The following commentary assumes the business is normally entitled to reclaim the VAT it incurs as input tax. For those businesses operating in a VAT exempt sector (such as finance, insurance, healthcare and education) reference to input tax recovery should be considered in line with your normal partial exemption calculation/VAT recovery method.
What is the background?
The provision of something ‘free of charge’ normally does not allow a business to reclaim the VAT incurred on the associated incoming expense.
However, unlike other taxes such as PAYE and NI, the VAT rules on employee related costs are quite generous and do allow a business to reclaim VAT (i.e., input tax) on hospitality provided to a business’ employees free of charge; providing, of course, that there is a genuine business reason for incurring the expense, for example staff morale, team building etc.
The position though starts to become less straightforward when the focus of the entertaining is towards clients, customers or suppliers, where input tax recovery is not allowed. Employees taking part with this type of focused entertaining are also ‘tarred with the same brush’ with input tax recovery also not allowed.
Is it ‘entertaining’?
Entertaining is considered by HMRC to be the provision free of charge of food, drink, tickets to events and potentially use of business assets.
In its simplest form, this could be a working lunch attended only by employees, to something more lavish such as a Christmas Party attended by employees and their spouses, to a box at a sporting/musical event attended by a mix of clients and employees.
As noted above, it is possible to reclaim VAT on the first type of event, but the other two types of events are more problematic. By concession though, HMRC will allow businesses to deviate from its rules, and for Christmas parties attended by spouses, HMRC will allow a sensible apportionment to be made based on attendees, say on a 50:50 basis.
What about re-imbursing travel and subsistence expense to employees?
Often confused with ‘entertaining’, but providing the re-imbursement is for costs incurred by an employee working away from their normal place of work, input tax recovery is allowed providing that the expense is supported with a valid VAT invoice or receipt.
If, as an alternative to re-imbursement of actual expenses an employee is provided with a monetary allowance (for example lunch, overnight stay etc.), then despite the likelihood that the allowance will be spent on items bearing VAT, no input tax is reclaimable by the business.
Care is also needed where an employee is working away but takes the opportunity whilst in the area to entertain a customer, perhaps a meal on an evening. Just like the example above, this categorises the employee with ‘entertaining’ and the VAT is no longer reclaimable.
What should businesses consider?
A common theme we have when discussing this topic with clients is the cost versus benefit analysis when trying to determine the correct amount of VAT which can be reclaimed on employee entertaining and travel expenses.
Clearly, it should be easier to identify the VAT incurred on annual employee functions such as a Christmas party and larger related travel expenses such as overnight accommodation, but often with the latter, the employee books ‘online’ using a personal credit card making it harder to obtain a valid VAT receipt in the name of the business.
We have found that developing an improved process for employee expense claims does help with enhanced VAT recovery because it captures the VAT (recovery) treatment at source and puts an employee on notice of what documentation is required to support their expense. It also helps when looking at other taxes such as PAYE and NI where different rules apply, and which are potentially less generous than those concerning VAT.
If you would like more information about this, or any other VAT related matter, please contact one of our dedicated VAT specialists:
T: 07715 704 739
VAT Senior Manager
T: 0191 243 6017