The taxman's a party-pooper

Virtually all entertaining - even the staff social - means a tax penalty for someone

One of the most famous business sayings is that there is no such thing as a free lunch. The truth of that is something I leave you to judge, but one certainty is that virtually all entertaining has a tax cost.

The basic thrust of the tax system is that entertaining leads to a tax penalty for someone. There are exceptions, but anyone planning a function should bear in mind that a corporation tax disallowance - or an income tax charge - may be waiting in the wings.

Add a VAT disallowance that will likewise be lurking and that pounds 100 lunchtime gathering can be up to an equivalent pounds 150 spend. (I'll concentrate on income and corporate tax in this article but VAT irrecoverability basically parallels corporate tax disallowance). The extra tax cost can fall on the business (or employer if you prefer it) or, at least in part, on the individual.

Starting with the business, entertaining spending is essentially tax disallowable. Entertaining is not just that lunch either - it means 'hospitality of any kind". Thus overnight accommodation for a consultant or sub-contractor counts as entertaining - and is therefore disallowable. Better to let the sub-contractor pick up the hotel bill (as subsistence) and recharge it (as expenses) perhaps.

There is one tiny, and one large, exception to this general disallowance. The tiny one relates to gifts. A gift counts as entertaining and is thus disallowable - but not if it costs under pounds 10, is not part of a series and carries a prominent advert for the donor. That probably covers the pen I am writing with - but not a bottle of Scotch because food, drink and related vouchers are excluded.

The major exception is staff entertaining. Some may remember entertaining overseas customers being allowable, but that went in 1988. There is a rule of thumb that anything for staff is tax-deductible for the employer - not a foolproof rule but it works here. The rationale is that there is always the opportunity to tax the individual. And that gives us the link to the second half of this issue - the fact that staff entertaining can lead to a benefit-in-kind income tax charge.

You may start to question this - after all, all those staff functions you went to were working lunches, or necessary staff socials to maintain morale. But, like it or not, there is a benefit here for the staff concerned. The Revenue will argue that benefit is taxable.

Such charges are often raised through PAYE audits carried out by the Revenue, with the employer frequently agreeing to settle the tax due on the employees' behalf. This doesn't always happen - and I know one sizeable employer which warns the staff of the value of social functions so they can declare it on their tax return.

Again there are exceptions. Many readers will be aware that there is a concession for a Christmas party. Actually, the Revenue allows party costs up to pounds 75 per head before raising a charge - and that doesn't have to be at Christmas. But it is all you get for a year and to count it has to cover the entire cost of one or more functions, not the first first pounds 75 of some mega-bash.

With self-assessment now upon us, "third party" benefits are an issue. If someone other than your employer gives you a benefit, that may also be taxable. Normally hospitality won't count in this argument: remember it will have been disallowed on the "entertainer" - who will see it as non-staff entertaining. But go beyond this to an outright gift, prize or something similar and there is a taxable benefit looming.

Under self-assessment, the provider has an obligation to report benefits given in this way to the individual concerned. A value also has to be put on them, on a "cost to the provider" basis, so that the recipient can put the item on his or her tax return if appropriate.

It has to be said that we are getting into controversial areas here, not least because many such recipients are self-employed under different tax rules. For example, many travel writers would not see a benefit in a trip that is undertaken to write about a particular destination. But if their partner went with them, or if the trip was given to someone not involved with travel writing, there could be tax-sickness as well as travel-sickness from the trip.

All in all, entertaining is a fruitful area for the taxman to check up on. It may seem unfair, but don't forget that few people entertain the taxman.

John Whiting is a tax partner at Price Waterhouse