Let me entertain you…when can VAT be claimed
Businesses can claim input tax on their expenditures, assuming that they are VAT registered and not partly exempt. However, a specific tax block applies to entertainment expenses. Neil Warren considers some practical examples.Example 1
John is the audit partner in a firm of accountants ie, he is a business owner. When working at clients’ premises, he often visits restaurants for lunch, usually accompanied by a member of his audit team (employee), and often by one or two directors of the company that he is auditing at the time (client). Can input tax be claimed on the lunch costs? Would the situation be different if the clients came from outside the UK?
In effect, there are three different categories of people involved in this arrangement:
- business owner …we’ll consider the treatment of each category.
No input tax can be claimed on the ‘client’ meals. The expense here is classed as ‘hospitality of any kind’ (HMRC VAT Notice 700/65, para 2.2), and therefore is classed as business entertainment within the VAT regulations. The only exception would be if the client was an ‘overseas customer’ and the expense related to a ‘business meeting’ in which case input tax could be claimed on the meal cost, without any output tax liability against the partnership – this issue is considered later in the article.
It needs to be considered whether the employee is ‘acting as host’ to the client, in which case input tax is also blocked on the cost of his lunch ie, through the business entertaining rules. However, if (as seems likely) the meal cost for the employee in this example is being incurred because he is away from the office on a business related job (the audit), then input tax can be claimed because the expense is classed as ‘subsistence’ rather than ‘entertainment’. Input tax would also be claimable if the employer paid for hotel accommodation for the employee as well.
Input tax can be claimed on lunches for the business owner (audit partner) in my example, as long as they are classed as ‘subsistence’ – usually indicating a business purpose that is away from the main trading premises of the business (HMRC Notice 700, para 12.1.2). As a guideline, a claim should not be a problem if the business meeting/audit work is at least five miles away from the main trading base.
In the case of the meal in my example above, the same situation would apply to the owner’s meal as with the employee ie, as long as it is a subsistence cost rather than a meal to entertain the client, then an input tax claim is not a problem.
What about the staff Christmas party?
The festive season is approaching and the good news is that there is no problem (for input tax purposes) in an employer paying for employee meals or other staff entertaining costs eg the cost of the office Christmas party, a meal out at a local restaurant following a good trading month, a theatre trip to celebrate a trading anniversary. In such cases, the expense is seen as a reward for hard work/motivational expense and is for a clear business purpose. It is only input tax on entertaining non-employees that is blocked (or employee costs where they are acting as hosts).
There is also no problem claiming input tax on the costs of meals for business owners where entertainment is available to staff generally within the firm, as is the case with the office Christmas party. But there would be a problem if the directors or partners entered local restaurant meals into the business records and claimed input tax. (HMRC Notice 700/65, para 3.2). As another positive outcome, there is no monetary cap as far as an input tax claim on the staff meals is concerned ie it is not restricted to, say, a value of £150 per head.
Planning tip – a small charge for guest meals?
What is the situation if the directors decided that the company would not only pay for the staff meals at the annual Christmas party but also the cost of guest meals as well eg spouses, relatives, customers, suppliers etc? In such cases, the ‘free hospitality’ to non-employees means an input tax block would apply to the cost of these meals.
However, as a planning tip, if a small charge is made for the guest meals (let’s say £5 per head), then we no longer have a business entertainment situation because the meal is no longer being provided free of charge. So input tax can be claimed on the cost of the guest meals, as long as output tax of 83p is accounted for on each meal sold to a guest (£5 x 1/6).
When are staff acting as hosts?
As a practical example of how the rules can get tricky, what is the situation when a company hires a 12-seater box at a top football match for example, which will be enjoyed by six employees and six non-employees? In this situation, at least 50% of the input tax on the cost of the box will be blocked by the business entertaining rules for the non-employees, and it then needs to be considered what role the employees are expected to carry out on the day of the match. If their function is to make sure the guests have an enjoyable time, and place lots of future business orders with the company, then input tax on the employee expenses will also be blocked because they are acting as host to the non-staff. But if they are able to enjoy the game without any entertaining function, then input tax can be claimed on their part of the cost.
VAT windfall on entertaining overseas customers…but beware output tax liability!
A European Court of Justice case heard in 2010 led to HMRC reviewing its policy on whether a UK business can claim input tax on entertaining overseas customers.
- Although input tax can be claimed on any entertaining of overseas customers, a ‘private use’ output tax charge will apply if the entertaining is not business related and is not classed as being necessary to the making of taxable supplies (defined as a ‘necessity test’ and a ‘strict business purpose test’).
- It means that limited hospitality provided at a business meeting to discuss business related matters with overseas customers is not a problem – but an output tax charge will apply if the gathering is not specifically linked to business, for example a day at the races or trip to a show. HMRC also expect a business to only recover input tax (with no output tax charge for private use) if the entertaining is clearly used for the making of taxable supplies, as well as being reasonable in scale and character.
Note – the phrase ‘reasonable in scale and character’ is a bit controversial – HMRC refer to an expense being allowable if the meals comprise ‘normal basic food and refreshments such as sandwiches and soft drinks.’ (HMRC Notice 700/65, para 2.6).
- Be aware that the potential input tax claims only relate to overseas ‘customers’ – there is no scope to make a claim in relation to overseas suppliers or other business contacts based outside the UK.
- HMRC list ‘corporate hospitality events’ such as golf days, trips to sporting events and night clubs, track days and evening meals as events where an output tax charge will be needed because the entertaining is not essential to the making of taxable supplies.
As a final practical situation, imagine that you own a building business, and use a combination of subcontractors and employed builders to carry out the various jobs. You agree to pay the petrol bills of the subcontractors who use their own vehicles (if they give you a petrol receipt) as well as their meal and hotel costs for jobs that are away from your local area. What is the input tax position in relation to the subcontractor expenses?
The good news is that input tax can be claimed on the ‘subsistence’ costs relevant to the subcontractors, as long as they get the same treatment in terms of expenses as employees on the same job, but there is no scope to make a claim on any of their travel expenses ie, the road fuel (HMRC Notice 700/65, para. 2.3).
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