For many business owners, expenses for meals and entertainment (M&E) can represent a significant portion of operating costs. Whether it’s hosting clients, organizing team-building events, or attending networking functions, these expenditures often serve as essential investments in business growth. However, when it comes to GST (Goods and Services Tax) compliance, the rules surrounding M&E expenses are unique and can easily trip up even the most diligent business owner.
Understanding the Rules: The Excise Tax Act
Under the Excise Tax Act, the rules for claiming GST/HST Input Tax Credits (ITCs) on meals and entertainment expenses differ from other business expenses. Specifically, only 50% of the GST paid on M&E expenses is claimable as an ITC. This restriction applies regardless of whether the expense was incurred for a legitimate business purpose.
For example, if a business pays $100 for a client lunch (including $5 in GST), only $2.50 of the GST can be claimed as an ITC. The remaining 50% is considered non-recoverable.
Common Pitfalls for Business Owners
Failing to account for the 50% restriction can lead to costly errors, as many business owners mistakenly claim the full GST amount. These errors often surface during audits, catching business owners off guard and potentially resulting in penalties, interest, and reassessments. Even worse, such mistakes may damage a business’s reputation with tax authorities, leading to increased scrutiny of future filings.
Consequences of Non-Compliance
The Canada Revenue Agency (CRA) takes GST compliance seriously. Misreporting ITCs—even unintentionally—can lead to:
- Penalties: Financial penalties may be imposed for errors in GST returns.
- Interest: The CRA charges interest on unpaid GST amounts, compounding the financial impact of errors.
- Audits: Non-compliance increases the likelihood of a tax audit, which can be time-consuming and stressful.
For businesses already operating on thin margins, these consequences can be particularly damaging.
The Solution: Properly Setting Up a Tax Code for M&E in QuickBooks Online
One of the simplest ways to ensure compliance with the 50% rule is by setting up a dedicated tax code for M&E expenses in QuickBooks Online (QBO). By automating the calculation of recoverable GST, this approach minimizes the risk of errors and ensures accurate reporting.
Here’s how to set up a custom tax code for M&E in QBO:
- Access the Tax Settings: Navigate to the “Taxes” section from the left-hand menu in QBO.
- Create a New Tax Code: Select “New Tax” and choose “Custom Rate.”
- Define the Tax Rate: Set the recoverable GST rate to 50% of the applicable rate (e.g., 2.5% for provinces with a 5% GST rate).
- Label the Tax Code: Name the tax code “M&E GST (50%)” for easy identification.
- Apply the Code: Use this tax code for all M&E transactions to ensure accurate ITC calculations.
By integrating this tax code into your workflow, you can streamline compliance and reduce the risk of non-compliance.
Final Thoughts
Accounting for meals and entertainment expenses may seem like a minor detail, but the consequences of getting it wrong can be significant. The 50% rule under the Excise Tax Act is one of the most commonly misunderstood aspects of GST compliance, catching many business owners off guard. However, with proactive measures such as setting up a dedicated tax code in QuickBooks Online, businesses can ensure accurate reporting, avoid costly penalties, and maintain a clean record with the CRA.
Remember, staying on top of GST rules is not just about avoiding pitfalls—it’s about demonstrating professionalism and due diligence in your financial practices. If you’re unsure about how to handle M&E expenses in your business, consult with a bookkeeping or accounting professional to ensure compliance and peace of mind.