Disbursements v. Payments – What’s the Difference?
As is well known VAT can only be recovered if they are incurred by a business for the purpose of its business activities. Sometimes a business will incur a cost that relates to the work or job they do for a customer and under the terms of the agreement they are entitled to onward charge for that cost.
For example, Joe runs an IT business which provides a range of IT solutions to businesses and individuals. Each customer is charged for the service and also for the cost of transport for one of Joe’s employees to visit the customer. This may either be a train fare or a mileage allowance if the employee uses his own car. Recently a customer complained to Joe that did not think VAT on the train fare element of the invoice because train fares are zero-rated. So, is the customer correct here?
The word “disbursement” can be confusing from a VAT perspective. In Joe’s example, the train fare is an additional cost Joe’s business incurs in order to enable Joe to provide services to his customers. In addition, Joe is not providing a transport service to his customers. It just happens to be the case that in Joe’s charging structure (or it is customary in his business) he details the cost of transport within his formula for calculating the charge to the customers. As a result, Joe would need to charge VAT on the full amount.
In contrast to this, there are a few very limited cases where a business makes a payment on behalf of its customer and passes this cost onto the customer. In such a case it may be possible for the business to leave out these payments when it charges VAT. In the UK, disbursement treatment can only apply where all of the following apply (as detailed in HM Revenue & Customs ‘HMRC’ Guidance):
you paid the supplier on your customer’s behalf and acted as the agent of your customer
your customer received, used or had the benefit of the goods or services you paid for on their behalf
it was your customer’s responsibility to pay for the goods or services, not yours
you had permission from your customer to make the payment
your customer knew that the goods or services were from another supplier, not from you
you show the costs separately on your invoice
you pass on the exact amount of each cost to your customer when you invoice them
the goods and services you paid for are in addition to the cost of your own services
In practice it is condition 3 which causes the most problems. Looking back at our example it is clear that it is Joe’s responsibility to ensure his workers are able to travel to customers’ premises and homes. Therefore, Joe will need to charge VAT on these amounts.
So, when might a business be able to treat a cost as a disbursement? In truth there are very few cases where this occurs and its worth remembering that disbursement treatment is only helpful where the customer is unable to recover VAT in full.
For example, HMRC takes the view that where an unapproved garage shows the exact amount charged by an approved garage for an MoT Test separately on the invoice to its customer, and meets the other conditions for disbursements, no VAT needs to charged on the MoT fee.
Many solicitors purchase and use local authority searches in the provision of conveyancing services. Until recently they treated such services as outside the scope of VAT, since by concession HMRC allowed postal searches to be treated as a disbursement for VAT purposes. A firm of solicitors sought to extend this to cover electronic searches and this was challenged through the Courts. Unsurprisingly, the Court held that the solicitor (and not the client) used the search to provide the conveyancing services. As a result, from December 2020 HMRC announced that no searches are eligible for disbursement treatment.
In conclusion, be very wary of treating something as a disbursement. The chances are that its not a disbursement, and HMRC will expect you to charge VAT.