Can you claim a tax deduction for entertainment? Probably not, but maybe yes. It depends on four questions and a few specific rules. It is complicated and doesn’t just cover income tax, but affects FBT and GST as well.
Tax Deduction for Entertainment
A business expense is tax deductible. Entertainment is not. Unless entertainment is subject to FBT, then entertainment is deductible nevertheless. And GST follows whatever happens for income tax purposes. That is the short answer.
The long answer starts with one crucial question: What is entertainment? Once you worked this out, the rest will follow. So what is entertainment?
Entertainment is defined in s32-10 ITAA 97 and both FBT and GST leverage off this definition. But there is not a lot to go by.
s32-10 (1): Entertainment means (a) entertainment by way of food, drink or recreation and any transport or (b) accommodation or travel to do with providing entertainment by way of food, drink or recreation.
There is some additional guidance in the note to s32-10.
Note to s32-10: These are some examples of what is entertainment: Business lunches, social functions. These are some examples of what is not entertainment: meals on business travel overnight, theatre attendance by a critic, a restaurant meal of a food writer.
This is not a lot, but there is one important point here. Meals on business travel overnight is not entertainment.
Sustenance is not entertainment. Anything viewed as sustenance is not treated as entertainment. You won’t find this in Division 32 though. It is just a practical approach the ATO chose to apply.
So refreshments for example made available at a presentation to staff on business premises – think of muffins, sandwiches, biscuits, water, orange juice, tea or coffee – are sustenance in the eyes of the ATO and hence deductible as a business expense.
TR 97/17: 4W Rule
But coming back to s32-10, it basically just says that entertainment is….entertainment.
Realising how unhelpful this is and to clarify the concept of entertainment, the ATO issued TR 1994/17. Based on this ruling the ATO looks at entertainment in the context of four questions.
They are four very simple questions — why, what, where and when – to see whether an expenses is entertaiment or a business expense. And it is not one question that will decide it all, but the balance of your answers to all four questions. Let’s call this set of 4 questions the 4W Rule.
Why did you do it? For a social reason or business? Taking a client out to lunch is a solid business reason. Taking out a friend is not.
What did you have? Was it purely functional or lavish? Sandwiches, muffins and coffee hint at a business meeting. A lavish four-course meal with plenty of alcohol doesn’t. At least not today. In the ’90s it probably would have. Alocohol weakens your What in a huge way. In the eyes of the ATO alcohol and business don’t mix. But there are exceptions. There are always exceptions. It would be boring otherwise.
Where did you do it? A weak Where can undermine your claim. If the food and drink is consumed on premises, it will back up your claim that the expense is a business cost. Being at a restaurant or café is still ok, but you need the When to back you up.
When did you do it? If the food and drink expense is incurred during business hours, it supports your claim of a business expense. If it is at night, it doesn’t.
So now you wheigh up your answers to all four questions. Your Why and your What are crucial. If you don’t have a solid back up for those two, it probably isn’t a business expense but entertainment. But your Where and When shouldn’t completely undermine your Why and What. The four answers should tie together and make sense. So this is the general rule. Let’s call it the 4W-Rule.
Lavish business lunches were a common feature in the 80’s and 90’s in Australia. And Division 32 was to put a stop to all that. That’s why the legislator proclaims in s32-10:
s32-10 (2): You are taken to provide entertainment even if business discussions or transactions occur.
And just in case there is any doubt, the Note to s32-10 declares:
Note to s32-10: These are some examples of what is entertainment: business lunches and social functions.
So if we didn’t have TR 97/17 and just had to go by s32-10, no business lunch would be tax deductible.
But the Commissioner relented in TR 97/17. The 4W Rule says if you discuss business and the why, what, where and when supports the notion of a business purpose, then it is not entertainment. So the 4W Rule opens a backdoor back in for some business lunches to be tax deductible.
So now you know whether a specific expense is entertainment or not. The next question is whether you can claim a tax deduction for this expense. And it starts with a clear Yes or No answer.
If it is a business expense: Yes
s8-1 (1): You can deduct from your assessable income any loss or outgoing to the extent that (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.
If it is entertainment: No
s8-1 (2): However, you cannot deduct a loss or outgoing under this section to the extent that (d) a provision of this Act prevents from you from deducting it.
s32-5: To the extent that you incur a loss or outgoing in respect of providing entertainment, you cannot deduct it under s8-1.
So that is a clear answer. Yes or No. But there is a ‘however’ in s32-5.
s32-5: To the extent that you incur a loss or outgoing in respect of providing entertainment, you cannot deduct it under s8-1. However, there are exceptions which are set out in Subdivision 32-B.
And this Subdivision 32-B is a whole different story.
The first big exception is in s32-20 and is about FBT. If you pay FBT for an expense, then you can deduct the expense even though it is entertainment.
s32-20: Section 32-5 does not stop you deducting a loss or outgoing to the extent that you incur it in respect of providing entertainment by way of providing a fringe benefit.
The other exceptions are listed in tables for s32-30 Employer expenses, s32-35 Seminar expenses, s32-40 Entertainment industry expenses, 32-45 Promotion and advertising expenses and s32-50 Other expenses.
They all follow the same format and that is: Section 32-5 does not stop you deducting a loss or outgoing for X. But the exception does not apply if Y. That is the format.
Some of these exceptions are rabbit holes that require an entire article to explore. Anything to do with an in-house dining facility for example. But here are two common exceptions.
s32-35 Seminar expenses
If you incur entertainment expenses at a seminar, you can deduct these entertainment expenses. It doesn’t matter how lavish the meal and whether there is alcohol involved. The 4W rule doesn’t apply here.
But it does matter how long the seminar is. The threshold is 4 hours.
s32-35 2.1: Section 32-5 does not stop you deducting a loss or outgoing for providing food, drink, accomodation or travel to an individual …that is reasonably incidental to the individual attending a seminar that goes for at least 4 hours.
It says seminar in s32-35 but s32-65 (1) expands that.
s32-65 (1): Seminar includes a conference, convention, lecture, meeting…, speech, question and answer session, training session or education course.
s32-45 Promotion and advertising expenses
If you incur entertainment expenses to promote or advertise to the public, you can claim a deduction. This would cover a product launch or other public promotional events for example. But it is a grey area because of the But in this.
s32-45 4.3: Section 32-5 does not stop you deducting a loss or outgoing for providing entertainment to promote or advertise to the public a business or its goods or services. But the exception does not apply if some people have a greater opportunity to get the benefits of the entertainment than ordinary members of the public have.
And the But in this is often overlooked. If you invite a business friend out for dinner, other members of the public clearly can’t join you. So you need to go back to the 4W rule.
So now you know whether a specific entertainment expense is tax deductible for income tax purposes. If it is entertainment and an exception applies, it is tax deductible. If it is entertainment and no exception applies, it is not.
GST just follows all this. Whatever is tax deductible as a business expense, gives rise to an input tax credit. So if the ATO labels something as entertainment and throws the tax deduction out the window, then the input tax credit flies along.
FBT uses the definition of entertainment in s32-10 ITAA 97. There are several ways you can treat entertainment for FBT purposes, but whatever you pay FBT on, is tax deductible for income tax purposes per s32-20. So you never pay FBT and loose the tax deduction. You only get hit once, not twice.
Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 23 March 2020