The cost of entertaining customers or potential customers is not tax deductible for income tax or corporation tax. Your accounting records need to distinguish between the cost of hospitality such as the provision of food or drink, and significant gifts to customers, from other marketing expenditure. The amount classified as non-deductible entertaining is added back to the profits to calculate the tax due.
You can't reclaim VAT on the costs of entertaining customers or potential customers. Where your staff are required to attend an event to act as hosts for potential customers, all of the VAT cost is blocked. A VAT registered business can reclaim the VAT on small gifts that cost up to £50 each, including gifts comprising of tobacco and alcohol.
Entertaining staff is tax deductible if it is not incidental to customer entertaining. The VAT on staff entertaining can be reclaimed, but a portion of the cost may need to be disallowed where customers also attend the event.
Staff entertainment can be tax free for the employees if it is in the form of an annual event or number of events to which all the staff are invited. However, you should try to limit the annual cost to £150 per head, counting all those who actually attend the event. If the costs exceed £150 per head (including VAT) your employees will be taxed on the total cost per head (not the excess above £150) as a benefit in kind. You as the employer can pay this tax on behalf of your employees through a payroll settlement agreement (PSA), but this does involve a degree of grossing-up, which can be expensive.
Free samples of the products or services your business normally sells are permitted, as long as you are not in the food or restaurant business. Small promotional gifts of any item are also acceptable if they cost less than £50 each and carry a clear advertisement for the business, although food, drink, tobacco and gift tokens of any value do not fall into this exemption. Small gifts worth more than £50 in total should not be made to the same person in one year.
So think carefully before you splurge this Christmas and make sure you have a happy, tax efficient celebration!