Private ruling: Deductibility of entertainment expenses
Date of advice: 18 April 2017
Published: September 2017
Ruling period: 1 July 2016 to 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Are “Boat Expenses” (defined in the facts below) incurred in relation to the purchase and maintenance of a coastal vessel deductible under section 8-1 of the Income Tax Assessment Act 1997 ( “ITAA 1997” )? | A1: Yes, partially. | Q2: If Fringe Benefits Tax (FBT) applies to the Boat Expenses, will the amount of the benefit subject to FBT be apportioned between the directors/employees and clients? | A2: Yes. | Q3: Are the “Meal Expenses” (defined in the facts below) incurred in relation to the cost of food, drink and refreshments deductible under section 8-1 of the ITAA 1997? | A3: Yes.

Relevant facts and circumstances: The Company is based in City A and its directors and employees reside in City A. The Company also conducts business in City B, and is considering the purchase of a coastal vessel (fishing boat) to use in the City B region. The sole purpose of the coastal vessel is for the promotion of business, by building rapport and relationships with business clients in City B. The coastal vessel will only be used by the Company's directors and employees while in City B conducting business. The Company currently owns another coastal vessel, which is located in City A and held for purposes relating to private use . At no time will any directors or employees use the coastal vessel in City B for private purposes or any purposes not relating to providing entertainment to clients. One or more of the Company's directors or employees will be present at all times on the costal vessel while it is being used to entertain business clients. The following expenses will be incurred in relation to the use of the coastal vessel: a. The purchase price of the coastal vessel; fuel costs; annual servicing; trailer registration; and insurance (the “Boat Expenses” ); and b. The cost of food, drink and refreshments (the “Meal Expenses” ).

Relevant legislative provisions: Income Tax Assessment Act 1997, section 8-1 | Income Tax Assessment Act 1997, section 32-5 | Income Tax Assessment Act 1997, section 32-10 | Income Tax Assessment Act 1997, paragraph 32-10(1)(a) | Income Tax Assessment Act 1997 , subsection 32-10(2) | Income Tax Assessment Act 1997, section 32-15 | Income Tax Assessment Act 1997, section 32-20 | Income Tax Assessment Act 1997, section 32-45 | Fringe Benefits Tax Assessment Act 1986, section 45 | Fringe Benefits Tax Assessment Act 1986, section 136

Reasons for decision: Summary: Prima facie, section 32-5 of the ITAA 1997 will preclude the Boat Expenses from deductibility, as they will fall under the category of “entertainment expenses”. However, under section 32-20 of the ITAA 1997, entertainment expenses incurred in the course of providing a “fringe benefit”, as defined under subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 ( “FBTAA 1986” ), will not be precluded from section 8-1 deductibility. Therefore, to extent that the Boat Expenses will be incurred in the course of providing a fringe benefit (use of the vessel), they will be deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - i. Deductibility under section 8-1: Section 8-1 of the ITAA 1997 allows for the deduction of expenses incurred in earning or producing assessable income. However, paragraph 8-1(2)(d) states that a loss or outgoing is not deductible where a provision of the Act prevents you from otherwise making a deduction. Importantly, the exclusionary rule contained under section 32-5 of the ITAA 1997 prevents deductions for “entertainment expenses” under section 8-1 of the ITAA 1997. Therefore, if the Boat Expenses amount to “entertainment expenses” in the present case, they will not be deductible under section 8-1. | Detailed Reasoning - i. Meaning of entertainment: “Entertainment” is defined as entertainment by way of food, drink or recreation under paragraph 32-10(1)(a) of the ITAA 1997. For the purposes of section 32-10 of the ITAA 1997, entertainment is still taken to occur in the context of business discussions or transactions. Further, pursuant to subsection 32-10(2), business lunches or social functions are provided as common examples of entertainment expenses. In relation to the Company, the Boat Expenses incurred in respect to the coastal vessel constitutes entertainment expenses as the use of the coastal vessel is in connection with the provision of entertainment by way of food, drink or recreation as defined in section 32-10 of the ITAA 1997. Additionally, the Company's directors and employees' use of the vessel will still be regarded as entertainment in the event that business discussions or transactions take place on the vessel with clients. Accordingly, as the Boat Expenses relate to entertainment, section 32-5 of the ITAA 1997 will preclude the Company from making any deductions for the Boat Expenses under section 8-1 of the ITAA 1997. | Detailed Reasoning - ii. No deduction for property used for providing entertainment: Further, section 32-15 of the ITAA 1997 effectively provides that expenses incurred in respect of property used for providing entertainment are not deductible. The Boat Expenses are not deductible under section 32-15 of the ITAA 1997 for property used for providing entertainment. As the Company is using the property (i.e. the vessel) to provide entertainment, the expenses will not be allowable deductions under section 8-1 of the ITAA 1997. | Detailed Reasoning - iii. Exceptions to non-deductibility under section 32-5: Although the Boat Expenses are prima facie not deductible under section 32-5 of the ITAA 1997, there are various exceptions to this exclusionary rule contained in Subdivision 32-B of the ITAA 1997. | Detailed Reasoning - Promotion and advertising expenses: Item 4-3 of section 32-45 of the ITAA 1997 provides that section 32-5 does not preclude a deduction for entertainment expenses if they are incurred in providing entertainment to promote or advertise a business. However, item 4-3 stipulates that promotion and advertising expenses will not be allowed if “some people have a greater opportunity to get the benefits of the entertainment than ordinary members of the public have”. In the present case, given only directors/employees and clients are permitted on the coastal vessel, the benefit of entertainment (i.e. use of vessel) will not be offered to general members of the public. Therefore, the Boat Expenses will not be deductible under section 32-45 of the ITAA 1997. | Detailed Reasoning - The main exception - fringe benefits: Section 32-20 of the ITAA 1997 provides that section 32-5 does not prevent deductions for entertainment expenses to the extent that they are incurred in providing entertainment by way of providing a fringe benefit. | Detailed Reasoning - i. Meaning of fringe benefit: For the Boat Expenses to be deductible under section 32-20 of the ITAA 1997, the items must be considered a “fringe benefit”. The meaning of “fringe benefit” is provided under subsection 136(1) of the FBTAA 1986. Hence, the following elements contained under the stated definition must be satisfied to constitute a fringe benefit: The benefit must be provided by the employer (or associate) to an employee (or associate) in respect of the employment during the year of tax. | Detailed Reasoning - a. Meaning of entertainment: Subsection 136(1) of the FBTAA 1986, adopts the meaning of entertainment as per the definition provided under section 32-10 of the ITAA 1997, discussed in question 1 of the ruling. | Detailed Reasoning - b. Meaning of benefit: Paragraph 136(1)(e) of the FBTAA 1986 broadly defines “benefit”, to include any right or privilege provided in respect of employment. The benefit identified under the arrangement is the “use” of the coastal vessel, by way of recreation, provided by the Company to its directors/employees. | Detailed Reasoning - c. Residual benefit: The Boat Expenses is considered a residual benefit in accordance with section 45 of the FBTAA as the “benefit” (i.e. use of the coastal vessel) does not fall within the meaning of the other categories listed under Divisions 2 to 11 of the FBTAA. | Detailed Reasoning - d. Meaning of employee: Subsection 136(1) of the FBTAA 1986 defines employee to include current, future or former employee who is entitled to receive salary or wages. This element is satisfied as, the benefit will be provided to the Company's current employees. | Detailed Reasoning - e. Meaning of “in respect of the employment”: The Boat Expenses must be provided by the Company to its directors/employees in respect of their employment for it to constitute a fringe benefit within the meaning of subsection 136(1) of the FBTAA 1986. Therefore, in accordance with subsection 136(1) of the FBTAA 1986, the phrase “in respect of” is given to include by reason of, by virtue of, or for or in relation directly or indirectly to, the employment of the employee. Moreover, in J and G Knowles and Associates v FC of T 2000 ATC 4151, the Full Federal Court contended that a sufficient or material connection, rather than a causal connection must be established between the benefit provided and the employment for a fringe benefit to exist. Thus, it is established there is a sufficient or material connection between the entertainment benefit provided by the Company to its directors/employees and their employment. The required nexus exists as the Company's directors/employees receive the benefit only in their capacity as an employee, which is in the course of their employment. Hence, in respect of subsection 32-20 of the ITAA 1997, the use of a coastal vessel in relation to providing entertainment by way of food, drink or recreation constitutes a fringe benefit under subsection 136(1) of the FBTAA, and as such is deductible under section 8-1 of the ITAA 1997. The Company will need to determine the taxable value of the use of the coastal vessel by the employees. This value will not be reduced by the otherwise deductible rule as section 32-5 would prevent the employees from deducting the expenditure if they had incurred it. | Detailed Reasoning - Question 2: If FBT applies to the Boat Expenses, will the amount of the benefit subject to FBT be apportioned between the directors/employees and clients? | Summary: Yes. The amount of the benefit subject to FBT will be apportioned on either a “per head” basis or an “exact expense” basis. | Detailed Reasoning - Detailed reasoning: Although entertainment provided by an employer may give rise to a FBT liability, Taxation Determination TD 94/25 provides that only that part of the benefit which relates to entertainment provided to an employee (or an associate of an employee) will be subject to FBT. Accordingly, where entertainment is provided to both employees and non-employees (e.g. clients), only that part of the benefit which relates to entertainment provided to employees is subject to FBT. TD 94/25 further provides that where that part of the benefit which relates to employees only is not easily extracted from the available information, the Commissioner will accept a "per head" basis of apportionment or an “exact expense” basis of apportionment, unless an election to apply Division 9A of the FBTAA 1986 has been made. Here, Division 9A of the FBTAA 1986 is not applicable as that Division applies only to meal entertainment expenses. Therefore, in relation to the Boat Expenses, the Company must apportion the amount of the benefit using either the “per head” or “exact expense” method of apportionment in order to determine the amount which will be subject to FBT. | Detailed Reasoning - Question 3: Are the Meal Expenses incurred in relation to the cost of food, drink and refreshments deductible under section 8-1 of the ITAA 1997? | Summary: The Meal Expenses do not constitute 'entertainment' for the purposes of section 32-5 of the ITAA 1997, and therefore are deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Meaning of meal entertainment: As discussed in Question 2 above, the exclusionary rule contained under section 32-5 of the ITAA 1997 prevents deductions for “entertainment expenses” under section 8-1 of the ITAA 1997. Therefore, to the extent that the Meal Expenses constitute entertainment, they will not be deductible under section 8-1. Taxation Ruling TR 97/17 provides guidance on determining whether the costs associated with the provision of food or drink will constitute “meal entertainment” for the purposes of the ITAA 1997. Importantly, it outlines factors that should be considered in making this determination, including: a) Why the food or drink is being provided Food or drink provided for the purposes of refreshment will not generally have the character of entertainment, whereas food or drink provided in a social situation has the character of entertainment; b) What food or drink is being provided Light meals and refreshments are generally not considered entertainment; whereas a three-course meal provided to an employee is likely to constitute entertainment; c) When the food or drink is being provided Food or drink provided during work hours is less likely to have the character of entertainment; whereas food or drink provided outside official work hours; and d) Where the food or drink is being provided Food or drink provided on the employer's business premises is less likely to have the character of entertainment; whereas food or drink provided in a function room, hotel, restaurant or café is more likely to have the character of entertainment. Furthermore, Taxation Rulings IT 2675 and TR 97/17 provide that expenditure that is incurred in providing food and drink that is classified as “sustenance” does not amount to meal entertainment. Applying the above criterion to your case, the food or drink provided on the vessel is expected to be provided for the purposes of light refreshment. It will also be provided at a private venue outside normal working hours, rather than on the employer's premises during work hours. Therefore, when your circumstances are examined objectively, the Meal Expenses incurred by the Company in providing light meals such as morning tea or afternoon teas (i.e. light lunches, sandwiches, cold meats) are not considered to be 'meal entertainment' and therefore are deductible under section 8-1 of the ITAA 1997.

Are the Boat Expenses incurred in relation to a coastal vessel deductible under section 8-1 of the ITAA 1997?