Entertainment Tax Explained
As a professional or consultant, your business success relies on developing and nurturing relationships. So choosing to pay for a client’s lunch, or shouting a Christmas dinner for staff and associates, is part of doing business.
I am guessing, however, that your invitations do not normally extend to the person you’ve dealt with at IRD. Whether or not that is the reason, the taxman hasn’t quite come to the party.
The general rule, for income tax purposes, is that expenses incurred in deriving income or running your business are fully deductible. I.e., we deduct the full expense from our income when calculating our taxable profit. However, the Income Tax Act limits the deduction of certain entertainment expenditure to 50% of the cost. The rationale behind the law is that these expenses provide a significant private benefit in addition to any business benefit.
So what expenses are limited and what can we claim in full?
50% Deductible Expenditure
The Income Tax Act limits the tax deduction to 50% of spending on:
- Corporate boxes, marquees etc at entertainment events and food and drink provided there
- Holiday accommodation or pleasure craft
- Food and drink provided away from your business premises, or at your premises if you’re having a social function
If you reimburse an employee for expenditure on these items, while the reimbursement may be a tax-free allowance to the employee, the cost will remain 50% deductible to the business.
Fortunately, not all expenditure on food and drink is subject to the 50% limitation.
Fully Deductible Expenditure
You can claim 100% of:
- Meals and accommodation when travelling for the principal purpose of business, unless you are also entertaining a business contact or attending a function
- Light refreshments provided at work including tea and coffee
- Light refreshments at a conference or professional development workshop
- Light refreshments that are incidental to a function, conference or seminar put on to promote your business
- A meal at a conference where the professional development or learning time exceeds four hours
- Meals for staff working overtime
- Food and drink when overseas on business
Consider These Examples
- A business consultant puts on a seminar after work for existing and prospective clients to promote the value of business planning for professionals. Drinks and nibbles provided are incidental to the primary purpose of the seminar and are therefore fully deductible.
- An Auckland architect travels to Wellington to discuss an upcoming project with a client. After their meeting, the architect takes the client to dinner. If the architect pays for both meals, it is entertainment and therefore 50% deductible. If the architect just pays for their own meal, it is fully deductible as a travel cost.
- The three partners of an Auckland IT Consultancy go to Fiji for an annual planning retreat. As food and drink overseas is not subject to the entertainment limitation, all expenses are fully deductible. However, if part of the expenditure is purely entertainment, this will be subject to Fringe Benefit Tax.
When Does the Expenditure Become a Fringe Benefit?
Entertainment, as above, refers to a business entertaining its staff or business contacts. If benefits are provided to employees, including shareholder-employees, which the employees can enjoy at their discretion, or it is provided overseas, it is no longer entertainment expenditure but becomes a fringe benefit.
For example, you buy your employee a restaurant voucher to use if or when they choose. This is a fringe benefit.
While Fringe Benefit Tax is a whole other area, basically, the business can claim the full cost of providing fringe benefits, but has to pay Fringe Benefit Tax on the value of the benefits.
What About Gifts?
If you give your staff cash, it will generally be considered part of their remuneration and subject to PAYE. Non-cash gifts to staff however are considered fringe benefits. As above, these are fully deductible to the business but subject to Fringe Benefit Tax.
The good news is that non-cash gifts of up to $300 per quarter (or $1,200 per year) per employee are generally exempt from Fringe Benefit Tax. Note however that if you exceed this threshold, the whole benefit is subject to Fringe Benefit Tax.
As the Fringe Benefit Tax rules apply to employer-employee relationships, gifts to clients and other business contacts are treated differently. They are generally fully deductible; however, gifts of food and drink to business contacts are subject to the 50% entertainment tax limitation. Keep this in mind when buying those Christmas hampers.
The business of professionals and consultants is built on relationships, so you may choose to spend some money showing your appreciation of those relationships. But before you splash out, make sure you understand the tax implications and manage your options accordingly.
Robb MacKinlay is an accountant and business advisor to professionals and consultants, helping them convert their expertise into profitable business.
Contact us with your business questions.