Entertainment is a normal part of business life, from events for clients to Christmas parties for employees. How straightforward are the tax implications?
In this article we’ll examine the rules and the exceptions for direct tax and indirect tax, including VAT.
As a general rule for direct tax purposes, expenditure on entertainment or gifts incurred in the course of a trade or business is not allowed as a deduction against profits, whether incurred directly or paid to a third party such as an events organiser.
This applies to ‘hospitality of any kind’ provided to a customer, potential customer or any other person and includes expenditure that is merely incidental to the provision of entertainment, for example payment of customers’ travelling costs to a sporting event where they are to be entertained.
There are however a number of exceptions to this rule where the deduction of entertainment expenditure is in fact allowed, as follows:
Entertainment in the normal course of trade, for payment – businesses in the hospitality sector, such as restaurants or pubs, are not precluded from tax relief on the costs they incur in making their sales.
In addition, the costs of entertaining provided as part of a ‘package’ of services, where there is no element of free hospitality, such as meals included with a residential training course are not disallowed.
Entertainment in the normal course of trade, for advertising to the public – the entertaining expenditure must be of a kind that the business provides, e.g. free samples, and be incurred in order to advertise to the public generally.
Promotional events – events publicising a business’ products or services are not entertaining expenditure, but the cost of any related food, drink or other hospitality provided as part of the event is disallowed. Only the direct costs of publicising the products is allowed, e.g. the costs of a golf day organised by a car manufacturer at which test drives are available are only allowed to the extent that they directly relate to the test drives or to publicity material provided to the attendees. Immaterial costs, such as teas and coffees, are allowed however.
Staff entertainment – such entertainment is allowable provided that it is not merely incidental to customer entertaining.
The cost of training lunches, or food and accommodation at training courses, provided for employees is also allowed.
It should be noted however that, regardless of any deduction allowed against the profits of the business, a tax charge may arise on the employee personally, with the employer reporting details on form P11D, where:
- Free or subsidised meals are provided otherwise than in a canteen on the employer’s premises, unless part of qualifying business travel or incidental to business entertaining
- Or in respect of annual parties or other social functions, available to employees generally where, the cost per head exceeds £150 in aggregate
Employers are able to pay any Income Tax and National Insurance Contributions related to the above items on behalf of their employees by entering into a PAYE Settlement Agreement (PSA) with HMRC.
Gifts – costs will be allowed where gifts:
- Are given away in the course of business to advertise to the public and are of items that it is the trader’s trade to provide
- Incorporate a conspicuous advertisement for the trader, do not exceed £50 in value (for all gifts made to the same recipient in a year) and are not, food, drink, tobacco or tokens or vouchers exchangeable for goods
- Are made to employees, provided not incidental to gifts to others
- Are given to charities, etc.
Other direct tax points
- Mixed services that include entertaining, where no specific amount is invoiced for it, should be apportioned on a just and reasonable basis
- Sales incentive schemes where awards such as luxury items or holidays are made as a way of rewarding genuine performance are not business gifts. Such awards are likely to be taxable on the employee, but the employer can pay this on their behalf via a PSA.
- Sponsorship costs in respect of sporting, cultural or other events are generally allowable apart from the value of any tickets or other benefits received in exchange for the sponsorship
Usually, provided any goods or services you buy are directly linked to your business sales, you can reclaim any VAT on those costs. However, the VAT rules for entertaining expenses stipulate that any VAT recovery is blocked i.e. VAT recovery is not available.
There are two exceptions to this rule: staff entertainment and entertaining overseas customers.
You can recover VAT incurred on staff entertaining expenses. However, if the function is mainly for directors (and so excluding other staff where applicable) HMRC will strongly resist any claim for input VAT.
Where you’re entertaining clients as well as your staff, you will need to disallow a proportion of the VAT suffered (based on the ratio of clients to staff). Additionally, where your staff are present simply to look after your clients then HMRC is likely to resist a claim in these circumstances.
Where the event is mainly for marketing and the overall cost includes room hire and food etc, then the cost will need to be apportioned to disallow any part related to entertaining i.e. food and drink.
Entertaining overseas customers
An overseas customer is defined as any customer not ordinarily resident or carrying on a business in the UK.
You can reclaim VAT on the cost of entertaining an overseas customer of the business providing, in HMRC’s words, it is “of a kind and on a scale, which is reasonable”.
HMRC’s view is that entertainment which is not of a reasonable nature has a secondary function of providing a personal perk to the recipient. As providing a perk is a VATable supply, a business must charge output VAT on this value. This effectively cancels a proportion, or all, of the VAT that has been reclaimed.
HMRC will not permit a claim if the entertaining is part of a corporate event, such as a golf day, day at the races or trip to some other type of event.
Entertaining overseas customers: additional points
You should be able to reclaim the VAT on the costs incurred for yourself (or your employees) if your attendance is essential to entertain overseas customers – for example, if you are hosting a business meeting which happens to be held at a restaurant.
Where entertaining foreign customers doesn’t meet HMRC’s definition of ‘reasonable’, rather than reclaim the VAT and have to account for it as a personal perk, you can simply not recover it.
For more information, please get in touch with your usual BKL contact or use our enquiry form.