The Inland Revenue asks for extra vigilance on the arm's length nature of expenses.
Annual survey
Every year, the Inland Revenue takes a sample from all businesses. The businesses that fall into this sample (which is generally about 3,000, and this sample includes businesses affiliated with horizontal supervision) are subjected to an extensive book audit. The results from these book examinations are used by the Tax Administration, in addition to information from other sources, to determine on which points its (vertical) supervision should focus. One such focus this year is the arm's length nature of expenses.
The Tax Authority says that the annual sample surveys showed that many corrections in income and corporate tax returns have to do with private expenses being wrongly claimed as business expenses. As examples, the Tax Office gives: painting work on a private house, subscriptions to play sports and streaming services. Both for self-employed entrepreneurs and for one-person BVs, the Tax Authorities noticeably often see high tax corrections, which are related to reported non-business expenses.
3 questions
To determine whether expenses qualify as (business) costs of the company, 3 questions need to be answered. And here, of great importance is who bears the burden of proof.
- Was the expenditure incurred (in part) in pursuit of the company's business interests?
- Does the expenditure serve (in part) to satisfy the personal needs of the entrepreneur or DGA?
- Would a reasonable-thinking entrepreneur have incurred the expenditure to the same extent?
The burden of proof for question 1 rests on the entrepreneur. The Inland Revenue may not review the entrepreneur's policy more than marginally. This means that, in principle, the Tax Administration may not interfere with the entrepreneur's policy. For example, the Inland Revenue may not use the argument that it believes that the expense is not necessary for the operation of the business.
The burden of proof for questions 2 and 3 rests on the tax authorities. To the extent that the expenses were incurred for the personal needs of the entrepreneur or DGA or they exceed what a reasonably thinking entrepreneur would spend, they are not deductible expenses but a withdrawal from the company's assets.
When expenses qualify as business expenses, the company may still run into legal restrictions on deduction of expenses.
In the case of the DGA, there is an additional aspect. In many cases, the DMS wears two hats: that of shareholder and that of employee of the BV. Expenses incurred for the DGA, in his capacity as employee, in principle qualify as salary. Wages always qualify as deductible expenses, but are taxed with wage tax, unless an exemption or lower (nil) valuation can be applied.