Business Tax Deductions:
Claim a tax deduction for staff entertainment
As the festive season approaches, many businesses are planning the annual ‘knees up’. The recession meant that many events were cancelled last year but maintaining staff morale is vital to any business’s survival, so it is likely that many events will go ahead this time.
It comes as a surprise to many people that staff entertaining is an allowable business expense. The allowable costs of a staff function include food, drink, entertainment (e.g. musicians) and any other incidental costs, such as venue hire, transport and overnight accommodation. VAT registered businesses can also recover VAT incurred on allowable staff entertaining expenditure.
There is no limit to the amount which a business can claim in respect of staff entertaining providing that there is no other motive behind the expenditure. There are some restrictions to the scope of the relief, however, plus one major catch!
The first problem is that sole traders and business partners are proprietors, not staff, so entertaining spend for them alone is not allowable. The same goes for director/shareholders of private companies.
So, you need to take some staff with you before any expenditure can be claimed. Let’s say that two business partners take their 12 office staff out for dinner to celebrate winning a new contract. That’s fine: this expenditure would all be allowable and there is no need to restrict the claim for the element which relates to the proprietors themselves.
But what if two directors of a small trading company take their only member of staff to lunch? As a one-off event for a special reason, such as a ‘thank you’ for an especially good piece of work, this would be fine. But if the three are in the habit of all lunching together every Friday, it could be seen as personal expenditure and hence not allowable.
This is where we start to get into the question of the motive behind the expenditure. Any staff entertaining undertaken to boost staff morale is an allowable cost as it is for the benefit of the business. Once there is any other relationship between proprietors and staff, however, the motive becomes less clear.
The most obvious example of this is where the staff member is also a relative: any entertaining expenditure in these cases is potentially a personal expense. Nevertheless, where the relative is included in a larger group, the expenditure may remain allowable. For example, a sole trader taking his four office staff to dinner could still claim all of the expenditure, even if his own son were one of them. If, however, he took the son out to dinner alone, the position would be very doubtful.
Even less clear is the position when a personal relationship develops between a proprietor and a member of staff. Again, we must look at the motive behind the expenditure. A close personal relationship would effectively put the staff member into the same category as a relative but what about a simple friendship?
In a small business, the proprietors and staff are all colleagues and friendships will often develop. This does not prevent you from claiming staff entertaining but the amount of expenditure claimed must be kept ‘within reason’.
What is ‘within reason’ will depend on the circumstances of each case. A proprietor might take all the staff out for drinks every Friday evening. This is not unusual and the cost could be an allowable expense if motivating the staff appears to be the main reason for the expenditure. This, however, brings us to the catch!
In principle, an employee is liable for Income Tax on the value of any benefit provided by reason of their employment. This includes the cost of any staff entertaining. It even includes so-called benefits like the cost of sandwiches provided at a lunchtime staff meeting. Company directors are subject to the same tax charges as other employees.
On top of this, the employer is also liable for Class 1A National Insurance at 12.8% on the cost of the staff entertaining. The ‘cost’ of entertaining, for both Income Tax and National Insurance purposes, must include VAT, even if the employer is able to recover it.
None of this affects the business’s ability to claim a deduction for the expenditure. It’s like a salary – the employee pays Income Tax, you pay employer’s National Insurance and the business gets a tax deduction. (The only difference is that the employee does not also pay National Insurance, so there is a small saving.)
Nevertheless, taxing employees on entertaining expenditure is an absolute disaster when the original motive was to improve staff morale. Any good done by the entertaining will be completely undone when the employees receive a tax bill. Can you imagine the countless arguments: “I only drank Water”; “I only went to show my face”; “I would never have gone if I knew I had to pay for it!”
Fortunately, there are a couple of ways to get around this problem. The employer could make a voluntary settlement. Better still, there’s the annual party exemption.
The Annual Party Exemption
Expenditure of up to £150 per head on an annual staff function can be exempted from both Income Tax charges and employer’s National Insurance. In fact, it doesn’t have to be a single function and several events can be covered by the exemption, as long as the total aggregate cost per head over the tax year does not exceed £150.
This sounds great but there are a few pitfalls to watch out for.
The exemption only covers annual events: either a Christmas party or a similar event. It does not cover ‘casual hospitality’, like taking the staff for a drink on a Friday night.
The event must be open to all members of staff. It can be restricted to staff working at a particular location, such as a branch or regional office, but it cannot be restricted to staff of a particular grade, such as management only.
Where the total cost of the event, including incidental costs like transport and overnight accommodation, and VAT (regardless of whether the business can recover it) exceeds £150 per head, none of the expenditure can be covered by the exemption. However, where there are several qualifying events in the year, the exemption can be used on any combination of these whose total aggregate cost adds up to no more than £150 per head.
Greedy Bank plc spends £160 per head on a Christmas party. None of this is covered by the exemption.
Slightlybetter Bank plc spends £30 per head on a staff barbecue in May, £60 per head on a summer ball in August and £80 per head on a Christmas party. The exemption can be used to cover the summer ball and the Christmas party (total cost £140 per head), but the full cost of the staff barbecue will be taxable.
Quite bizarrely, Slightlybetter Bank plc has spent £10 more per head on staff entertaining but its staff are taxable on a cost of only £30 each compared with £160 for Greedy Bank plc’s staff.
As we can see, careful planning of the timing and scale of your staff functions will enable you to make the most of the exemption.
The good news is that the cost per head is calculated by dividing the total cost of the event by the number of people attending, including staff’s partners and other guests. Sometimes this could mean that increasing the size of the event reduces the cost per head to the point where the exemption applies.
One way to keep the cost of an event to no more than £150 per head is to advise staff that they will be required to reimburse any costs in excess of this amount. However, this may not be good for morale and a fixed contribution in advance of the event is usually more acceptable to staff.
Staff Entertaining versus Business Entertaining
Where customers or other external parties are present at an event, it may become business entertaining rather than staff entertaining. The business is unable to claim a tax deduction but there is no tax charge on staff attending the event, nor any Class 1A National Insurance.
Given the cost of a voluntary settlement, this may actually work out cheaper and we will look at this issue in detail, including the question of just how many customers it takes to turn an event into business entertaining, in a later edition of Business Tax Saver.
For expenditure not covered by the annual party exemption, there is another way to prevent morale-shattering tax charges from falling on the staff, but it comes at a cost.
The employer can negotiate a voluntary settlement with HMRC and pay all the Income Tax and National Insurance arising. This payment is treated much like PAYE, so the payment itself is usually tax deductible.
To arrange a voluntary settlement, it is sensible for you to approach HMRC first and to provide full details of all the staff entertaining costs which you wish to cover under the settlement. You may also wish to include other items, such as sandwiches provided at lunchtime meetings or pizzas bought for staff working late (oh yes, these are a taxable benefit).
You will then need to agree a suitable rate to gross up the cost to allow for the fact that you are settling the staff’s Income Tax liability. Finally, you will need to add on Class 1A National Insurance.
Omega Limited spends a total of £12,000 on a staff party (including VAT) which is not covered by the annual party exemption. The company advises HMRC that it wishes to make a voluntary settlement rather than allow the staff to be taxed on this benefit.
Half of the staff at the party were basic rate taxpayers, so the grossed up cost of their benefit is £6,000 x 100/80 = £7,500. The other half were higher rate taxpayers, producing a grossed up cost of £6,000 x 100/60 = £10,000. The total grossed up cost is thus £17,500, giving rise to a tax charge of £5,500 (£17,500 - £12,000) plus Class 1A National Insurance of £2,240 (£17,500 x 12.8%).Omega Limited’s voluntary settlement is £7,740 (£5,500 + £2,240). This is 65% of the cost of the party, but at least it can be claimed for Corporation Tax purposes.