Should you add VAT to expenses your customers will be paying?
There can’t be many companies that don’t pay their employees’ out of pocket expenses and this is an accepted part of business.
But it is less common that these expenses get charged on to the end customer, sometimes as expenses and sometimes called ‘disbursements’ - so when you do this should you charge VAT or not?
The answer might not be what you think. Carry on reading to find out.
3 minutes
Written by Steve Thomas, Finance Software and Systems Specialist
The difference between disbursements and expenses
This is an important distinction although, at first sight, it might seem that these charges are the same thing.
Expenses are when you charge the customer for something you bought that allowed you to carry out the work for them.
Very often these will be for companies that charge a fee per job like estate agents, IT companies, training businesses.
In these cases, their costs will be expressed as their fee plus expenses.
Disbursements feel the same but there is a key distinction in that they are simply a cost that is paid on behalf of the customer and no value is added.
The no value-added part is really important because it is this that decides whether VAT is charged or not.
The IT company
Let’s take an IT company as an example.
Imagine that they have a client who wants them to install several PCs at their premises.
The business agrees and says it will charge £5,000 plus expenses.
Their technician drives to the site (mileage £20) and stays for two days. They rent a hotel room overnight for £70 and buy food for an evening meal at £25.
The mileage, room and food are all examples of expenses because they were needed to allow the technician to do their job and they are used to provide value for the customer.
As part of their service, the company pays for the anti-virus subscription on behalf of the company (£150 per month). It makes no money from this, doesn’t install or manage it and simply passes through the cost to the customer. In short, no value is added.
This is a disbursement.
Easy so far…
The VAT treatment of expenses and disbursements
This is where it gets trickier.
VAT is charged on expenses even if the item in question was zero-rated or exempt.
And VAT is not added to disbursements even if the item in question does attract VAT. They are simply charged at the gross amount.
Consequently, the invoice to the customer will look like this;
Fee = £5,000 + VAT (VAT equals £1,000)
Expenses = £115 + VAT (VAT equals £23)
Disbursements = £150
Total = £5,265
VAT = £1,023
Grand Total = £6,288
As you can see, we have charged VAT on the fee and expenses but not on the anti-virus software. If we’d charged it on the whole amount the VAT figure would be £1,053.
This all comes down to the usage of the item in question.
HMRC takes the view that if you used the goods or services that you charge to your customers then they form part of your service. If your service is chargeable for VAT then so are the expenses.
However, with disbursements, you don’t use the item to provide a service and so it is not chargeable by you.
So even if the technician had taken the train and underground to visit the client, which are both zero-rated, the company would still add VAT on top of these.
One important point to note about disbursements.
As you are not using these and simply passing on the cost to the customer then you cannot claim back the input VAT.
Instead, the end customer will do this using their own return although they will need evidence that VAT was originally paid and so it is good form to include the original VAT invoice with your own.
In summary, the message has to be that if you use something to add any value for the customer then the cost is an expense and you need to make sure that VAT is charged on your invoice.
Looking for more advice on VAT on expenses?
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