HMRC recently refused to allow a tax deduction to a business for the cost of food and drink provided at business seminars where customers were charged to attend. HMRC argued that this was business entertainment. Were they correct?
What is business entertainment?
Corporation tax and Income tax legislation does not permit a tax deduction for business entertainment. i.e. it is ignored when calculating the taxable profits of a business. Putting this another way, once the profits of the business are calculated, and shown in the Profit & Loss Account, the cost of business entertainment is added to increase the accounting profits subject to taxation.
Similarly, VAT cannot be recovered on the costs of business entertainment. Businesses should therefore include business entertainment as a gross cost in their accounting records and show no separate amount for recoverable VAT.
When I ask if my clients have incurred any costs on business entertaining they often respond that they do not provide business entertaining. In other words, they do not take business contacts and customers to sporting events, nightclubs or take them out for a round of drinks.
However, I expect that lots of my clients may, for example, go to café to meet a business contact and where they will have a bit to eat and a cup of tea or coffee. This will be more relevant to smaller businesses where they have no formal business premises and where they work from home.
Tax legislation states that entertainment ‘includes hospitality of any kind, and also includes ‘expenses incurred in providing entertainment or a gift’ and ‘anything incidental to the provision of entertainment or a gift’.
As can be seen from the above definition, business entertainment includes a much wide definition than what many people would regard as entertainment. The latter part of the definition would include the cost of a hotel and travel to the event of as part of the business entertaining costs.
An exception to the rule is staff entertainment. The cost of staff entertainment is always tax deductible because it’s part of the cost of employing workers. However, there can be tax consequences for the employees who are being entertained e.g. if the amount is more than £150 per tax year.
VAT - Entertainment or staff cost
In the above commentary, we have looked at the direct tax consequences of entertainment i.e. the income tax and corporation tax consequences.
The rules for indirect taxes e.g. VAT differ. You still cannot reclaim VAT paid on the cost of business entertainment. However, VAT rules do allow you to apportion the VAT paid on any expense and reclaim the VAT paid on the business element.
HMRC state quiet clearly that a business cannot claim an income tax or Corporation Tax deduction for any part of the cost of an employee taking a customer for lunch, even if had the employee eaten alone the cost would have been tax deductible as subsistence. However, for VAT purposes HMRC accepts that the rules do permit you to apportion an expense and reclaim the VAT relating to the business element i.e. the employee’s part of the lunch. The apportionment must be done in a ‘fair and reasonable’ manner. You are not expected to identify who ate and drank exactly what. So, if an employee met up with two clients for lunch, it would be fair and reasonable to reclaim one third of the total VAT.
Food and drink as part of the business
The cost of food and drink is a tax deductible cost where it is incurred ‘as part of the principal activity’ of a business and ‘not supplementary to its business.’
Therefore, the cost of food and drink purchased by a restaurant or café in the course of their business is a tax deductible cost.
The more removed the cost of catering is from the principal activity of the business the more problematic it will be in making a claim for a tax deduction for the food and drink.
Food and drink not part of the business
At the other end of the scale you could find a business consultant who wishes to wine and dine her business contacts and customers to keep them sweet. The cost of wining and dining is incurred to promote the consultant’s services and is clearly not part of their main business service. The business is that of a consultant and not the provision of food and drink. The main motive of incurring costs on meals and drinks is to provide hospitality i.e. entertainment for the customers and contacts.
The inbetweeners
HMRC has generally accepted that the cost of light refreshments (tea, soft drinks biscuits etc) at a business meeting or event is tax deductible. However, this does not stretch to taking a prospective client for a drink at a café or pub where the motive is hospitality (entertaining).
Personally, I see very little difference between having tea and biscuits in the office as part of a business meeting or doing the same at a local café, especially where the business owner has no formal business premises e.g. if they work from home.
The recent HMRC case involved a business coach who provided courses and seminars. They lasted anywhere between three hours and a full day, including time for breaks. She provided tea and biscuits on short courses and a full lunch and beverage for those attending a full day event.
HMRC did not have an issue with claiming a tax deduction for the light refreshments at the events but it did for the higher costs of the lunches. This was on the basis that the cost of the lunches was hospitality.
I hear many clients saying that they have incurred costs on business lunches and meals with a customer whilst they are away from home or the office. The clients argue that the only reason why they have incurred such costs is because they are away on business travel. I would fully agree with my clients. That does not however mean that they can claim a tax deduction for the expenditure.
HMRC has specific legislation at its disposal that categorically states that entertainment includes hospitality of any kind. It is by concession, rather than by law, that HMRC does not challenge the cost of reasonable light refreshments.
Food and drink as part of the service being provided
HMRC was incorrect. The business coach’s reply to HMRC is that she is providing lunch as part of the courses that she runs. While the lunches are not directly connected with her business services she is selling a lunch as part and parcel of what she is charging her customer. Essentially, when a customer pays for a course they are also paying for the lunch. This is because the food and drink is part of the product being sold by the business for which it had paid. The motive and purpose of the expenditure was not to provide hospitality. It would be difficult for HMRC to successfully dispute this if the case went to a tax tribunal.
I would therefore suggest that where you provide food and drink which is more substantial than light refreshments that you mention this in any advertising, contracts and invoices issued. It does not change what you are actually paying for and providing to the customer but it does make it much easier to claim the cost for tax purposes.
In conclusion
Generally, food and drink provided to business contacts and customers is entertainment and therefore is not a tax deductible cost. A business should have no issues in paying for light refreshments at a business event. However, where there is no contractual agreement to provide more substantial food and drink at a business meeting or event then HMRC has a stronger argument for denying a tax deduction for the cost.