Following on from previous articles on reclaiming VAT on expenses and on the correct treatment of disbursements, we thought it might be a good idea to cover recharges in a bit more depth and examine the correct way to treat them from a VAT perspective.
Having got our heads around disbursements and the eight rules specified, we have established that we have incurred an expense in the course of our professional services, it is not a disbursement but we need to recover the expense from our client.
In many instances there is no VAT on such costs; train and airfares are good examples, and these normally have to be identified separately on an invoice and VAT added where the cost is passed on to the client. You as a professional services firm incurred the train or airfare to provide services to your client so the cost forms part of the overall service to the client.
It is then likely that your client may query the bill, adamantly asserting that there is no VAT on train fare and you have to explain that it is part of your overall service, and therefore subject to VAT.
If we go back to the legislation on VAT, the definition of VAT is contained in VATA 1994, s 4, where it is described as a tax “on any supply of goods or services made in the UK where it is a taxable supply made by a taxable person in the course or furtherance of any business carried on by him”.
So if we charge customers for items such as travel or photocopying paid on behalf of a client, are these charges part of our own “supply” of goods or services and therefore, subject to the same rate of VAT as our own supplies, or are they subject to a different VAT treatment? Unless they qualify as ‘VAT disbursements’ then they form part of the service to clients.
A law firm based in London is engaged to visit a client’s premises in Newcastle to provide legal services. The fees are £3,000, the train fare £250 and the hotel bill is £150 excluding VAT – totalling £3,400.
VAT is chargeable on £3,400 and so £680 is to be included in Box 1 of the law firm’s next VAT return. Input tax of £30 is recoverable on the hotel bill as it is a standard rated supply and the portion of output tax related to the hotel is also £30.
Everyone is or should be happy, but this scenario has the capacity to cause great confusion.
If the law firm takes the VAT inclusive cost of the hotel bill of £180 and recharges that to the client, then VAT of £36 is due on the £180, rather than £30 on the £150, but still, only £30 is recoverable as that is all that has been charged by the hotel.
The law firm, by including the VAT in the cost recharged has effectively given themselves a 20% mark up on the recharge. This is fine provided the client accepts that and any argument on this score is commercial rather than one determinable by VAT legislation.
What also often happens is the £180 is treated as a disbursement and input tax is neither reclaimed nor charged. You might follow the logic through and think “well that’s ok because the VAT has just missed a step and the VAT charged has stuck with the person it was intended to”. That is, the hotel accounts for VAT it charged to the law firm on its return, the law firm then recharges the gross amount and the client ultimately pays the VAT that has already been accounted for by the hotel.
HMRC, unfortunately, would not see it that way and if we go back to the legislation (VAT Act 1994 section 4) we have already established that the cost forms part of the law firm’s services to the client and the line of supply is from the hotel to the law firm. There are no concessions for eliminating VAT between VAT registered businesses so it must account for VAT where it is due.
If the law firm were to receive an inspection, HMRC would not consider how the law firm’s client may have dealt with a particular supply, but would simply focus on how the law firm receiving the inspection dealt with it.
I acted for a law firm a couple of years ago where this issue arose. HMRC identified a number of recharges that the law firm had passed on without VAT as a gross figure. There were also non-VAT recharges such as train fares.
An assessment was raised for in excess of £30,000. Most of the recharges were subject to VAT but the officer in this case only raised the assessment on the VAT underpaid and did not give the law firm any credit for the VAT they had not claimed in passing the amount on gross. In that case, I was able to reduce the assessment significantly by asking the VAT officer to give credit for the input tax.
As ever in VAT it is always important to fully understand who is supplying what to whom!