Expenses and disbursements are two terms that are often used interchangeably but they have distinct differences in terms of the effect on VAT (Value Added Tax) purposes in the UK.
What are expenses?
Expenses refer to costs that a business incurs in carrying out its trade or business, such as rent, salaries, utilities, and office supplies. These expenses are typically incurred by the business itself and are subject to VAT if they are taxable supplies. The business can recover the VAT paid on these expenses by claiming input tax credit on their VAT return.
What are disbursements?
On the other hand, disbursements refer to expenses that a business incurs on behalf of its clients or customers, which are then passed on to the client or customer as a reimbursement. Disbursements can include expenses such as travel costs, courier fees, or postage costs.
Disbursements are not subject to VAT and do not count towards the business’s taxable turnover. Therefore, a business cannot recover VAT on disbursements and should not include them in its VAT returns.
It is important to note that not all costs that a business incurs on behalf of its clients or customers are considered disbursements for VAT purposes. For a cost to be considered a disbursement, it must meet certain criteria.
For example, the cost must be incurred by the business as an agent of the client or customer, and the client or customer must be responsible for paying the cost directly to the third-party supplier. The business must not make any profit on the disbursement and must not be responsible for any VAT charged on the cost.
Additionally, the following criteria must be met to justify the costs incurred on behalf of your customers as a disbursement:
- 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 invoices
- 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
The distinction between expenses and disbursements is important for VAT purposes, as it can impact the amount of VAT a business is required to pay or can recover. It is also vital for businesses to understand the difference between the two, as misclassifying costs can lead to incorrect VAT accounting and potentially costly penalties.
We understand that there are a lot of technical terms within VAT, so we recently published a VAT Jargon Buster to help. If you have any further questions on expenses and disbursements, please get in touch by calling us on 01792 346272 or contacting our team here.
How we can help
We can support many aspects of tax advice, including income tax, capital gains tax, inheritance tax as well as tax planning and other areas of personal tax. Within our accountancy services offering, we can also aid with quarterly returns and corporation tax returns.