One of our clients, who runs a one-man company, wanted to know if he was entitled to a tax deduction for the cost of an extravagant meal with his partner following the completion of a successful contract?
Generally, expenses incurred by businesses in the course of trading are tax deductible, but there are exclusions. Tax law doesn’t provide a list of what type of costs are deductible, but it does identify certain expenses which aren’t, including a general exclusion for purchases which aren’t “wholly and exclusively for the purpose of the trade”. This rule applies to companies and unincorporated businesses, i.e. sole traders and partnerships.
One type of expense tax law specifically excludes is “business entertainment”. However, there’s an exception to the exclusion if the “entertainment is provided for employees”. The bad news is that this is no help to owners of businesses which operate as sole traders or partnerships. They aren’t employees and so the business can’t claim a tax deduction for entertaining them. Conversely, it’s good news for companies as they can normally claim a deduction for the costs of entertaining directors where they are also employees of the company (which they inevitably will be if it’s a one-man company).
Is it a business expense?
Before you go rushing off with the company credit card paying for countless meals at your favourite restaurant, keep in mind that the exception which allows a deduction for employee-related entertainment costs is still subject to the general rule which says expenses aren’t deductible unless they are wholly and exclusively for the purposes of the business. These factors together make the tax position very tricky to determine.
One view is that because the cost to a company of entertaining a director is taxable on them as a benefit in kind, the expense must be deductible as it’s part of their remuneration – this would definitely meet the wholly and exclusively condition. The counter argument is that while a director is taxable on whatever the company spends on entertaining them, this doesn’t necessarily make it part of their remuneration. It’s therefore just a general expense to which the wholly and exclusively test applies. So the expenditure must have a business motive or it won’t meet the wholly and exclusively condition.
Trap. We lean towards the latter view, so that if the entertainment expense is excessive it won’t be deductible. That’s also HMRC’s stance.
Tip 1. You can get around the Trap by including the provision of meals etc. as part of the director’s remuneration package. That way the company is bound to meet the expense as one of its trading costs and so it will be tax deductible. However, that’s not a good idea as remuneration in this form is, as already mentioned, taxable (and NIable) as employment. It is more tax efficient for the director shareholder to take more dividends and pay for their own entertainment.
Tip 2. An exception to Tip 1 is where the cost of the entertaining isn’t taxable on the director because of a specific exemption. That is, where the meal or other event, e.g. a Christmas party, takes place annually. In that case the company can pay entertainment costs up to £150 per head for the director plus guests and claim a tax deduction for the cost while the director escapes tax and NI free.
A tax deduction can be claimed if the cost isn’t excessive. However, it counts as employment income on which tax and NI is payable, thus overall it’s not a tax- efficient arrangement.
The only exception is where the entertainment is exempt for employment tax and NI, i.e. where it’s an annual event, e.g. a Christmas party.