Tax on Staff Entertainment
Staff Entertaining is an Allowable
The general rule is that staff entertainment expenditure is not tax deductible, e.g. entertaining business clients.
It comes as a surprise to many people that staff entertaining is, however, 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 entertainment 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. 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.
The motive behind the expenditure is important. Any staff entertainment 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.
On top of this, the employer is also liable for Class 1A National Insurance at 13.8% 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 staff entertainment 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.