Entertaining, subsistence and travel: the inputs and outputs
When can a business claim input VAT on employee costs such as travel, subsistence and entertaining? And when an employer recharges such costs to a client are these subject to VAT? – or are recharges for costs such as rail and air travel zero-rated? It is not always as clear cut as you might think. In addition, just because input VAT may be claimable, it doesn’t necessarily follow that the expense is deductible for direct tax purposes.
Let us take the example of John, the audit partner of a firm of accountants. When working at clients’ premises, he has lunch in a nearby pub or restaurant, usually accompanied by a member of his audit team, and perhaps also by one or two directors of the client company. Can input VAT be claimed on the lunch costs? Would the situation be different if the clients came from outside the UK?
In effect, there are three different categories of people involved in this arrangement:
- The client’s directors/employees
- The audit staff
- John himself as the business owner
The client’s directors/ employees
The first key point is that no input VAT deduction can be made for the ‘customer’ meals. The expense here is classed as ‘hospitality of any kind’ (art. 5(3) of Value Added Tax (Input Tax) Order 1992 (SI1992/3222), and therefore is classed as business entertainment within the VAT regulations. The only exception would be if the customer was an ‘overseas customer’ and the expense related to a ‘business meeting’.
But what is an overseas customer? It is not simply someone with a foreign sounding name; the individual must not be ‘ordinarily resident, and not carrying on a business in, the UK or the Isle of Man. He must also be a customer or client of the business providing the entertainment, or be a potential customer or client. Even if that condition is satisfied, the entertainment must be ‘of a kind and on a scale which is reasonable having regard to all the circumstances’. Essentially this will limit the input tax recovery to meals which have a ‘strict business purpose’, e.g. working lunches, where the provision of food is solely to enable a meeting to proceed without interruption. Input tax suffered on corporate hospitality events, e.g. race meetings, theatre visits, etc. will not satisfy this test.
Even if input tax is allowable, there may be instances where output VAT on ‘private use’ effectively cancels out the input tax. Such a private use charge will, according to HMRC Notice 700/65/2012, para. 2(6), arise where anything other than sandwiches and soft drinks are provided during a business meeting. Hospitality provided after the meeting, a couple of pints in the nearest pub or a meal in a restaurant will lead to a private use charge. The accepted alternative is not to claim the input tax in the first place.
Even in the perhaps unlikely event that input VAT was reclaimable, the cost of that entertaining would not be an allowable deduction for income tax or corporation tax.
The firm’s employees
If the client is being entertained by the audit manager, and John is absent, the question needs to be asked whether the cost of the manager’s meal is being incurred because he is ‘acting as host’ to the client. If so, input tax is also blocked on that cost through the business entertaining rules described above.
However, if (as may often be the case) the meal cost for the manager is being incurred because he is away from his normal office on a business related job (the audit), then input tax attributable to that cost can be claimed because the expense is classed as ‘subsistence’ rather than ‘entertainment’. Input tax would also be claimable if the employer paid for hotel accommodation for the employee as well.
Perhaps the only time when an employee might be acting as host would be if the meal was taking place near the employee’s normal office.
As a practical example of how the rules can get tricky, what is the situation when a company hires a 12-seater box at a top football match, which will be enjoyed by 6 employees and 6 non-employees? In this situation, at least 50% of the input tax on the cost of the box will be blocked by the business entertaining rules for the non-employees, and it then needs to be considered what role the employees are expected to carry out on the day of the match. If their function is to make sure the guests have an enjoyable time, and place lots of future business orders with the company, then input tax on the employee expenses will also be blocked because they are acting as hosts to the non-staff. But if they are able to enjoy the game as some kind of reward or incentive, without any entertaining function, then input tax can be claimed on their part of the cost. However is it likely that the employees attending will not be expected to look after the clients? So it would seem that it would only be if all 12 attendees were the firm’s employees that the input tax would be allowable. (The position gets even more complex if the firm hired the box for the whole season, rather than just one match, and paid the cost up front. At that point the firm will have no idea who will be attending which match!)
There is no problem (for input tax purposes) with an employer paying for employee meals generally, e.g. the cost of the office Christmas party, a meal out at a local restaurant following a good trading month. In such cases, the expense is seen as a reward for hard work or a motivational expense and is for a clear business purpose. It is only input tax on entertaining non-employees that is blocked (or employee costs where they are clearly acting as hosts). In contrast for direct tax purposes the cost of a staff function is an allowable deduction even where those attending include past employees, their partners and the partners of present employees, but not where the provision of that entertainment was incidental to entertaining others.
Key Message - as a planning tip, if a small charge is made to non-employees attending an event (eg spouses attending the staff Christmas party) then input tax can then be claimed on the costs of the guests hospitality because there is no longer a ‘free meal’ situation. But output tax must be accounted for on the payments made by the guests.
Input tax can be claimed on lunches for the business owner (audit partner) in my example, as long as they are classed as ‘subsistence’ – usually indicating a business purpose that is away from the main trading premises of the business (HMRC Notice 700, para 12.1.2). As a guideline, a claim should not be a problem if the business meeting/audit work is at least five miles away from the main trading base.
There is also no problem claiming input tax on the cost of meals for business owners where entertainment is available to staff generally within the firm eg the office Christmas party. But there would be a problem if the director or partner entered local restaurant meals into his records and claimed input tax. (HMRC Notice 700/65, para 3.2) In this latter case no deduction would be allowed in computing the firm’s direct tax liability.
Mileage expenses – input tax opportunity
It is very common for an employer to pay employees a mileage rate for business journeys in their own vehicles. A rate of 45p per mile is common (for the first 10,000 miles in a tax year, then reducing to 25p per mile) because this is the maximum payment that can be made without a benefit-in-kind implication. But how much input tax can be claimed on mileage payments?
- The starting point is that the employee must attach petrol receipts to his mileage claim as a condition of the employer being able to claim some input tax. The amount of VAT shown on the petrol receipts is irrelevant but it should exceed the actual input tax claimed by the employer.
- The employer can now claim input tax claim based on the ‘road fuel’ element of the mileage payment. This amount is obviously lower than the 45p total payment to the employee. HMRC assist this process by producing quarterly fuel advisory rates, taking into account the movements in fuel prices depending on the cc (cylinder capacity) size of the vehicle. The rates below took effect on 1 September 2014.
|Up to 1400cc||14p||9p|
|1401 - 2000cc||16p||11p|
|Greater than 2000cc||24p||16p|
|Up to 1600cc||11p|
|1601 - 2000cc||13p|
|Greater than 2000cc||17p|
Key Message – this is one of the few opportunities when an employer can claim input tax on a payment that is not based on the actual VAT amount shown on a purchase invoice. But the key challenge is to make sure that employees retain their petrol receipts and attach them to their relevant expenses claim.
Recharging expenses to a client – VAT or no VAT?
Brian is a computer consultant who has travelled from London to Edinburgh to carry out some work at the offices of a client. His fee is £1,000 and his return rail fare is £300. He raises his sales invoice as follows, which is on exactly the same basis as he has raised invoices since he started trading in April 2005.
|Attended your offices as agreed:||1,000|
|Expenses - first class return rail fare||300|
|VAT charged on £1,000 @20%||200|
What is the supply?
When a business recharges expenses to a customer, eg travel expenses, the VAT liability of the expenses follows that of the main service being performed. In the Brian situation, he is not providing a rail ticket to his client – only computer services. The supply of zero-rated rail travel (zero-rated as a form of transport carrying more than ten passengers) is between Brian and the rail company. The whole of Brian’s charge is standard rated as relevwant to computer services. The correct invoice is as follows:
|Attended your offices re project X||1,000|
|Expenses - first class return rail fare||300|
|VAT charged on £1,300 @20%||260|
Brian has underpaid output tax on his VAT returns since April 2005 – and should correct this underpayment on his next VAT return now that he is aware of the problem (assuming the net underpayment of tax is less than £10,000 or £50,000 and 1% of his Box 6 turnover figure – if it exceeds these limits, disclosure must be made to HMRC on form VAT652). The good news is that he only has to go back four years (the error correction period that applies to errors on past VAT returns), so some of the errors are out of time.
Key Message – always consider the question about what goods or services are being supplied to the customer. Expenses recharged as part of the goods or services supplied then follow the same VAT liability.
As a final practical situation, imagine that you own a building business, and use a combination of subcontractors and employed builders to carry out the various jobs. You agree to pay the petrol bills of the subcontractors who use their own vehicles (if they give you a petrol receipt) as well as their meal and hotel costs for jobs that are away from your local area. What is the input tax position in relation to the subcontractor expenses?
The good news is that input tax can be claimed on the ‘subsistence’ costs relevant to the subcontractors, as long as they get the same treatment in terms of expenses as employees on the same job, but there is no scope to make a claim on any of their travel expenses ie the road fuel (HMRC Notice 700/65, para. 2.3).
By Neil Warren
Neil is an independent VAT speaker, author and consultant, who also serves on the Association’s Technical Steering Group. He was Taxation magazine’s Tax Writer of the year in 2008.