Business entertainment: Will HMRC have the last laugh?

HMRC has stated that expenditure on business entertainment cannot be claimed as a deduction against profits (and is therefore also non-VAT-recoverable), even if a genuine business expense. However, that is not entirely correct – there are exceptions.

What is ‘entertaining’?

The rules are designed to prevent tax relief from being used to subsidise personal or social costs, but interestingly, there is no legal definition of ‘entertaining’. Therefore, HMRC has taken a broad interpretation, treating any hospitality provided free of charge as entertaining. In practice, HMRC accepts the cost of light refreshments (e.g., tea, soft drinks, biscuits, etc.) provided and does not normally challenge such claims, provided the provision does not amount to hospitality in its own right. The position becomes more complicated where meetings are accompanied by more substantial catering.

HMRC’s guidance in its Business Income Manual at BIM45034 provides a useful test of whether the expenditure would have been incurred had the guest not been present. If not, the cost is likely to constitute business entertainment. HMRC cites a common example in which a director or employee takes a customer to lunch. Here, the full cost is generally disallowed, as the expenditure would not have arisen but for the customer’s presence. The employee’s meal is treated as incidental to the entertainment provided to the customer and is similarly disallowed. HMRC’s view is that entertainment provided to customers and other external business contacts is blocked for both tax and VAT purposes. Relief is possible only where entertainment is provided exclusively to non-customers (i.e., employees).

Entertaining employees

Where entertainment is provided exclusively for employees, tax relief can usually be claimed. Difficulties arise where attendees include nonemployees, such as spouses, family members or other guests. In such cases, only the proportion relating to employees is recoverable. HMRC also accepts VAT recovery where directors attend staff functions alongside employees, provided the event is genuinely for staff generally. Input VAT recovery will normally be denied should the event be exclusively for directors and partners. The benefit-in-kind exemption for annual functions remains available where the statutory conditions are met. The £150 limit is an exemption rather than an allowance and can apply even where the only employees are directors. Note that this exemption is commonly termed the ‘Christmas party’ exemption; however, it applies to any annual event.

Contractual obligation

Despite the disallowance rules, tax relief and VAT reclaim are possible should the business entertainment be supplied under a contractual obligation (i.e., an obligation that requires the other
party to provide something of value in return). A deduction will be allowed so long as the obligation is genuine and the business can demonstrate a full and real value of return for the entertainment. The key issue is whether there is a genuine quid pro quo. Typical examples include hospitality supplied as part of a package of services for which consideration is received, or where attendance at an event forms part of a contractual sponsorship arrangement. A comment by HMRC at BIM45014 should be noted. The section 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.’

Stick to the rules

It is important for businesses to track and document their business entertainment expenses to ensure compliance. Records should clearly identify:

• the individuals entertained;
• their relationship to the business;
• the business purpose; and
• the allocation between employees and nonemployees where relevant.

As with other business records, documentation should generally be retained for at least six years.

Practical tip

It should not be assumed that where hospitality is provided in a commercial context, the business entertainment rules apply automatically. Further investigation may be needed to determine
whether the expenditure constitutes gratuitous hospitality or forms part of a transaction in which identifiable value is received.

Disclaimer: The information provided on AccountingFirms.co.uk is for general informational purposes only and should not be considered professional accounting, tax, or legal advice. Always consult a qualified accountant or tax adviser for advice tailored to your individual circumstances.