Sometime we get a client’s list of expenses from the year and it just makes us laugh! There are things listed
that clearly are not business expenses. Quite often there are things that are borderline, and there are always things that are simply unclear. In this article I want to address the topic of “Entertainment” expenses. Some things are just not deductible at all, some fully deductible, and some 50% deductible.
Section DD 1 of the Income Tax Act 2007 limits the deduction of entertainment expenses to 50% of the amount unless you have met some exceptions. “Entertainment” is defined (loosely) as food and drink and related expenses (including room & equipment hire, serving staff, entertainers, etc.). But it also includes corporate boxes, holiday accommodation and pleasure craft.
What this means is that if you incur an entertainment expense you may only deduct half of it unless you have satisfied one of the exceptions.
Entertainment provided/consumed during the following activities are fully deductible (code to 420 in our standard chart of accounts):
- travelling out of town on business or for overtime work where no client/prospect is present (includes tax-free meal allowances)
- business conference or training event that lasts for at least 4 hours (excluding meal times)
- promotional event available to the general public (such as a trade show)
- outside NZ
- light refreshments (including morning tea) provided on your premises during the normal course of your business (includes temporary premises other than entertainment purposes)
- providing meals to patrons at market value
- advertising or promotional samples to prospects or public
The following are only 50% deductible (code to 424 in our standard chart of accounts):
- corporate boxes, holiday homes, pleasure craft
- entertainment on your premises at a celebration meal, party, reception or similar social function that is not available to all employees working on the premises
- meals provided in an area restricted to senior management
- all entertainment off premises (in NZ) not covered by any of the 100% items above
The following are not deductible (code to 424 (with notes) or to Drawings in our standard chart of accounts):
- Entertainment that is not for business purposes (not connected with generating income)
- Any entertainment that could be deemed to be a private expense (e.g., lunch or cafe expenditure where there is no business contact present)
- Entertainment that meets the capital tests (shareholder events may satisfy this)
One of the biggest tests for deductibility is whether the entertainment is provided on or off-premises. Therefore the question of “temporary premises” needs some exploration. Section DD 11 of the Act defines “business premises” as “the normal business premises or a temporary workplace of the person (or an associate) but does not include premises or a workplace established mainly for the purpose of enjoying entertainment.”
So how do you treat that business lunch or meeting over coffee? If the expense is incurred/consumed at a bar, café or restaurant then it will only be 50% deductible (being premises established mainly for the purpose of enjoying entertainment), but if it was at a business centre or professional meeting location (even if catering is available on site) then it would be 100% deductible.
This is a hot area for IRD to audit or review. It is important that you document your expenses adequately – relying on the so-called “$50 receipt rule” may not serve you well here. For each item of expenditure you should document:
- the time and date of the event
- who attended
- the business purpose of the event
As a general rule – you should treat an item of entertainment expenditure as 50% deductible unless you have provided satisfactory support for a 100% claim.
Please note that the non-deductible portion of entertainment expenditure is also not claimable for GST purposes, so you will need to adjust your GST returns accordingly. There are some types of entertainment expenditure that can be subject to FBT rather than the entertainment rules (where the employee can enjoy the benefit at their discretion and outside their employment duties).
We take care of this automatically for Business Express clients when we prepare your GST return.