HMRC’s rules state that expenditure on business entertainment or gifts cannot be claimed as a deduction against profits (and therefore also non-VAT deductible), even if a genuine expense of the trade or business. However, that is not entirely true – there are a few exceptions.
What is ‘entertaining’?
The rules are designed to prevent tax relief from being used as a means to subsidise personal or social costs. Still, interestingly, there is no legal definition of what constitutes ‘entertaining’. Therefore, the courts have taken a broad interpretation, considering ‘hospitality of any kind’ as entertaining when provided free of charge. HMRC’s Business Income Manual at 45034 states that when determining whether an expense comes under the heading of ‘entertaining’, the consideration needs to be as to whether the business would have paid for the event if no guests were present. If the business does not, then the event is classified as business entertainment.
One example HMRC quotes is where a director or employee takes a customer to lunch. In this situation, the entire cost of the lunch is business entertainment and not allowable, because the company would not have paid for the lunch if the guest had not been present. The employee’s lunch is incidental to that of the customer.
Despite the ruling above, in practice, HMRC accepts that the cost of light refreshments (tea, soft drinks, biscuits, etc.) at business meetings or events is tax deductible except where the underlying motive is hospitality.
Exceptions
HMRC’s view is that expenditure incurred on the provision of business entertainment to business contacts who are not customers cannot be claimed against income and is blocked from VAT recovery. Consequently, claims are only permissible for non-customers (i.e., employees).
Entertaining employees
When entertainment is provided exclusively for employees, tax relief and VAT can usually be reclaimed. However, for VAT purposes, this does not apply should the entertainment be solely for the benefit of the company’s directors and/or partners or for non-employees, such as employees’ relatives.
However, there are some grey areas for input VAT recovery purposes despite the strict rules. For example, when directors and partners attend staff parties along with other employees, tax relief and VAT can be claimed so long as all employees have been invited to the event. Events attended by both employees and non-employees permit a partial claim for the entertainment of employees only.
Note that the £150 benefit-in-kind specific allowance for annual functions (usually the Christmas party, though it need not be) can be claimed even if the only employees are directors.
Contractual obligation
Despite the disallowance rules, tax relief and VAT reclaim are possible if the business entertainment is supplied under a contractual obligation (i.e., an obligation that requires the other party to provide something of value in return). The cost will be allowed so long as the obligation is genuine and the business can demonstrate a full and direct return for the entertainment. The most common scenario under this heading will be where hospitality is provided as part of a package of services for which some payment is received.
Keeping to the rules
Businesses need to track and document their business entertainment expenses to ensure compliance. On enquiry, HMRC would expect records to itemise invoices and receipts so that VAT is only claimed on the portion directly related to the business purpose. Records should be accurate enough to show the names of individuals entertained, the business purpose of the expense, with any supporting documentation – these records should be kept for at least six years.
Practical point
BIM45014 states that for entertainment to be allowable, something of equivalent value must be given in return….‘a purely nominal service (such as the completion of a questionnaire) is unlikely to provide sufficient value to cover the cost of the hospitality.’
