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Steve Allen of VAT Advisers Ltd looks at recent developments affecting the VAT treatment of entertainment expenses.

Introduction

In Revenue & Customs Brief 44/10, HMRC announced that it had reviewed its existing policy on the treatment of business entertainment provided to overseas customers, in light of the ECJ’s decision in the joined cases of Danfoss and AstraZeneca (Case-371/07). This article takes a look at the Brief, as well as giving a recap on the general entertainment rules.

Background

The UK has blocked the recovery of input tax on business entertainment since the inception of VAT. Initially, the block denied recovery of such input tax except where the business entertainment was provided to an overseas customer, but in 1988, the law was amended to block recovery of those costs as well. This change was made to align VAT law with changes introduced in relation to direct tax.

Revised Policy

Following the review, HMRC concluded that the UK’s block on the recovery of input tax on the business entertainment of overseas clients is inconsistent with EU law. As such, UK law will be amended shortly.  In the meantime, HMRC will accept claims for VAT previously restricted in respect of the entertainment of overseas customers, subject to the normal four-year cap. HMRC announced in March 2009 that, pending the outcome of its review of policy in this area, it was inviting claims for the period 1 August 1988 (when UK law was amended) to 30 April 1997 (as prescribed following the Fleming judgment). However, HMRC now says that it will no longer accept claims for this period.

The Brief states that the block on recovering input tax on entertainment provided to anyone other than an ‘overseas customer’ (e.g., UK customers and non-UK business contacts who are not customers) remains effective, and any VAT incurred on such entertainment still cannot be recovered. Going forward, VAT incurred in future periods on the entertainment of overseas business customers can be recovered in the usual way.

Making Claims

With regard to making a claim, the Brief says that, as a minimum, the following supporting evidence will be needed:

• details of the overseas customers
• the type of expenditure, for example, meals to support business meetings, etc.
• the amount of VAT claimed
• evidence that VAT has been incurred and not previously been deducted
• if required for historical claims, evidence of the type of business entertainment the business normally excludes from recovery by reference to recently rendered tax periods.

Private Use Charge?

HMRC point out that, in some circumstances, an output tax charge to reflect private use can arise which cancels out any deductible input tax. In such cases, there is no benefit in making a claim, so the issue of a private use charge needs to be considered when deciding whether to make a claim. The private use charge ensures that a taxable person does not achieve an advantage over private individuals simply because it is registered for VAT and can recover the VAT incurred on costs. The ECJ has addressed the circumstances under which an individual can benefit privately from a business expense without a private use charge arising, and it is clear from the decisions in two particular cases, Julius Fillibeck Sohne (C-258/95), and Danfoss and AstraZeneca (C-371/07), that it should be very narrowly defined. These two cases introduced separate tests to be applied to private use of business expenditure. As no advantage arises where the VAT is not recovered by the taxable person, there is no need to consider the private use charge unless you intend to recover the VAT paid.

The Fillibeck Sohne case, which concerned free transport for construction site staff, introduced a ‘necessity test’. This considers whether it is necessary for the taxable person to provide goods or services that are privately enjoyed in order for him to make his taxable supplies. The Danfoss and AstraZeneca case, which concerned free meals to employees and business contacts, introduced a ‘strict business purpose test’. This dictates that no charge arises where the costs are incurred for a strict business purpose. 

HMRC says that if the application of the tests results in the conclusion that a private use charge should be applied, the input tax should be simply treated as non-deductible rather than deducting it and then offsetting with an output tax charge. The Brief closes with three scenarios to assist in determining the correct treatment of the entertaining costs. The three scenarios are:

1. Meetings in Your Office

HMRC considers that where you entertain overseas customers in your staff canteen or similar, and the entertainment is provided to facilitate a business meeting, the VAT on such expenditure will be recoverable and no charge to reflect the private use will arise.

2. External Meetings/Events

Where you cannot host meetings in the office (e.g., there are a large number of attendees or you have no in-house facilities), you can still use the principles set out above to determine if your input tax is recoverable or a private use charge should be applied. For example, basic refreshments provided at a training event or a meeting will be treated as if it were supplied by your own in-house canteen. However, where it goes beyond merely providing basic food and refreshment to facilitate the smooth running of the event, then you should not recover any input tax or, failing that, account for output tax under the private use charge.

3. Corporate Hospitality Events

Many businesses offer their customers or potential customers general entertainment and hospitality (e.g., golf days, track days, trips to sporting events, evening meals, trips to night clubs). HMRC will generally not allow deduction of VAT in respect of these events, or else will require an output tax charge, as they are unlikely to have a strict business purpose, and be necessary for the business to make its supplies.

A Recap of the Normal Rules for Business Entertainment

You can recover VAT incurred on goods or services used for a business purpose, but the VAT incurred on the provision of ‘business entertainment’ is blocked from recovery under a special legal provision.

‘Business Entertainment’

According to HMRC, ‘entertainment’ becomes ‘business entertainment’ when it is provided to persons who are not employees of your business and is provided for free. ‘Entertainment’ can take a wide variety of forms, such as the provision of food and drink; provision of accommodation, entry to theatres, concerts, sporting events, and clubs, and the use of capital assets such as yachts and aircraft for the purpose of entertaining.

In terms of who should and should not be treated as an ‘employee’ for business entertainment purposes, HMRC make the following distinctions:

Employees

• directors/partners
• ‘standard’ employees
• self-employed persons treated for subsistence purposes as employees;
• helpers, stewards and others essential to running sporting or similar events;

Non-employees

• pensioners and former employees
• job applicants and interviewees
• shareholders who are not also employees

It should be noted that subsistence costs incurred by employees whilst working away from the business are not business entertainment expenses, and can be claimed as input tax subject to the normal rules. 

‘Employee Entertainment’

Where an employer provides entertainment to employees to reward good work, or to maintain and improve staff morale, it does so wholly for business purposes. Thus the VAT incurred on events like staff parties, team building exercises, staff outings and similar events is recoverable input tax.

There are two main exclusions: one is entertainment provided to directors, partners or sole proprietors of the business, because the costs are not used for business purposes (although directors and partners attending staff parties with employees is acceptable). The other is where employees act as hosts to non-employees. The VAT incurred by the employees on the cost of the hosting is not deductible.

Where a business stages an event attended by employees and non-employees, only the proportion of the VAT costs relating to employees is recoverable.  However, if a ‘reasonable charge’ were made to the non-employees for attending, then all of the VAT incurred on the event would then become recoverable.