Christmas is often seen as a great time to entertain clients and staff, to thank them and to encourage them to continue working with or for you. Clearly businesses were unable to entertain last year due to COVID-19, but as we all become more confident to be in social settings, we are seeing an increase in clients entertaining their clients and staff. So we thought now may be a good time to remind clients of the tax rules and implications around entertaining clients and staff.
What is an entertainment expense?
HMRC states that entertainment can involve eating, drinking and other hospitality such as accommodation or tickets to an event. Types of entertainment include:
- ‘business entertainment’ of clients – eg discussing a particular business project or forming or maintaining a business connection
- ‘non-business entertainment’ of clients – eg entertaining a business acquaintance for social reasons
What to report and what to pay depends on the type of entertainment, who arranges and who attends. Staff entertainment also has its own rules that need to be considered.
Client or business entertaining covers expense occurred when hosting existing clients, potential clients or anyone else who is not an employee. In most cases, the cost of entertaining is not tax-deductible, nor is VAT on expenditure recoverable.
However, when taking clients out, always pay through the business rather than through personal accounts. Whilst the expense is not an allowable deduction for Corporation Tax purposes, you will save the income tax you would otherwise pay on withdrawing funds to pay the costs personally.
On the whole, VAT cannot be reclaimed on client entertaining, unless you are entertaining overseas customers (not overseas suppliers). The rules are rather complex. However, the principle is that the VAT may be recoverable if the hospitality is provided because it would be polite to do so or because it is expected. However, there may be a private benefit to the employee enjoying the entertainment.
HMRC stipulates that a member of staff is someone on your payroll who is paid a salary. This means you cannot claim tax relief for previous employees, interviewees, subcontractors or shareholders who do not work in the business. In addition, sole traders or partners in an LLP or partnership do not count as an employee as there’s no legal difference between them and the business.
Staff entertaining is an allowable business expense and is therefore tax deductible. Allowable costs include food, drink, entertainment, venue hire, transport and overnight accommodation. VAT-registered businesses can also recover VAT incurred on allowable staff entertaining expenditure.
While there is no limit to the amount businesses can claim, there are a few restrictions. For example, if people within a business have close relationships such as relatives and dine together this becomes a grey area. There must be a clear business reason for the expense, and expenses must be kept ‘within reason’.
In principle, an employee is liable for Income Tax on the value of any benefit provided by their employment, including the cost of any staff entertaining. To avoid this the employer could opt to make a voluntary disclosure to HMRC or a more popular option is to keep within the boundaries of the Annual Party Exemption.
The Annual Party Exemption
Expenditure of up to £150 per head on an annual staff function, such as a Christmas party or a summer gathering, can be exempt from both Income Tax charges and employer’s National Insurance. It does not have to be a single function, several events can be covered by the exemption, so long as the total cost per head does not exceed £150 per tax year.
To benefit from this, the event(s) must be open to all employees. It should be noted that if the total cost exceeds £150 per head, none of the expenditure can be covered by the exemption. However, where there are several events in the year, the exemption can be used on any combination of these so long as the total aggregate cost adds up to no more than £150 per head.
If your business only has directors and no employees, the rules are different. HMRC stipulates that the cost of providing entertainment only to directors or partners does not qualify for tax relief or a VAT deduction. However, if the entertainment takes place when the directors are away from their usual place of work, such as on a business trip, then VAT paid on the costs of travel, meals and accommodation can be reclaimed. The rules for tax relief would mirror this.
If you have any queries on what is and what isn’t allowable, please speak to Jackie or Andrew.