Many Professional Contractors and Freelancers have a contractual
agreement whereby they can re-charge expenses incurred in the
performance of their duties to either an agency or end customer.
Some contracts will state that expenses are only re-chargeable net
of VAT and others will accept recharging of the gross expense.
Under the VAT Act, all billed recharged expenses must have Output VAT added unless the expense is a disbursement.
For example
You incurred £115 gross expense which includes £15 of input VAT.
According to your contractual terms you can either recharge:
- £100 net and add 15% VAT = £115.00
- £115 gross and add 15% VAT =£132.25
Both ways are correct under the VAT Act. The client can reclaim the
15% VAT as input VAT, and you can reclaim the £15 VAT on the expense as
input VAT (unless operating the VAT flat rate scheme).
Disbursements
A disbursement is a cost that you have paid for on behalf of your
customer that you will recharge for. For example in the case of a
lawyer, they have disbursements like search fees, court fees and such
like. In the case of a contractor, you could be designing a website
for a client and purchase the domain name on their behalf, this
qualifies as a disbursement.
Certain conditions apply to disbursements:
- You have paid the cost on behalf of your customer
- You recharge exactly the cost
- It is the responsibility of the customer to pay the cost, not you
- You had permission from the customer to pay the cost
- The disbursements are listed separately on the invoice
Disbursements do not come into the Output VAT calculation; that is
to say that you do not add Output VAT to them on the invoice. These
are referred to "Disbursements" for VAT purposes by HMRC.
Where IR35 is concerned, paying for goods or services on behalf of
your client may not put you in a favourable position. Careful
consideration should be made to your IR35 status before paying for
disbursements.
Expenses and Output Tax
In the case for contractors and Freelancers, expenses incurred in
the performance of their duties do not qualify as disbursements, and
are known as "Recharges" by HMRC.
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 customer.
It is important to remember that expenses incurred that did not
include input VAT (Zero rated supplies), such as an airfare or postage
stamp are invoiced with output VAT added on, again because it is you
who has incurred the expense not your customer.
Disbursements and Input VAT
If you have paid for goods or services that qualify as disbursements
for your customer that include Input VAT, you cannot claim the Input
VAT because the goods or services were for the customer not your
business. The customer may claim the Input VAT back if they have a
valid VAT invoice or receipt in their name.
Expenses and Input VAT
Expenses that you have incurred for your business that include Input
VAT may be reclaimed by your business unless you are operating the Flat
Rate VAT Scheme.
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 Flat Rate scheme then the gross cost of the expense is claimed in your profit and loss account.
The recharged expense to the customer is accounted for as a cost of sale and counts towards 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
cost of sale named disbursement and counts towards total turnover.
VAT Schemes
When on the standard of 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 Flat Rate Scheme (FRS) you charge 15% of Output VAT but in
effect only pay 11% (dependent on the SIC code) of the 15% to HMRC but
you cannot recover the Input VAT.
You need to calculate whether the 4% gain on Output VAT outweighs
the loss of reclaiming Input VAT even though the gross expense is
deductible in the profit and loss account. If this is the case, you
may wish to leave the FRS for the duration of the contract. You can
change VAT schemes at any time providing you qualify for the scheme in which you are applying for.