Tax Treatment of Entertainment Expenses

This article appeared on The SME paper, Malaysia on July 14 - July 27 issue 083

TAX TREATMENT OF ENTERTAINMENT EXPENSES

These are some of the questions commonly asked by my clients, my relatives and my friends on the treatment of entertainment expenses:

  1. Shin, I recently gave ang pow to my customer for his son's wedding. I consider the ang pow as my company's entertainment expense. Is the ang pow tax deductible?

  2. Shin, I buy an expensive lunch for a potential customer. I charged it to my company's entertainment expense, because I need to "entertain" him hoping to close the sales. Is the lunch expense tax deductible?

Now, before I reply yes or no (and more so to make sure that those who ask are truly convinced), I usually start with providing the definition of entertainment.

Definition of entertainment

Entertainment is defined in the Income Tax Act as (a) the provision of food, drink, recreation or hospitality of any kind and (b) the provision of accommodation or travel in connection with or for the purpose of facilitating entertainment of the kind mentioned in (a); by a person or an employee in connection with a trade or business carried out by that person.

So if we look back to question number (1), ang pow does not fall within the Income Tax definition of entertainment as it is cash contribution and is not provision of food, drink, recreation or hospitality of any kind. It is therefore not a tax deductible expense.

As for question number (2), buying an expensive lunch for a potential customer falls within the Income Tax definition of entertainment. However, entertainment provided to a potential customer is not allowed a deduction because it is not wholly and exclusively incurred in the production of gross income under subsection 33(1) of the Income Tax Act (entertainment for existing customer is allowed 50% deduction).

2 simple steps to determine the deductibility of entertainment

From the examples above, you can see that there are 2 steps in determining whether an entertainment expense can be allowed as a deduction:

Step 1: Does the expense fall within the definition of entertainment. If not, no deduction is allowed.

Step 2: If the expense falls within the definition determined in step (1), the taxpayer has to determine whether the expense is wholly and exclusively incurred in the production of gross income. If not no deduction is allowed.

The 3rd step: To determine whether entertainment is 100% OR 50% deductible

Step 3: Now the good news is there are 8 categories of entertainment expenses that are 100% tax deductible. Expenses incurred in the following entertainment will qualify for full deduction:

  Entertainment expense 100% deductible
1. Provision of entertainment such as food, drink and recreation to employees.

Examples - Free meals and refreshments for staff, annual dinners and family day.
Yes
2. A taxpayer whose business consist of providing entertainment to paying customers such as restaurant or cinema.

Examples - Meals provided by airlines or other transportation business to passengers and cultural shows provided by hotels or restaurants.
Yes
3. Promotional gifts at trade fairs, trade exhibitions or industrial exhibitions held outside Malaysia for the purpose of promoting exports.

Examples - Souvenirs, bags and travel ticket to visitors at trade fairs.
Yes
4. Promotional samples of tax payers' products

Examples - Free samples to guests at launching of product and giving away of health drink samples to school children.
Yes
5. Provision of entertainment for cultural or sporting events which are open to the members of public for the purpose of promoting the business. Yes
6. Promotional gifts within Malaysia consisting of articles incorporating a conspicuous advertisement or logo of the business. The promotional gifts need not be the product of the business as long as the business logo is affixed on those articles. The promotional gift should be given to the public on a non-discriminatory basis. Yes
7. Provision of entertainment which is related wholly to sales arising from that business.

Examples:

- Expenses incurred on food and drink during launching of a new housing project - Redemption vouchers and lucky draw prizes given for purchases made - Free gifts for purchases exceeding a certain amount - Redemption gifts based on a scheme of accumulated points - Free service charges or contribution to sinking fund by property developers - Expenditure on trips given as an incentive to dealers for achieving sales target - Expenditure incurred on refreshments given to its customers while waiting for their cars to be serviced.
Yes
8. Provision of benefit to an employee consisting of leave passage

Examples - Costs of travel to facilitate yearly event within Malaysia which involves employer, employee and immediate family members of the employee
Yes

Entertainment expenses which qualify under Steps 1 and 2 but which do not fall under any of the above categories of expenses are only allowed 50% deduction. Examples of such expenses include:

  Entertainment expense 50% deductible
1. Gifts without business logo for customer's annual dinner Yes
2. Gift of flower for customer's opening of new outlet Yes
3. Entertainment to existing customers or suppliers Yes
4. Hampers for customers during festive seasons Yes

In answering the questions asked by my clients, relatives and friends on the tax treatment of entertainment expenses I would normally conclude with a caution on the increasing importance to keep proper records (such as invoices, receipts and payment vouchers to support the claim) and to determine the appropriate tax treatment of entertainment expenses.

In the event of field audit by Inland Revenue Officers and additional 45% penalty will be imposed on top of the additional tax payable on discovery of any understatement of tax due to claims of expenses which are not tax deductible.