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How to treat Entertainment expenses

Short Answer

Client Entertainment is not tax deductible but should be put through the company still. Employee Entertainment is tax deductible but usually creates an unwanted taxable benefit in kind for the employee.

What are Entertainment expenses?

Entertainment expenses cover two scenarios:

  1. Client Entertainment – The cost of entertaining your clients
  2. Employee Entertainment – The cost of entertaining your employees

Click on the relevant tab below.


Client Entertainment

 

Client Entertainment should be business expenses only!

Legitimate client entertainment requires there to be a genuine business connection between yourself and the client. Here is how HMRC distinguish between business entertainment and non-business entertainment:

– 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
https://www.gov.uk/expenses-and-benefits-entertainment/overview

So if you’re taking out a friend who has only a tentative link to your business, unfortunately it is non-business entertainment and should not go anywhere near your company accounts. Assuming there is a legitimate connection however …


A unique tax treatment

Client Entertainment sits in an usual category where the cost can go through your company accounts but is not tax deductible for corporation tax purposes.

So let’s say you take a client team out for a meal and it costs £200. The company can pay the cost but when it comes to preparing your corporation tax return we would work out your accounting profit, let’s say it’s £150,000 but then we need to add back any client entertainment before we calculate the corporation tax so that would look like:

Accounting Profit £150,000
Plus Client Entertainment £200
Taxable Profit £150,200
Corporation Tax @ 20% of Taxable Profit £30,040

VAT on Client Entertainment

With client entertainment VAT is also treated differently, you simply cannot claim back the VAT on any client entertainment.

So when you are entering client entertainment receipts into Xero enter them as ‘NO VAT’ with the cost equal to the total cost including VAT.


Why are the Client Entertainment rules so harsh?

If HMRC treated Client Entertainment like any other expense it would be very easy to abuse.
If my company buys me a car then I have to pay a lot of income tax on that. So if all client entertainment was tax deductible then maybe a client of mine could buy me a car. They have a tax deductible expense and I pay no income tax.

If the client is doing that then I guess it would only be fair for me to buy them a car too. Clearly this isn’t the sort of arrangement HMRC likes to see, hence the strict rules!


Why put it through the company at all?

By this point you may be wondering why you should put these expenses through your company, it is still advantageous though.

The benefit is that if you don’t put them through the company they would get paid out of your after tax personal funds. So in the small £200 example above, all other things being equal, you would have to take additional dividends of £200 from your company and pay income tax on that before you can pay the £200 to the restaurant. By paying through the company you save on that income tax.


Employee Entertainment

 

Employee Entertainment is tax deductible for Corporation Tax purposes but it may result in additional income tax for the employees being entertained, that is because HMRC would deem entertainment as a ‘benefit-in-kind’, which means it needs to be taxed as income tax.

Let’s take two examples

  1. Project meal with client and staff – You take out a client and the staff that worked on the project to celebrate a successful completion of the project.
  2. Staff meal – You decide to take your staff out for lunch to celebrate a profitable month. It costs £50 per head.

In the first example it could be said that the staff enjoyment of the lunch is ‘incidental’ and the true purpose of the meal is client entertainment, in which case the rules on the client entertainment tab of this page apply.

In the second example though there is no client involvement so this is 100% staff entertainment. How do you treat it?

Corporation Tax and Accounting

You can charge the cost of the meal to the company and there are no corporation tax adjustments required. It’s a normal tax deductible expense.

VAT

You can claim the VAT on the meal as usual.

Benefit-in-kind

This is where it gets messy. HMRC will consider the £50 spend on the employees lunch to be broadly equivalent to a bonus of £50 and will want to receive tax and national insurance in accordance with it.

This means you have to declare the £50 on your P11D (follow the link to understand more about P11Ds) and in doing so you will create an income tax liability for the employee. It will also create an employers national insurance liability of 13.8% of the cost.

Please note that from April 2016 it will be possible to report benefits-in-kind during normal monthly payroll, which will save having to complete a P11D.

Simplify things with a PSA

If you regularly take employees out for meals or other entertainment (eg a football match) you may find it easier to set up a “PAYE Settlement Agreement” “PSA” these work by declaring in advance the normal sort of entertainment provided and agreeing an amount of tax to pay HMRC. This allows the employer to pay the income tax on behalf of the employee and saves having to complete P11D forms.


Summary

So staff entertainment is all straight forward on the corporation tax side of things but does create some admin and income tax for employees. That means that by simply taking an employee out for lunch and following the rules you are likely creating an unexpected tax bill for your employee. It goes without saying that they won’t like this.

As such our advice is to avoid Staff Entertainment whenever possible. If it’s an important part of how you work speak to your accountant about arranging a PSA with HMRC.


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