Entertaining people is a normal part of running a business, and most owners assume that if they’re paying for it for work reasons, they can claim it against their tax bills.
With staff, that’s broadly true. With clients, it usually isn’t.
The rules aren’t complicated, but they aren’t intuitive either. Client entertaining and staff entertaining are treated as opposites, the VAT functions to its own rules, and there’s a separate exemption for staff parties that people routinely confuse with the main one.
Read on as we cover the client and staff entertainment tax treatment, VAT, and the £150 staff-party exemption.
The Rule Depends on Whether the Person Is an Employee
The tax treatment of any hospitality comes down to one question, which is whether the person you’re entertaining works for you.
HMRC divides all entertaining into two categories on exactly that basis, and which one a cost falls into decides whether you can deduct it, whether you can reclaim the VAT, and what you have to record. It’s worth being clear on the two before going further:
- Business entertainment is hospitality provided to anyone outside the business, such as a client, a prospect or a supplier.
- Staff entertainment is hospitality provided to your own employees, including company directors if they are employees.
The category applies to Corporation Tax for a limited company, or Income Tax for a sole trader or partnership – but whether a cost is allowable is decided the same way for both.
Entertaining Clients (Usually) Offers No Relief
Business entertainment is free or subsidised hospitality provided to people who don’t work for you – meals, drinks, hotel rooms, tickets to sporting or cultural events. In practice it usually means clients, prospective clients and suppliers.
Subcontractors normally fall under it too, though ordinary subsistence you cover for a subcontractor on a job can be treated the way it would be for an employee. Whatever form it takes, client entertainment earns no relief, neither against your profit nor on the VAT.
The Cost Isn’t Tax-Deductible
Business entertainment is not tax-deductible. Most costs a business incurs reduce its taxable profit, and so reduce its tax. Entertainment is one of a small number of costs the law specifically excludes, so it has no effect on your tax bill. You pay for it in full.
You Can’t Reclaim the VAT
Normally you reclaim the VAT you’re charged on a business cost, so it isn’t really a cost to you. VAT on business entertainment can’t be reclaimed.
Take a £120 client lunch with £20 of VAT. You get no deduction for the £100, and you can’t reclaim the £20. The business pays the full £120.
Entertaining Overseas Customers Is the One Exception
There is one exception to the normal VAT rule for client entertainment – overseas customers. It affects VAT only. The cost of entertaining a client is still not deductible from your taxable profit, wherever that client is based.
An overseas customer is someone who does not live or carry on business in the UK. If you entertain one, you may be able to reclaim the VAT on the cost, provided the hospitality is reasonable in scale and genuinely connected with the business.
The catch is that HMRC then looks at whether the customer received a personal benefit from the hospitality. A meal, event or day out will usually give them some private enjoyment as well as serving a business purpose. If it does, the business has to account for VAT on that benefit – effectively paying VAT back to HMRC.
For example, suppose you take an overseas customer to dinner, and the bill is £120, including £20 of VAT.
- You reclaim the £20 VAT on the dinner.
- HMRC treats the customer’s enjoyment of the dinner as a private benefit.
- You then have to account for £20 of VAT on that benefit.
- The £20 reclaim and the £20 charge cancel each other out – so you are no better off.
You only keep the VAT saving where the hospitality is provided strictly for business purposes and does not give the customer a private benefit.
That is a high bar. HMRC says hospitality provided because it is polite, expected or useful for maintaining the relationship is not enough on its own.
So, in practice, entertaining an overseas customer often ends up in much the same place as entertaining a UK customer – no Corporation Tax deduction and no net VAT saving. HMRC therefore allows businesses in these circumstances to leave the VAT unreclaimed rather than reclaiming it and then accounting for the same amount again.
Sponsorship Must Be Split
A sponsorship package can contain both advertising and entertainment, and HMRC treats the two differently.
The advertising part – for example, having your logo on shirts, banners or event materials – can normally be deducted from your taxable profit because the business is paying for promotion.
Hospitality is different. If the package also gives you tickets, meals, a hospitality box or a table for guests, that part is treated as entertainment and is not deductible where it is used to entertain clients or other business contacts.
For example, suppose you pay £5,000 to sponsor a local event. In return, you receive advertising worth £4,200 and a hospitality table worth £800.
- The £4,200 advertising element is normally deductible.
- The £800 hospitality element is treated as business entertainment and is not deductible.
- You therefore claim £4,200 – not the full £5,000.
The important point is that you need a reasonable value for the hospitality. If the sponsorship agreement or invoice gives a separate price for the tickets or hospitality, that is a useful starting point. If it does not, you should make a reasonable allocation based on what those benefits are actually worth rather than simply treating the whole payment as advertising.
Entertaining Your Own Staff Is Deductible
Money you spend entertaining your own employees is treated as a cost of employing them, alongside wages and other staff welfare, rather than as entertainment.
Because of that, both reliefs are open to you. You can deduct the cost from your profit, and you can reclaim the VAT on the part relating to employees. The one condition is that the event has to be genuinely for your staff – an occasion laid on for clients, with a couple of employees present to host, is client entertainment however it’s described.
Directors count as employees for this. A director doesn’t have to take a salary or be described as on the payroll for the cost of entertaining them to qualify. Subcontractors aren’t employees, so entertaining them is business entertainment, with no relief.
Guests Reduce the VAT You Can Reclaim
You can reclaim the VAT on entertaining your employees – but not on their guests. A partner, friend or other guest isn’t an employee, so the VAT relating to their share of the event is blocked as business entertainment.
For example, say ten employees each bring a partner to a Christmas meal, making twenty people altogether. If everyone receives the same meal and the cost is £2,400 including £400 of VAT, half of the attendees are employees and half are guests.
You can therefore reclaim half of the VAT – £200. The other £200 relates to the ten guests and is blocked.
A per-head split is usually the simplest approach where everyone receives the same hospitality. If some guests or employees have materially different costs, use a fair allocation based on the actual expenditure instead.
An Event Only for Directors
A meal or party attended only by directors can be confusing because VAT, Corporation Tax and the £150 annual-party exemption each apply their own rules.
Say a small limited company has two directors and no other employees, and the company pays for their Christmas dinner:
- VAT – normally blocked: HMRC does not normally allow VAT recovery where entertainment is provided only to directors or partners. So even though the directors work for the company, the VAT on their dinner is generally not reclaimable.
- Corporation Tax – normally deductible: Directors are employees of the company for this purpose, so genuine staff entertainment can still be deducted from the company’s taxable profits. The VAT rule does not stop the underlying cost being deductible for Corporation Tax.
- The £150 exemption – can still apply: If those two directors are genuinely the company’s only employees, a Christmas party open to both of them is open to the whole workforce. Provided the other conditions are met and the cost is no more than £150 per head, there is no taxable benefit.
The position changes if the company has other employees. If the directors hold a private Christmas dinner and the rest of the staff are not invited, the £150 exemption does not apply to that event because it is not open to all employees.
The £150 Exemption Decides Whether Your Staff Are Taxed
Everything above concerns your business – what it can deduct and what VAT it can reclaim.
The £150 exemption answers a separate question, and confusing the two is the most common mistake made with entertainment. It has nothing to say about your business’s claim. It’s relevant to whether your employees have to pay tax on a staff party, because HMRC counts a party as a perk, and perks are taxable.
Why a Staff Party Is Taxable
When your business pays for a staff party, HMRC treats each employee’s share of the cost as a benefit in kind – the same category as private medical cover or a company car.
Each employee who attends is taxed on the value of their share, and the business owes employer’s National Insurance on the whole cost. That National Insurance is Class 1A, currently charged at 15%.
You can cover the tax for your employees yourself, through a PAYE Settlement Agreement. Under one, the business pays the tax rather than the employee. It’s a cost to the business, not a way of removing the charge.
The Three Conditions for Exemption
The annual function exemption removes both charges – the employees’ tax and the business’s National Insurance. It applies only where the event meets all three of the conditions below, and failing any one of them loses the exemption in full:
- Open to all staff: every employee has to be able to attend. With more than one site, an event for everyone at a single site still counts, and separate events for separate departments are fine, as long as nobody is left without one they can reach.
- An annual event: it has to be recurring, such as a Christmas party or a summer party. A one-off, like a party for the firm’s twentieth anniversary, doesn’t qualify, however lavish it is.
- £150 a head or less: the £150 has to cover the entire cost of the event, including the VAT and any extras such as taxis home or overnight rooms.
The £150 Limit Is All-or-Nothing
Two aspects of the £150 figure tend to cause trouble, so be especially aware of:
- That fact that it’s a limit, not an allowance. At £150.01 a head, you don’t get the first £150 tax-free and pay tax on the penny above. The whole amount becomes taxable. Going over by any amount loses the exemption entirely.
- You count everyone who attends, not just employees. The cost per head is the total bill divided by the number of people who turn up, guests included – not the number of employees, and not the number invited.
A Worked Example
Say you hold a Christmas party for 20 employees, and 12 of them bring a partner, so 32 people attend. The bill, including VAT, comes to £3,840. Divided by 32, that’s £120 a head, under £150, so the party is exempt – no tax for your staff, and no National Insurance for you.
Suppose the bill is £5,120 instead. That’s £160 a head, over the limit, so the whole £160 is taxable for every employee. An employee who brought a partner is taxed on £320 – their own £160 and their guest’s, since both attended at the business’s expense.
Holding more than one event in a year doesn’t give you £150 for each. The £150 is a single limit across all of them. Say you run two parties, one at £100 a head and one at £70. Together they come to £170, over the limit, so both can’t be exempt.
You apply the exemption to one, and you’d choose the £100 party, since it saves the most tax. The £70 party is then taxable in full. You can’t put half the £150 against each.
It Doesn’t Affect What Your Business Claims
This is the part most often tangled up, so it’s worth stating on its own. Whether the party comes in over or under £150 affects your employees, and only your employees. It has no effect on what your business can claim.
Spend £200 a head and the party is a taxable perk for your staff – or a cost you settle through a PSA – but the business still deducts the full cost from its profit, and still reclaims the VAT on the employees’ share. The deduction and the £150 exemption are two separate rules covering two separate taxes, and neither affects the other.
Client Entertainment vs Staff Entertainment at a Glance
The easiest way to understand the rules is to compare the two side by side. Client entertainment and staff entertainment can look similar in practice, but the tax treatment is very different.
| Client entertainment | Staff entertainment | |
|---|---|---|
| Deductible from taxable profit | Generally no | Generally yes |
| VAT reclaimable | Generally no | Generally yes, on the employee share |
| Non-employee guests | No relief | VAT on their share is blocked |
| £150 annual function exemption | Does not apply | Can apply to qualifying annual events |
| Taxable benefit for employees | Not relevant | Can arise if the £150 exemption is not met |
| Directors | Usually treated as business entertainment where clients are involved | Directors can count as employees for the tax deduction |
| Mixed staff and client events | Client share is disallowed | Genuine staff share can usually be claimed |
| Overseas customers | Corporation Tax relief still denied, but limited VAT exceptions can apply | Normal staff entertainment rules apply |
The important point is that the £150 rule does not decide whether the business can claim the cost. It only determines whether a qualifying annual staff event creates a taxable benefit for the employees attending. The Corporation Tax, VAT and employee-benefit rules each need to be considered separately.
Mixed Events and the Records to Keep
A client lunch is easy to classify. So is a Christmas party for the whole team. The harder cases are events where staff and clients attend together, because part of the cost may qualify for relief and part may not.
The other issue is evidence. HMRC can ask how an entertainment expense was treated long after the event, so you need enough information to show who attended, why the event took place and how you worked out the amount claimed.
Splitting an Event Between Staff and Clients
Where an event genuinely caters for both employees and clients, split the cost between them on a reasonable basis. If everyone receives the same hospitality, headcount is usually the simplest method.
For example, suppose a dinner costs £1,200 and is attended by six employees and four clients. If the cost is evenly shared, 60% relates to employees and 40% to clients. The employee portion can generally be deducted and the VAT on that portion reclaimed. The client portion is business entertainment – so it is not deductible and the VAT is blocked.
But headcount does not turn a client event into a staff event. If the evening is really being held for clients and the employees are there only to meet, serve or look after them, HMRC can treat their attendance as part of the client entertainment. In that case, you cannot simply carve out a staff share because employees happened to be in the room.
The Records HMRC Expects
Keep enough information to show exactly how you treated the expense. For each event, record:
- What the event was
- The date and total cost
- Who attended
- Whether each person was an employee, client or guest
- The business reason for the event
- How you calculated any split between staff and non-staff
- The cost per head, where relevant
Keep the invoice or receipt with those notes. If HMRC later questions the claim, you can then show how the treatment was worked out rather than trying to reconstruct the guest list and purpose months afterwards.
How Double Point Can Help
As you can see, there are quite a few nuances here, and they do trip businesses up regularly.
At Double Point, we make sure your entertainment is recorded and coded correctly in your accounts, that you reclaim the VAT you’re owed and none that you aren’t, and that a staff party stays inside the £150 exemption rather than becoming a tax charge in January.
If you’d like advice on entertaining clients or employees, how to account for it and the tax interactions, book a free consultation and we’ll go through it with you.