Business entertainment expenses occupy a unique space in South African tax law. While they may or may not be deductible for income tax purposes under strict rules, a deduction of input VAT on these expenses is generally not allowed.

Income tax deduction? What the law says…

Under Section 11(a) of the Income Tax Act, an expense must satisfy four conditions to be deductible. It must be:

1. actually incurred
2. in the production of income
3. expended for the purposes of trade; and
4. not of a capital nature

As Judge Watermeyer explained in the landmark Port Elizabeth Electric Tramway Co v CIR case, expenses are deductible when they are “so closely linked to such acts as to be regarded as part of the cost of performing them.” In other words, you must be able to show that the entertainment was genuinely incurred for an income-producing business purpose and was sufficiently closely connected with your trade.

The “production of income” test is the key battleground in entertainment expense disputes. Expenses such as meals, venue hire, and live entertainment may be deductible if the event has a genuine business purpose, for example, entertaining clients or suppliers.

The purpose of the entertainment must be demonstrably commercial. You are required to retain sufficient records to demonstrate compliance with tax law. This might be in the form of a documented agenda or meeting notes, or a comprehensive function schedule including the date, venue, attendees, and the specific business objective.

VAT? Almost never…

Even if an entertainment expense qualifies for an income tax deduction, you generally cannot deduct input VAT on entertainment such as client meals, beverages, or hospitality. That’s because Section 17(2)(a) of the VAT Act explicitly prohibits input tax deductions on entertainment.

Entertainment is broadly defined in the VAT Act as “the provision of any food, beverages, accommodation, entertainment, amusement, recreation or hospitality of any kind.” This covers:

• staff refreshments (tea, coffee, snacks)
• business lunches and dinners
• catering for staff canteens
• annual functions (venue hire, entertainment, staff costs)
• marketing promotions and events
• entertaining clients at restaurants, bars and nightclubs

The exceptions

There are nine express exceptions to the prohibition on input VAT recovery for business entertainment expenses, of which two are especially important.

1. Where the vendor is in the business of supplying entertainment (to either customers or employees), the vendor may generally claim VAT on inputs used to make its taxable supplies, provided the statutory requirements are met. SARS explains that the entertainment must generally be supplied for consideration intended to cover the direct and indirect costs, or meet the relevant open-market-value rules.
2. Input VAT may generally be claimed on an employee’s qualifying meals and accommodation where the employee is required by their duties to spend at least one night away from both their usual residence and usual workplace, and the trip relates to making taxable supplies on behalf of the vendor.

Ducks in a row

The Tax Administration Act places the burden of proof on the taxpayer. To satisfy SARS during an audit, you must maintain contemporaneous records for every entertainment claim and retain these for at least five years from the submission date of the return in which the expense was claimed.  It’s a good idea to include the following:

1. Date and location of the event
2. Full names and company details of clients and staff present
3. A specific description of the business purpose or commercial discussion
4. Itemised tax invoices and proof of payment

Mind the audit

Professional advice is strongly recommended before claiming entertainment expenses, because a claim for entertainment expenses is likely to be flagged for investigation by SARS.