Most businesses entertain customer, suppliers and useful business contacts from time to time. It has long been the case that tax relief is not available on entertaining expenses, but in large companies, employees whose role includes entertaining will always seek to reclaim these expenses to avoid being out of pocket.
The position with a one person company is different. Many accountants advise such clients not to seek reimbursement for entertaining expenses from their own company because it doesn’t achieve a tax saving. This is particularly so where a person is only able to draw dividends within the basic rate tax band. Even if the company is retaining modest profits each year it is likely that those profits will eventually be drawn tax efficiently or tax free at a later stage. Claiming entertaining (and reducing dividends accordingly) does make sense for higher rate taxpayers and those who accumulate large profits each year.
All of this is set to change from 6 April 2016 with the introduction of the dividend tax. An individual will see his overall tax liability reduce if he recharges entertaining expenses to his company and reduces dividends by the same amount. The following example explains this.
Samantha is a Management Consultant who provides her services through a limited company of which she is the sole director and shareholder. For the year to 5 April 2017 Samantha plans to take a salary of £11,000 and dividends of £40,000. She expects to pay tax on the dividends as follows:
She also expects to incur entertaining expenses of £3,000 which she intends to pay personally.
She runs the idea by accountant Edward Peters and he makes an alternative suggestion. He recommends that Samantha charges the entertaining expenses to her company and reduces her dividends to £37,000. Her net disposable income remains the same as does her company’s corporation tax liability, because entertaining expenses are not tax deductible. Her tax on dividends is now as follows:
Care needs to be taken when claiming entertaining expenses. Although tax relief is not available, the expense itself must be business related. So whilst it is perfectly acceptable to entertain clients, suppliers and business contacts, if a director entertains his friends and family, that is not business entertaining. If this was charged to the company, the correct treatment is to record it as a benefit in kind. The director will then pay tax on it personally, despite the fact that his company has been denied tax relief.
Care should also be taken to ensure that the expenditure could not be classed as a bribe. So an IT Contractor taking his manager for lunch to discuss a contract renewal is fine, but if instead a contract extension was achieved by providing an all expenses paid weekend in Paris for the manager and his wife, that would not be acceptable as entertaining.
And as for Samantha, well, the first person she entertained was Edward Peters as a thank you for his services generally. They went to an Italian restaurant for a two course meal and a bottle of house wine. Samantha’s company paid the £80 bill.