Insights

The difference between expenses and disbursements for the purpose of VAT accounting can be confusing because they are technically very different from HMRC’s point of view. Many people use the terms interchangeably and mistakenly think they mean the same thing. This article explains the subtle difference and why it’s important to correctly distinguish between the two in order to ensure your VAT returns are correct and to avoid any penalties for mistakes made.

Getting the terminology right

What is a business expense? An expense is an extra cost that is incurred by a service provider when delivering their service to their client. For example, a consultant may add onto their invoice extra expenses incurred in order to put them in a position to deliver their service, e.g. train travel, mileage and accommodation costs. These are expenses that fall outside their fees for delivering their service; often the provider will suffer these costs, but in some cases it is agreed that the client will reimburse the service provider for the costs incurred. From HMRC’s point of view, VAT should be added to these expenses when they are included on the invoice, so for example, travel costs will be invoiced at cost plus 20% VAT.

Contrast this with disbursements. A disbursement is a different kind of expense that is incurred as part of the delivery of a service. It is an expense that arises specifically within the delivery of the service and is a cost that should be properly borne by the client. For instance, a PR consultant may act as an agent in sourcing and engaging a separate clippings agency to track their client’s press coverage. This service is the client’s expense but may be included as part of the overall service delivery cost for convenience. It is classified as a disbursement because it is the client’s expense and it should not be subject to VAT. Alternatively, a solicitor will have to pay for searches or court fees as part of their routine service delivery, but the expenses are specifically incurred for their client, and are not therefore subject to VAT.

The difference between the VAT treatment of expenses and disbursements is an important distinction; if they are treated incorrectly HMRC has the authority to go back and review the VAT treatment for a period of up to 4 years.

Qualifying conditions for disbursements

There are set qualifying conditions which must be met in order for an expense to be treated as a disbursement; these are as follows:

1. All relevant costs incurred by a service provider must belong to the buyer rather than the service provider, who has simply acted as an agent by buying in the services as part of the overall service delivery. Returning to the clippings example, the clippings sourced are purely for that client and paid for on their behalf;
2. The buyer (the end client) should have received the services (e.g. copies of the clippings) directly and should have authorised the cost of this service in advance;
3. All the payments should be detailed as individual items on the supplier’s invoice to their client e.g. the total number of clippings generated and their individual cost;
4. No surcharges or margin should be added to the final cost without this being separated from the actual cost of the expense. For example, if the supplier adds a mark up to the cost of the clippings, this needs to be itemised as a markup and accounted for separately on the invoice. VAT should be applied to the margin, but no VAT should be added to the actual disbursement cost. In reality this would be a tough practice for a supplier to adopt with their client anyway!

Implications for VAT registration

Another implication arising from the distinction between expenses and disbursements relates to VAT registration. In some cases, a business may not be VAT registered but close to the registration threshold and can be operating in this manner for many years. However, the correct treatment of expenses as part of their Vatable turnover may take their actual turnover over the VAT registration threshold. In such a case, HMRC has the power to backdate their review of whether a business should have been VAT registered to 20 years, and can assess the VAT that should have been collected, applying penalties.

If you have any issues relating to VAT compliance, or want advice on whether you may have the potential to reclaim VAT, please contact Simon Paterson by emailing partners@rjp.co.uk.