What are representation expenses in a sole proprietorship?

Representation expenses in a sole proprietorship, and especially the deduction of them as a deductible expense, have been a matter of debate for years. This is due to the lack of a clear definition of representation expenses in the legislation. Are they deductible at all and when? What about VAT? We sort out the knowledge on this subject.

Definition of representation expenses

The legislature does not give a precise definition of entertainment expenses or refer to other provisions on the matter. This gives rise to numerous disputes between taxpayers and tax authorities. For many years, the tax administration considered representation costs, costs characterized by lavishness, grandeur and aimed at creating a good impression.

The situation was changed by judgments and rulings of the Supreme Administrative Court. On January 25, 2012, in a judgment with the file number II FSK 1445/10, the Supreme Administrative Court determined: "Representation expenses, as referred to in Article 23(1)(23) of the Personal Income Tax Act, are expenses related to the representation of the taxpayer or the enterprise run by him, regardless of their lavishness or place of provision."

In turn, in a ruling of December 17, 2012, ref. II FSK 702/11, the Supreme Administrative Court adopted the following interpretation of the term "representation."

The court took into account the dictionary definition of the term "representation" and explained "that according to the accepted view of the tax law doctrine, representation is considered to be "appearing on behalf of the taxpayer (company), involving grandeur, exquisiteness, in order to create the best possible impression when representing the company. Representation is primarily activities involving official and commercial contacts with other business entities, related in particular to the maintenance of delegations or contractors, participation in receptions related to the stay of these entities."

When can representation expenses be tax deductible?

When deciding on the nature of the costs, you need to be very precise about their purpose. They will be representative if their main purpose is to create a positive image and reputation for your business. Thus, they may be activities aimed at business partners or the external environment, which will result in the signing of a contract, agreement or satisfactory cooperation. Their nature is influenced by the situation in which the costs were incurred, as well as the type of business you conduct.

For example, meeting a client or business partner at a restaurant helps build relationships and make a good impression, so it is a representation expense that you can deduct as a tax-deductible expense.

Representation or advertising?

According to the Broadcasting Law, "advertising is a commercial message, originating from a public or private entity, in connection with its business or professional activity, aimed at promoting the sale or use of goods or services for a fee; advertising is also self-promotion." Practically, advertising is the widespread dissemination of information about a product, service, brand, company, which is intended to highlight the benefits and encourage the purchase of various groups of customers. There are innumerable forms of advertising and you can count advertising expenses as they serve to obtain sources of revenue. You can account for some expenses as needed. For example, flowers that are office decoration or a conservatory can be advertising, but also treated as decoration of a well-kept company headquarters, you can count as entertainment expenses deductible.

What about gifts for customers?

If the gift contains your company's logo then it will be a normal cost of advertising and you can deduct it as a tax-deductible expense and deduct VAT. Otherwise it will be a cost of representation, which you will no longer include in costs. This is stated in a tax interpretation by the Director of the Tax Chamber in Bydgoszcz, file number ITPB3/423-406/10/PS of October 21, 2010: "gadgets provided free of charge in the course of business meetings, if they bear the Company's logo permanently and their unit value is relatively low, will not be of the nature of representation referred to in Article 16, paragraph 1, item 28 of the Act, and consequently the expenses relating to them will also constitute, pursuant to Article 15, paragraph 1 of the Income Tax Act, deductible expenses."

For example, if you run an advertising agency and at the same time make homemade liquor, and put your company's logo on the label, you can give it to a client and deduct it as a business expense. Otherwise, the alcohol with the logo will be a gift, which will remain a representation expense that you cannot deduct.

You can deduct VAT

According to Article 23(1)(23) of the Personal Income Tax Act, entertainment expenses cannot be tax deductible, but you can deduct VAT in this situation, as stated in Article 16(1) of the Corporate Income Tax Act. This is confirmed by an individual interpretation of the Director of the Tax Chamber in Łódź dated March 6, 2012, ref. no. IPTPB3/423-319/11-2/GG: "Representation expenses are not tax deductible, but the input VAT is a tax expense in that part in which, in accordance with the provisions on VAT, the taxpayer is not entitled to a reduction in the amount or refund of the difference of VAT." The exception here is the cost of accommodation and catering services, where you can't deduct VAT (Article 88(1)(4) of the VAT Act).

Remember that in case of doubt or a contentious situation, you can always apply to the relevant tax administration authority for an individual interpretation of the case.