VAT Calculations
If your business is VAT registered, then you will no doubt have had to wrestle with how to treat overhead expenses that you are recharging to your customers, and may be struggling with your VAT calculations. This is particularly so with contractors, who commonly have arrangements with customers along the lines that they will charge £xxx per day plus expenses like hotel bills, travel costs or mileage, subsistence etc. The invoice you send them sets all of this out but then the question is: do you charge VAT on top of these expenses? What about the ones that you yourself paid no VAT on (travel is generally zero rated and some subsistence may be too)? Where you did suffer VAT on the expense, do you recharge the net of VAT amount, or the VAT inclusive amount and add more VAT on top of that? Many of our clients are in this position so we know that it can cause great confusion. But here’s how I explain the position to my clients.
Firstly, it is important to understand that there can be two completely different sorts of expenses that you might be charging on to your customers. Firstly, there are those that you incur in the course of providing your services to the customer and, under the terms of the contract under which you work for them, you have agreed that you will recharge to them. These are called “recharges”. Secondly, there are expenses that are in reality liabilities of the customer but you have agreed to pay them on behalf of the customer, essentially acting just as an agent for them. These are called “disbursements”. Disbursements have a very specific meaning for VAT that you ought to be aware of and I go into some detail on this below.
VAT Calculations for Recharges
Recharges are essentially overhead expenses incurred by your business for services or goods consumed by your business, which you have agreed with your customer that they will reimburse you for. In other words, these are the items like travel, mileage, hotel bills, subsistence etc that your agreement might say you add to your bill on top of your daily rate. It’s important to understand that these are just ordinary overheads of your business, no different from your other costs – rent, insurances, accountancy fees etc, except that you are specifically recharging some or all to your customer. Thus as regards any VAT suffered on these costs, that you reclaim in the same way as VAT suffered on any other overheads that you are not specifically charging on. If you can reclaim all of the VAT suffered, then the actual net cost to your business is reduced accordingly. Most contracts call for the recharge to be made at net cost to you, so that you add no margin on when recharging and in that case you add the net cost to you onto your invoice and charge VAT at the standard rate (i.e. 20%) on top of that.
For example, say your contract is that you charge £750 per day net of VAT plus travel and subsistence at cost. Your calculations might look like this:
| £ | ||
| Daily rate: | 2 @ £750.00 | 1500.00 |
| Add recharges: | ||
| Train fare | (VAT zero rated) | 172.00 |
| UK hotel & food (VAT standard rated) | Gross £180.00 less VAT reclaimed £30.00 | 150.00 |
| Total charge net of VAT | 1822.00 | |
| VAT @ 20% | 364.40 | |
| Total charge inclusive of VAT | 2186.40 |
The principle here is that the overheads you are recharging are expenses incurred and consumed by your business in the course of your work. When you buy the train fare you are buying a zero rated service and pay no VAT on it. But when you recharge it you are not selling a zero rated train trip to your customer – you are selling them the standard rated service of your expertise, of which the cost of these recharges is but a component part. Thus you charge VAT on the recharge, even where you incurred none on purchasing them. If you add a margin to the cost of the recharges the principle remains the same – add VAT @ 20% to the amount you recharge, whatever its VAT status when you paid for it.
If your business uses the VAT flat rate scheme (and it should certainly consider doing, but that’s another article!), then most businesses do this calculation assuming that they have recovered the whole of any VAT incurred on the overhead, whatever their VAT flat rate. But more care is required if your business cannot reclaim all of its input VAT due to there being VAT exempt sales – so called “partial exemption”. The principles are the same, but the arithmetic to work out your net cost is more complicated! Take advice if in doubt on this.
VAT Calculations for Disbursements
As mentioned above, recharges have a specific meaning for VAT. A recharge is an amount that your business pays for and invoices on to the customer and:
- You paid the supplier on behalf of and as agent for your customer, and
- Your customer received, used or enjoyed the benefits of whatever it was you paid for, and
- Your customer was responsible for paying, not you, and
- Your customer knew the goods or services were coming from some other supplier and gave you permission to pay for them, and
- You show the goods separately on your invoice, on top of your charges for whatever it is you are charging them for, and
- You pass on the exact cost (inclusive of any VAT) – you must add no margin
If all of these conditions are met, then you simply omit these items from your VAT calculations and just pass the costs on at exactly the same price you paid. For example, an accountancy firm may agree with a client that they will charge their customer £50 for the service of completing and submitting online to Companies House their company annual return. They might also agree with the client that they will pay on the client’s behalf the Companies House filing fee of £13 (there is no VAT on these fees), and pass it on at cost. The invoice would then be set out like this:
| £ | |
| Charge for services net of VAT | 50.00 |
| VAT @ 20% | 10.00 |
| Disbursement at cost | 13.00 |
| Total charge inclusive of VAT | 73.00 |
Note that for you, this disbursement is entirely left out of your VAT calculations – you don’t add VAT onto it, you don’t reclaim any VAT paid on it and it isn’t included in your VAT statistics on the return – it is simply paid and passed on in exactly the same amount. Your customer is unlikely to be able to reclaim any VAT either, as it’s usually a requirement to have a VAT invoice and they won’t have. Because of that, there’s generally only ever any point in treating a payment as a disbursement if the supplier didn’t charge VAT or if your customer can’t reclaim the VAT – otherwise any VAT suffered on it is wasted.
As ever, be aware that the above is a general guide only and shouldn’t be relied on in any particular case – take advice if in doubt.
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