Tax relief for business gifts and entertaining: Getting it right

Lee Sharpe looks at the principles behind tax relief for entertaining and related expenses.

The issues around the tax treatment of entertaining expenses and gifts are widely misunderstood. It is important to recognise that some entertaining is allowable, some is not, and some expenses typically classed as entertaining could actually be classed as a different – allowable – deduction. 

Most expenses have to be incurred ‘wholly and exclusively for the purposes of the trade’ (ITTOIA 2005, s 34; CTA 2009, s 54). There has to be a relationship between the purpose of the expenditure and generating income. This requirement applies to entertaining and business gifts.

If (say) meeting a client for lunch to discuss new orders or an update on an ongoing project, there is clearly a strong relationship between the money laid out and generating turnover – or trying to. But there is a further barrier denying relief specifically for entertaining and gifts because of ITTOIA 2005, s 45 and CTA 2009, s 1298. It is important that there may be a good business case for incurring an entertaining expense, but it is nonetheless not deductible. 

Nevertheless, it is important to bear in mind that hospitality, etc., counts only when freely given, i.e. without the expectation of something meaningful in return. HMRC’s reasoning for denying relief is that while entertaining used to be allowable, it had become excessive to the point where it seemed to have become an end in itself as far as many businesses were concerned.

Exceptions to the disallowance follow in subsequent sections of the legislation:

The case Celtic Football and Athletic Co. Ltd v Customs and Excise Commissioners [1983] STC 470 is a good example of points 2 and 3; UEFA required each host team of a two-legged fixture to provide accommodation and other amenities to the visiting team at each match. Therefore:

So, HMCE lost the case twice over, since either reason was sufficient. But the consideration in exchange for the entertaining must be worth the outlay in providing the hospitality in the first place. And here, we must distinguish between, say:

HMRC might well be happy to allow the former, but not the latter, which is the classic corporate hospitality scenario at which the disallowance policy is aimed. Where a guest contributes to the trader’s hospitality costs then one disallows the net cost (see HMRC’s Business Income manual at BIM45012).

From a legislative point of view, hospitality is merely a form of entertaining. The words are used widely and are broadly interchangeable. But in natural English, business gifts might fall under hospitality but not entertaining. To add to the confusion, HMRC guidance then says that business entertaining is simply ‘hospitality that is provided free of charge’. 

Of course, corporate hospitality can extend well beyond a formal dinner and could cover golf tournaments, race days and a wide range of similar events.

This is one of the key areas where mistakes are made.

Entertaining employees (including directors) is allowable under the entertaining expenses rules unless it is merely incidental to the provision of hospitality to other parties (ITTOIA 2005 s 46; CTA 2009 s 1299).

This does not mean that entertaining employees is automatically tax-deductible; it must still satisfy the ‘wholly and exclusively’ test – particularly where the expenditure is ‘excessive’ – an issue typically picked up with close relatives of the proprietor or shareholder/director, rather than the principal of the business directly (see HMRC’s Business Income manual at BIM37700 – or even last month’s article).

Entertaining employees can, however, trigger a benefit-in-kind tax charge on the individuals involved, although there are useful exceptions for trivial benefits of less than £50 each event (£300 annual maximum for directors, etc.) and for annual staff events totalling up to £150 per guest and for where it falls under the duties of the employment, incidental to the provision of business entertaining non-employees.

But disallowing staff entertaining does not prevent it being taxable as a benefit-in-kind – they are not mutually exclusive (contrary to the long-held practice adopted by many accountants throughout the land). Even HMRC has begun to realise this – and given the potential yield in tax and National Insurance contributions (NICs), it is perhaps surprising it has taken so long (see BIM45033).

So, if employees (including directors) also receive a meal while entertaining clients, it is likely that the whole cost will be disallowed on the basis that the cost attributable to employees is incidental to the object of client entertaining, but there will be no benefit-in-kind if it falls under the director’s duties. 

By contrast, if the directors and their families have to entertain potential clients on a two-week cruise down the Danube, it could be argued that this should end up on the annual forms P11D, as well as potentially being disallowed in the company’s own tax computations (including the employees’ costs), depending on the particular circumstances.

Another difficult area is where the cost could be characterised as being for promotional purposes – for example, an exhibition or stand at a trade conference, or a product launch by invitation, or an event open to the public. 

Note that (4) above does not necessarily have to be directly to the public. For example, if an haute couture fashion house provides a famous actress with a ball gown for a televised event, the cost would be allowable on the basis that it would gain publicity. Many people would characterise this as sponsorship rather than entertaining. Of course, sponsorship must also be wholly and exclusively for the purposes of the trade – it cannot be primarily because the business owner is a fan of motorsport, for example.

HMRC states in its Business Income manual (at BIM45032) that the cost of goods or services given away as promotional advertising is always allowable. This really depends on the circumstances; a balance must be struck between the entertaining element and the advertising or promotion; one might be incidental to the other. For example, BIM45050 first states that the cost of any food, drink or any other hospitality must be disallowed at a promotional event, but later states that where hospitality is minimal, no disallowance need be made. 

Gifts costing £50 or less to the same recipient and which bear conspicuous advertising but are not food, drink, tobacco, or tokens or vouchers exchangeable for goods, are allowable; the £50 limit is per tax year or accounting period for companies.

Remember that assets acquired for business entertaining are ineligible for capital allowances by reason of CA 2001, s 269 (although this does not prevent relief for entities whose qualifying activity is itself corporate hospitality or similar). 

Also, the rules for VAT are similar but not identical to those for direct taxes. For example, VAT may be apportioned differently, and incidental costs are not necessarily disallowed; likewise, VAT may be claimed when entertaining business customers from overseas, but this distinction is not recognised under direct tax principles.

In my experience, very many businesses wrongly disallow far more entertaining expenditure than they should; however, many businesses also disallow entertaining expenditure without realising that this does not necessarily prevent a personal tax and NICs benefit-in-kind charge arising. As usual, it is important to get good advice from a professional adviser, to ensure that the tax treatment is in order.