upcoming financial year once the new tax regime comes into place in the UAE.

Non-Deductible Tax Expenses

While many business expenses can reduce your taxable income, some costs cannot be deducted when calculating your corporate taxes. In the UAE, these non-deductible tax expenses still play a role in your business operations but don't provide a direct financial benefit regarding tax savings. Understanding these disallowed deductions can help you manage your finances better.

Disallowed Corporate Tax Deductions in the UAE

For business expenses that serve multiple purposes, only the portion directly related to generating taxable income is deductible. If it's impossible to clearly separate the part that produces taxable income, a reasonable proportion can be claimed based on a justifiable calculation. 

Here are some common examples of disallowed deductions.

1. Owner's Salary: Payments made to business owners or partners, considered profit distributions, are not deductible.
2. Fines and Penalties: Amounts paid for legal violations or breaches, such as traffic fines or administrative penalties, cannot be deducted.
3. Lobbying Expenses: Costs associated with influencing legislation or political contributions are non-deductible.
4. Capital Expenses: These include costs related to starting or improving the business, such as major equipment purchases, renovations, or business acquisitions.
5. Related Party Payments to Free Zone Persons: Payments made from a mainland business to a Free Zone Person taxed at 0% are non-deductible unless attributed to a mainland branch of the Free Zone Person.

Also, Read Understanding UAE Free Zone Tax: What It Means for Your Business

6. Entertainment Expenses: Only 50% of expenses incurred for entertaining clients, shareholders, or business partners can be deducted, as these costs often have a personal component.
7. Donations to Non-Approved Entities: Contributions to organisations not recognised as public benefit entities or approved charities cannot be deducted.
8. Recoverable VAT: VAT that is recoverable through the tax system cannot be claimed as a deductible expense.

Tracking these categories allows you to manage your business expenses better and remain compliant with UAE tax regulations.

How to Maximise Your Tax Deductions?

Maximising your tax deductions requires a strategic approach to recording, timing, and evaluating your business expenses. 

Here’s how you can effectively maximise your tax deductions.

1. Keeping Accurate Records

Maintaining precise and comprehensive records is vital for claiming all eligible tax deductions. To ensure accuracy:

• Document Every Expense: Record each expense, including receipts, invoices, and payment confirmations.
• Track Mixed-Purpose Expenses: For expenses serving both personal and business purposes, clearly distinguish and justify the business portion.

Use Reliable Software: Invest in automation software to streamline record-keeping and reduce human error.

2. Itemised vs. Standard Deductions

The choice between itemised and standard deductions is not applicable in the UAE. Instead:

• Evaluate Each Expense Individually: Ensure that each expense is directly related to business operations and is not a capital expense.
• Assess Deductibility: Determine if an expense is allowable by the UAE Corporate Tax Law, focusing on its purpose and relevance to business income.

3. Timing Deductible Expenses 

The timing of your deductible expenses can influence your tax liability:

• Understand Thresholds: You can deduct the total amount if your net interest expense is below AED 12 million. If it exceeds this threshold, you can deduct either the threshold amount or 30% of your EBITDA, whichever is higher.
• Manage Negative EBITDA: If EBITDA is negative, the deductible limit is AED 0. Plan your expenses accordingly to avoid exceeding this limit.
• Carry Forward Disallowed Expenses: If any net interest expenses are disallowed, you can carry them forward for up to ten tax periods. This allows you to align your finance-related expenses with future tax liabilities.

4. Contributions to Retirement Accounts 

While UAE Corporate Tax Law doesn’t specifically address retirement account contributions, they still impact your taxable income:

• Offset Losses: Losses can be offset against future taxable income, subject to a 75% cap per tax period.
• Understand Continuity Requirements: Loss carryforwards are subject to conditions on ownership continuity and business operation after ownership changes.

5. General Tips for Maximising Deductions

• Stay Informed: Review updates to tax laws and regulations regularly. Although the IRS guidelines do not apply in the UAE, staying updated with local tax authority guidance is essential.
• Consult a Tax Advisor: Work with a tax professional to understand complex deductions and ensure compliance with UAE tax regulations.
• Regular Reviews: Review and adjust your expense categories and records to reflect any changes in tax laws or business operations.

By following these practices, you can optimise your business tax deductions, reduce your taxable income, and ultimately lower your tax bill. Keeping well-organised records and understanding the specific rules related to your expenses is key to maximising your tax benefits.Also, Read How to calculate Corporate Tax in the UAE.

How Do You Categorise Business Expenses?

Business expenses generally fall into three primary categories: payroll, employee benefits, and general and administrative (G&A) expenses. These can be further subdivided into marketing and advertising, research and development, and professional services.

To keep expense tracking straightforward, categorise expenses in a way that mirrors your business structure and management needs. For instance, you might create categories based on the expense type and the department responsible for it. 

Here's how you can approach this:

• By Type: Create broad categories like “General and Admin” or “Research and Development.”
• By Department: Further classify these by department, such as “Marketing” for marketing expenses and “Engineering” for R&D costs.

While you don’t need a separate category for each detail, recording this information in your expense management software simplifies reporting and helps maximise your potential tax savings.

Example of Detailed Categorisation

Let’s take the example of a business lunch. For internal records, it might be enough to note that the lunch took place. However, for tax purposes, you’ll need more details—such as whether the lunch was with a client or a colleague and the purpose of the meeting. You can easily capture these details by using custom fields in your expense system. This makes reporting simpler and ensures you can claim the correct tax deductions.

10 Key Business Expense Categories for Efficient Management

Now that you understand what qualifies as a business expense, familiarise yourself with the ten most common business expense categories. These categories can be tailored to fit your company's unique structure and operations, helping you streamline expense tracking and budgeting.

1. Travel and Business Trips

• Expenses related to airfare, accommodation, transportation (rental cars, trains, taxis), meals, and travel insurance incurred during business trips.
• Example: Flights for client meetings, lodging during conferences.
• Why it matters: Travel is a significant business cost, especially for client-facing or service-driven companies.

2. Employee Meals and Entertainment

• Meals during business meetings or entertainment for clients or employees, such as taking a client to dinner or hosting team events.
• Example: Team-building dinners, client lunch meetings.
• Why it matters: Proper categorisation can ensure tax deductibility and accurate financial records.

3. Office Supplies and Equipment

• Includes everyday supplies like paper, stationery, and office furniture, as well as IT equipment such as laptops and printers.
• Example: Purchasing laptops for new employees or upgrading office furniture.
• Why it matters: These expenses can quickly add up, and businesses must track them to ensure efficiency.

4. Employee Salaries, Benefits, and Payroll Taxes

• All payments made to employees, including salaries, wages, bonuses, and additional benefits such as health insurance, as well as taxes.
• Example: Payroll expenses for full-time and part-time employees,as well as healthcare insurance.
• Why it matters: This category is one of the largest expenses for most companies and needs to be managed carefully.

5. Marketing and Advertising

• Expenses for campaigns that promote business services, including digital marketing, print ads, and social media ads.
• Examples: Google Ads, LinkedIn marketing, print brochures.
• Why it matters: Tracking marketing costs helps businesses measure ROI and control budgets effectively.

6. Professional Fees and Services

• Costs associated with hiring external consultants, legal services, accountants, or financial advisors.
• Example: Fees paid to legal counsel for contract reviews or accountants for audit services.
• Why it matters: Outsourcing expertise is common, and these costs must be tracked for budgeting and compliance.

7. Utilities and Rent

• Monthly payments for office rent, electricity, water, heating, and internet.
• Example: Office space rental fees or electricity bills for business premises.
• Why it matters: These are fixed expenses, and managing them efficiently impacts the overall profitability.

8. Insurance

• Business insurance costs, including property, liability, health, and workers’ compensation.
• Example: Property insurance for office premises, health insurance for employees.
• Why it matters: Insurance is essential for mitigating risk, and costs can be deductible.

9. Business Fees and Licenses

• Fees for business registration, regulatory permits, and trade licenses.
• Example: Annual business license renewal, software licenses.
• Why it matters: Keeping track of regulatory compliance fees is crucial for operating without interruptions.

10. Software and Subscriptions

• Costs for business tools, software licenses, and SaaS subscriptions, such as expense management software, CRM tools, or accounting software.
• For example, subscribe to Alaan for spend management or Adobe software for design teams.
• Why it matters: Subscriptions often recur monthly or annually, making efficient tracking necessary to avoid overspending.

Why Effective Categorization Matters

Properly categorising business expenses is essential for maintaining financial transparency, ensuring regulation compliance, and maximising tax efficiency. 

Clear categorisation helps you see exactly where your money is spent, aiding in smarter financial planning. You can simplify the process by starting with broad categories and refining them based on your company’s specific needs and departments. 

Utilising accounting automation software to track expenses also ensures accurate reporting and organisation. Effective categorisation becomes even more critical for businesses managing complex operations across multiple departments or entities. 

For instance, one of our customers, Al Barari, a household name in UAE, a large company with multiple entities, faced challenges managing expenses across different divisions. With a complex array of purchases and payment systems, keeping track of spending became burdensome. 

By adopting Alaan, Al Barari streamlined its expense categorisation, ensuring consistency across entities while reducing manual effort.

Consulting a financial expert or accountant can also provide further guidance on setting up and refining your expense categories, ensuring your system works efficiently and aligns with industry best practices.

6 Steps To Track Business Expenses

Tracking business expenses is crucial to maintaining financial health and making informed decisions for your company.

 Did you know that according to a U.S. Bank study, poor expense management, including the inability to keep up with expenses, is one of the leading reasons why 82% of businesses fail due to cash flow problems? 

Effective expense tracking ensures your business remains organised, compliant, and prepared for financial planning. 

Here are six steps to help you efficiently track your business expenses.

Business and Banking Relationships 

Start by setting up dedicated business bank accounts and credit cards. Integrating these with your expense management software ensures that expenses are automatically tracked, reducing manual errors and saving time. 

A strong banking partnership can also make securing loans for growth or major purchases easier.

Excellent Tip: Do you know about corporate credit cards? You can use a corporate credit card to manage each payment with complete control and visibility, all in one place.

1. Tracking Receipts and Invoices 

Ensure that every receipt and invoice is tracked as they occur. This not only helps with budgeting and cash flow forecasting but also ensures compliance with financial reporting regulations. Detailed records simplify tax filing and auditing processes.

2. Choose the Right Accounting System 

Your accounting system should match the complexity of your business. Larger businesses will need systems that can manage accounts payable, automate finance tasks, and provide detailed reporting. Cloud-based systems are ideal for scalability and easier integration with other business functions.

3. Integrating Software 

Maximise the potential of your accounting software by linking it directly to your business bank accounts. This eliminates the need for manual data entry and provides real-time updates, enhancing both efficiency and accuracy.

4. Use Accrual Accounting 

Cash accounting may suffice if you’re a small business, but larger companies and those following standard accounting principles should use accrual accounting. This method records expenses as they occur, providing a more accurate picture of your financial position.

5. Regular Review 

Frequent review of business expenses allows for better control. Monitoring trends helps identify areas for cost reduction, such as renegotiating contracts or adjusting spending patterns, ensuring financial stability and preparedness for future budgets.

These steps provide the foundation for solid expense management, leading to improved financial control and long-term business health.

Conclusion

Effectively managing what qualifies as a business expense is critical in regulatory compliance and profitability. Tracking these expenses ensures your business complies with tax laws and takes full advantage of possible deductions. From office rent to employee costs, categorising these expenditures correctly can lead to significant savings and better financial forecasting. 

With the growing complexities of tax regulations, automating expense tracking saves time and money. In fact, according to the American Payroll Association, automation can reduce payroll costs by up to 80%. 

Alaan can help you streamline your business expense management process by offering seamless integration with your existing accounting software, such as Zoho, QuickBooks, and more. With everything in one place, you can easily manage all your business spending from a single platform.

Schedule a demo with Alaan today to discover how we can transform how you handle business expenses!