Vat on Disbursements and Recharges: When to Charge and When Not To

When passing costs on to your clients, it’s vital to understand how to treat them for VAT purposes. Should they be accounted for as recharges or disbursements? This distinction affects how VAT is calculated, what your clients can reclaim, and how transparent your invoices are.

Here’s a straightforward guide to help you navigate this complex area of VAT.

What Are Recharges and Disbursements? 

• Recharges: These are costs incurred by your business as part of providing your service, which you then pass on to your client. The cost forms part of your overarching service. For example, travel expenses incurred during consultancy work.
• Disbursements: These are costs you pay on behalf of your client, acting as their agent. You are simply passing on the cost, not charging them for your service. For example, paying a filing fee on behalf of your client.

Key Differences Between Recharges and Disbursements

When to Account for Costs as Recharges: Treat costs as recharges if: 

1. The expense is linked to your service: For instance, if you purchase train tickets for a consultancy visit, they are part of your service delivery.
2. You control the purchase: If the decision to incur the cost was yours (not your client’s).
3. VAT liability matches the overarching service: Add VAT to the recharge, even if the original cost didn’t include VAT. 

Example [1] Marketing Consultant
You book an external photographer for a marketing campaign. The photographer’s invoice doesn’t include VAT, but when you recharge the cost to your client, you must apply VAT based on your service’s VAT status.

Example [2]: Project Management Company
You book an external consultant to help deliver a project for your client.  If the consultancy was really for your company as you needed the external consultancy to deliver the end project to your customer, then it can’t be passed on as a disbursement.

If the consultancy was specifically for the benefit of the customer, and your company wasn’t the recipient of the consultancy service, then it could be passed on as a disbursement.

Please Note: There is no rule to say how much you should recharge a client.  The rule is if you recharge a cost, you must account for VAT on the supply according to the liability of the overarching service (Think UK versus Overseas clients).

In most circumstances, you would recharge the net cost you have incurred and apply VAT on the supply according to the liability of the overarching service.

When to Account for Costs as Disbursements: Treat as disbursements if the following 8 HMRC criteria are met:

1. You acted as an agent for your client.
2. The client requested the purchase.
3. The client is responsible for the cost (not you).
4. You paid the supplier on behalf of your client.
5. The client knew the cost was theirs.
6. The payment is shown separately on your invoice.
7. You pass on the exact cost without any markup.
8. The goods or services were provided directly to the client.

Example:
You’re a solicitor, and you pay a court filing fee on behalf of your client. You can treat this as a disbursement because it was incurred directly for the client, and they are responsible for the payment.

Please Note: The rule for passing on disbursements costs to your customers is you should pass on exactly the same cost that you have incurred.  Therefore, if it cost you £500+20% VAT, you pass on a disbursement fee of £600 No VAT.

If you pass costs on as a disbursement, you cannot reclaim the VAT on the original purchase as you have to be the recipient of the service.  Simply paying for the goods or service doesn’t give you the entitlement to claim it back.

What’s the Advantage of Treating Costs as Disbursements?

• No VAT is charged on the disbursement amount, which can be beneficial for non-VAT-registered clients or those unable to reclaim VAT.
• Transparency: The client sees the exact cost incurred without any additional VAT.

Common Misunderstandings to Avoid 

1. Amazon Gift Cards: If your business purchases Amazon gift cards as part of a promotion for a client, consider whether the purchase meets disbursement criteria. If the client did not explicitly request the purchase or assume responsibility for it, this is likely a recharge.
2. Consultancy Costs: Passing on consultant fees without adding VAT because “it wasn’t charged to you” is incorrect unless the criteria for disbursements are met.

In Summary…

When passing on costs to your clients, regardless of what the costs are, consider them initially to be a recharge.  Then, see if it is advantageous to consider if they meet the 8 disbursement criteria.  This generally only applies if there was no VAT on a cost to begin with, or if the customer can’t claim the VAT back).

Action Steps for SME Business Owners 

1. Review Your Invoices: Are you correctly distinguishing between recharges and disbursements?
2. Understand VAT Liability: Know the VAT implications for each type of cost.
3. Communicate With Clients: Clearly explain why costs are treated as recharges or disbursements.
4. Consult HMRC Guidance: Always cross-check against HMRC’s eight criteria for disbursements.

By getting this right, you can ensure compliance, maintain good client relationships, and avoid unnecessary VAT liabilities. If you’re unsure, it’s always worth seeking professional advice to ensure your business is on the right track.

Need support? Contact us at Adams O’Rourke Accountants—we specialise in helping UK SMEs manage VAT complexities with confidence!