Most businesses offer some form of entertainment for their staff as a normal part of business operations to reward, incentivise or encourage their employees.
The tax issues in this area are often misunderstood, resulting in many questions, incorrect VAT reclaims and in some cases businesses not claiming reliefs that they are entitled to.
Is staff entertaining allowable for Corporation Tax?
Entertainment covers a wide range of possible costs and activities. This often includes, but is not limited to, staff meals and drinks, team building events, Christmas parties and 'away days'.
To qualify as staff entertainment, such activities must be provided to employees of the business, workers and company officers.
Partners or guests of employees do not count as forming part of staff entertainment. Other individuals, such as suppliers, clients or other people connected to the business are not staff and so the cost of entertaining anyone from these groups is classed as "external" or "client" entertainment.
Most companies are surprised to hear that in fact any reasonable staff entertainment is allowable for corporate tax purposes. There is no limit!
This means that the cost can be deducted in full when calculating the company's corporation tax liability. Similar rules also apply to unincorporated employers.
Whilst this may be a surprise, businesses should be warned somewhat against heading out to nearest venue to splash out on employees, since whilst this is the case for Corporation Tax, the rules for benefits in kind are a little more complex.
Is staff entertaining VAT reclaimable?
More good news is that staff entertainment is considered to be a business cost and as such any VAT incurred on staff entertainment can also be reclaimed from HMRC or offset against the business' VAT liability.
Although if the entertainment is only provided to Directors or partners of a business, then HMRC may well object to the reclaim of VAT. So far, so good.
Is staff entertainment a benefit in kind or tax exempt?
Things get a little more complex when it comes to employment taxes and benefits in kind. HMRC recognise that a certain level of staff entertainment has always been provided as a customary gesture, many years ago often limited to Christmas parties or one-off events.
Therefore there is a specific exemption from any form of employment tax on staff entertainment on "one or more annual events" up to a maximum of £150 per employee. Up to this level, nothing needs to be taxed or reported to HMRC.
This applies equally to part time and full time employees and even those on temporary contracts as long as they are employees of the company at the point that the entertainment is provided.
The limit of £150 has been in place for many years and like many tax exemptions, does not increase in line with increasing costs or inflation.
This is bad for employers and bad for employees. It means more and more employers have an issue as more regular staff entertainment becomes a key part of staff retention and motivation strategy.
If the limit is breached, all staff entertainment for that employee becomes taxable. The employer will then have to report the value of the benefit on a P11D expenses and benefits form and pay NICs on the value.
Income tax will also be paid by the employee. In such circumstances, an employer may apply to HMRC to obtain a PAYE settlement agreement (known as a PSA).
This is an agreement between the employer and HMRC which confirms that the employer will settle all tax and NIC liabilities on staff entertainment on behalf of employees.
This is calculated by ‘grossing up’ the costs. After all, what employer wants to treat staff to a night out, at the same time as giving them the associated tax bill? Obtaining a PSA also means that P11Ds will not be required for staff entertainment covered by the agreement.
Note however that HMRC do not issue retrospective PSAs and so agreement must be reached in advance of the start of the tax year.
A brief return must also be filed in July after the end of the tax year and any tax payment must be made by October.
What about Client Entertainment VAT & Tax Issues?
Client entertainment or external entertainment comes under a totally different set of tax rules. HMRC do not consider such costs are incurred "wholly and exclusively" for business purposes, even if in today's business environment, they are unavoidable business costs.
Client or external entertainment is probably best described as entertainment provided to anyone except the employees of the company. This includes suppliers, clients, regulators, interviewees, business alumni and almost anyone else.
Corporation tax deductions are blocked as are VAT reclaims. This means that in comparison to staff entertainment, client entertainment is often more than 40% more expensive in most cases.
Of course, on the whole, such entertainment is usually incurred to win new business or retain existing clients.
HMRC guidance is of course available on such issues, but for a more impartial view in such circumstances, your tax adviser is the place to start.Â
Contact us for further help or advice from Wisteria's tax team.