Is entertainment deductible?

October 2nd 2023

You are the sole shareholder and director of a growing company. After a good year, you want to celebrate with the employees who helped and worked with you over the year. Will HMRC allow tax relief if you put the expense of entertaining everyone through the business?  Kenny Logan from our Edinburgh office outlines the details below.

The taxation of a trade for the most part follows the entries in the accounts, although deductible expenditure must meet the wholly and exclusively rule (whether a company or non-corporate enterprise). However, business entertainment itself is specifically excluded as a ‘trading deduction’ for obvious reasons as nobody would ever make a profit. The only exception is ‘staff entertainment’ which is allowed as it has a business purpose.

Staff can include spouses, partners, retired employees and directors.

For consistency with companies, by concession HMRC allows unincorporated businesses a tax deduction for entertainment costs for the business owners, but only where an event is held which is intended for the firm’s employees in general.

As the staff entertainment must still meet the wholly and exclusively rule, unduly lavish events, particularly those aimed at management or directors only, are likely to be deemed excessive and without a business motive. This could mean that HMRC will deny the company tax relief for all of the expense.

Unless exempt, directors are liable to income tax on entertainment costs incurred by the company from which they benefit. The company must declare the benefit for tax and Class 1A NI purposes, but only the latter if the benefit has been payrolled. Your company can enter into a PAYE settlement agreement to meet the tax and NI on behalf of directors and employees.

For director shareholders, paying out a dividend which is then paid back to the company to cover the cost of the business entertainment is more tax efficient. Of course, this option can’t be used for non-shareholding employees.

A limited exemption from the income tax and NI charge exists for annual recurring expenditure on staff entertainment. The exemption only applies where the total cost per tax year per attendee is not more than £150 (including VAT). This can include non-employees, eg spouses. Any number of events can be covered by the exemption so long as the total falls within the limit.

What about VAT?
Where directors or business owners are entertained at the business’s expense, VAT can only be reclaimed when other staff are involved. However, no VAT can be reclaimed in respect of entertainment costs relating to non-employees/directors, i.e. spouses and so on. Where an event involves directors only, this isn’t staff entertaining because HMRC doesn’t accept that there is any business need to reward these individuals, so any VAT reclaim is blocked.

Staff entertainment is tax deductible for your company but is likely to count as a benefit in kind for you and any other employees involved unless within the exemption above. VAT on the cost of staff entertainment can be reclaimed.

Our team are more than happy to discuss this further and of course other business expenses and tax related queries you may have.  Contact JRW