VAT on Expenses and Disbursements

Introduction

If you're VAT-registered and pass costs on to your customers, how you treat these for VAT depends on whether they count as expenses (recharges) or disbursements. Understanding the difference is crucial: you must charge VAT on recharges but not on disbursements, and this affects whether you can reclaim the VAT you paid.

The difference between expenses and disbursements

When you incur costs that you then pass to customers, they fall into two categories for VAT purposes.

Expenses (recharges) are costs your business incurs when supplying goods or services. Even if you separately itemise these on your invoice, you must charge VAT on them regardless of whether you paid VAT yourself. You're buying these goods or services for use in your own business.

Disbursements are payments you make on behalf of your customer, acting as their agent. The customer—not you—receives and uses the goods or services. When you treat a payment as a disbursement, you don't charge VAT when invoicing your customer, but you also cannot reclaim any VAT on it.

When costs must be treated as expenses (recharges)

Most costs your business incurs must be included in your VAT calculations as recharges. Common examples include:

• Travelling expenses: If you buy an airline ticket to visit a client and recharge the cost, you must charge VAT because the flight was for you, not the client
• Postage and delivery costs: When you send letters or parcels to customers, these are normal business costs and VAT must be added if you recharge them
• Bank transfer fees: Even though bank charges are VAT-exempt, if you recharge a transfer fee you must charge VAT because the service was provided to your business, not your customer

Whether you itemise these costs separately on your invoice or include them in your overall price, you must charge VAT at 20% on the total amount.

When you can treat costs as disbursements

To treat a payment as a disbursement, all of the following conditions must apply:

• You paid the supplier on your customer's behalf and acted as their agent
• Your customer received, used or had the benefit of the goods or services
• It was your customer's responsibility to pay for the goods or services
• You had permission from your customer to make the payment
• Your customer knew the goods or services came from another supplier, not from you
• You show the costs separately on your invoice
• You pass on the exact amount to your customer without adding anything
• The goods and services are additional to the cost of your own services

It's usually only beneficial to treat a payment as a disbursement if the supplier didn't charge VAT, or if your customer cannot reclaim VAT.

How to show disbursements and recharges on invoices

If you exclude disbursements from your VAT calculations, you must itemise them separately on your VAT invoices.

Here's a practical example: A website design consultant in London does a week's work for a client in Edinburgh. The consultant travels to Edinburgh at the start of the week and also purchases a website hosting package on behalf of the client. The agreed fees are:

• Consultant's work: £2,500 plus VAT
• Travelling expenses: £300
• Website hosting package: £150

The invoice would show:

• Design services: £2,500
• Travelling expenses: £300
• Amount on which VAT is due: £2,800
• VAT at 20%: £560
• Disbursements: £150
• Total including VAT: £3,510

The travel cost is a recharge (VAT must be charged), whilst the website hosting is a disbursement (no VAT charged) because it was purchased for the client's use, the consultant acted as the client's agent, and all the conditions for disbursement treatment were met.

Reclaiming VAT on expenses you recharge

When you charge VAT on items because they were supplied to you (not your client), you can reclaim any VAT you paid on them. This applies whether or not you passed these costs to your customers as recharges. You'll need a VAT invoice for each item you want to reclaim VAT on.

Your customer can also reclaim the VAT you charged them if they're VAT-registered.

Why you cannot reclaim VAT on disbursements

If you paid a VAT-registered supplier on behalf of your customer and treated the cost as a disbursement, you cannot claim back any VAT that was charged. This is because the goods or services were supplied to your customer, not to your business.

Your customer may also be unable to reclaim the VAT if they don't have a valid VAT invoice for the goods or services.

Record-keeping requirements

If you pass on disbursements to customers without charging VAT, you must keep evidence to prove you were entitled to exclude them from your VAT calculation. This includes order forms and invoices showing that:

• The items qualified as disbursements under all the required conditions
• You haven't claimed back the VAT on items paid for on your customers' behalf

For recharges, you must keep a valid VAT invoice or receipt for each cost if you want to reclaim the VAT.

Sources

• VAT: costs or disbursements passed to customers

This article provides general guidance based on current HMRC rules. For advice specific to your situation, speak to your accountant.