Recharged Expenses - The Treatment of VAT
Written by Sally Fletcher for plan.it, January 26th 2011
If your contract terms and conditions enable you to recharge expenses to your agency or end client then the following will apply to you.
Some contracts will state that expenses are only rechargeable net of VAT and others will accept recharging of the gross expense.
Under the VAT Act, all recharged expenses must have output VAT added unless the expense is a disbursement.
Output VAT is the VAT you charge on your sales to the client or agency. Input VAT is the VAT you reclaim on bills or expenses providing you are accounting under the standard or Cash Accounting VAT scheme. On the VAT flat rate scheme (FRS) you are unable to reclaim input VAT unless it is capital expenditure over £2,000.
You incurred £1,020 gross expense which includes £170 of input VAT.
The VAT fraction used to apportion the VAT from a gross amount is the gross amount divided by 6. This will give you the VAT rate at 20%.
According to your contractual terms you can either recharge:
- £850 net and add 20% VAT = £1,020
- £1,020 gross and add 20% VAT =£1,224
Both ways are correct under the VAT Act. The client can reclaim the 20% VAT as input VAT, you declare this as output VAT, and in addition, you can reclaim the VAT on the expense as input VAT (unless operating the VAT FRS).
A disbursement is a cost that you have paid for on behalf of your client that you will recharge for. For example, you could be designing a website for a client and purchase the domain name on their behalf, this qualifies as a disbursement. Where possible, have the receipt made out in the client's company name.
Certain conditions apply to disbursements:
- You have paid the cost on behalf of your client
- You recharge exactly the cost
- It is the responsibility of the client to pay the cost, not you
- You had permission from the client to pay the cost
- The disbursements are listed separately on the invoice
When recharging the client for a disbursement, you do not charge output VAT on the amount. These are referred to "disbursements" for VAT purposes by HMRC.
Expenses and Output Tax
Expenses incurred in the performance of your duties such as travel, do not qualify as disbursements, they are known as "recharges".
When you recharge expenses on an invoice you will need to add output VAT on the billed amount regardless of whether you have incurred Input VAT on the expense. This is because the expense was incurred by you, not your client.
It is important to remember that expenses incurred that did not include input VAT (Zero rated supplies), such as an airfare or private rental accommodation are invoiced with output VAT added on, again, because it is you who has incurred the expense not your client.
Disbursements and Input VAT
If you have paid for goods or services that qualify as disbursements for your client that include input VAT, you cannot claim this VAT because the goods or services were for the client, not your company. The client may claim the input VAT back if they have a valid VAT invoice or receipt in their company name.
Expenses and Input VAT
The input VAT on qualifying business expenses incurred may be reclaimed through your company unless you are operating the VAT FRS.
Accounting for the Expense
You claim the cost of the net expenses through your profit and loss account as an expense. The VAT element gets credited to the VAT account.
If you operate the VAT FRS then the gross cost of the expense is claimed in your profit and loss account.
The recharged expense to the client is accounted for as a company expense, and is also included in total turnover.
Accounting for the Disbursement
You claim the cost of the gross disbursement through your profit and loss account as a disbursement.
The recharged disbursement to the customer is accounted for as a company expense and is also included in total turnover.
When on the standard or cash accounting scheme it makes no financial difference whether you recharge gross or net expenses as the input VAT can be reclaimed regardless.
On the VAT FRS you charge 20% of output VAT but in effect only pay 14.5% (13.5% in the first year for Computer and IT Consultancy SIC code) of the 20% to HMRC. You cannot recover the Input VAT unless it is on net capital expenditure costing £2,000 and above.
Please see the following flow chart of actions to use.
For the purpose of this illustration, we have used a "Travel" expense amount of £100 including VAT. Where the expense is not a disbursement in the illustration, it will be treated as "travel" expenditure, purely for an example.
This brief is for guidance purposes only. In all cases we would recommend that you discuss any queries with professional advisors. plan.it Services is a firm of Chartered Accountants regulated by the Institute of Chartered Accountants in England and Wales. Please feel free to contact us if you have any questions relating to this article or other accounting issues affecting contractors.