The Correct Tax Treatment for Recharged Expenses

A Definitive Guide to the Correct Tax Treatment for Recharged Expenses

In the course of everyday business, it is incredibly common for a company to incur costs on behalf of a client. A marketing agency pays for a photographer for a client’s campaign; a law firm pays court filing fees for a client’s case; a holding company pays for centralized IT services that are used by its subsidiaries. The process of recovering these costs seems simple: you pay the expense, then add it to your client’s next invoice. However, from a tax perspective, this simple act of “recharging” an expense is one of the most misunderstood and incorrectly handled areas of compliance in the UAE.

The core of the issue lies in a critical distinction that both VAT and Corporate Tax law make: the difference between a “recharge” and a “disbursement.” Treating a disbursement as a recharge, or vice versa, can lead to significant errors in your tax calculations, resulting in over or underpayment of tax, incorrect invoices, and potential penalties from the Federal Tax Authority (FTA). Whether a cost passed on to a client is subject to 5% VAT or is considered part of your taxable income for Corporate Tax hinges entirely on this classification. This guide provides a deep dive into the rules, conditions, and practical implications of recharged expenses, offering a clear framework for businesses to ensure they are managing these pass-through costs correctly and compliantly.

Part 1: The Fundamental Difference – Recharge vs. Disbursement

To navigate the tax implications, we must first define the two concepts. While they may seem similar in that you are recovering a cost from your client, their legal and tax substance is completely different.

A. The Recharge (Acting as a Principal)

A recharge occurs when you, the supplier, incur a cost as part of the overall delivery of your own goods or services to a client. You are the recipient of the third-party supply and you are contractually responsible for it. When you pass this cost on to your client, it is seen as an integral part of your main supply.

In simple terms: You bought something and are effectively “re-selling” it to your client along with your main service. The cost is part of your business’s own expenses.

Example: A web design firm hires a freelance copywriter to write content for a client’s website. The firm pays the copywriter’s invoice. This cost is part of the firm’s project delivery. When they invoice the client, the copywriting fee is a recharged expense, part of the total project cost.

B. The Disbursement (Acting as an Agent)

A disbursement occurs when you pay a cost purely on behalf of your client, acting as their agent. You are simply a conduit for the payment. The client is the true recipient of the goods or services, and they are ultimately responsible for the cost.

In simple terms: You paid a bill for your client using your money, and they are now reimbursing you for that exact amount. The cost was never truly yours.

Example: A company formation consultant pays the government license fees on behalf of a new client. The government fee is a cost for the client’s business, not the consultant’s. The consultant is merely facilitating the payment. This is a disbursement.

Part 2: VAT Implications – A World of Difference

The VAT treatment for recharges and disbursements is black and white, with no middle ground. Getting it wrong is a common trigger for FTA audit adjustments.

VAT Treatment of a Recharge

When you recharge a cost, you are making a taxable supply to your client. Therefore:

• You must charge 5% VAT on the recharged amount, even if the original expense you incurred was exempt or zero-rated.
• The recharged amount is added to the value of your main supply, and VAT is calculated on the total.
• You are entitled to recover the input VAT (if any) that you paid on the original expense, subject to normal VAT recovery rules.

Example Walkthrough (Recharge):

1. An interior design firm pays AED 1,000 + 50 VAT (AED 1,050 total) to a courier for delivering furniture samples to a client.
2. The courier invoice is in the name of the design firm. The firm claims the AED 50 input VAT on its tax return.
3. The firm’s design fee for the project is AED 10,000. They add the courier cost of AED 1,000 to their client invoice.
4. The final invoice to the client is: Design Fee (AED 10,000) + Recharged Courier Cost (AED 1,000) = Total AED 11,000.
5. VAT at 5% is charged on the total: AED 11,000 * 5% = AED 550.
6. The total amount due from the client is AED 11,550.

VAT Treatment of a Disbursement

A true disbursement is outside the scope of VAT. Therefore:

• You do not charge VAT when you recover the cost from your client.
• The amount is listed separately on the invoice and does not form part of the taxable value of your supply.
• You are not entitled to recover any input VAT on the cost, because you were not the recipient of the supply. The right to recover the VAT belongs to your client (if they are VAT registered and the cost is for their business).

For a payment to be treated as a disbursement for VAT purposes, all of the following strict conditions must be met:

1. Your client must have been the recipient of the goods or services.
2. You were authorized by your client to make the payment on their behalf (ideally in writing).
3. Your client was responsible for paying the third-party supplier.
4. The invoice from the third-party supplier must be in your client’s name.
5. You must pass on the exact cost without any markup.
6. The payment must be shown separately on your invoice to the client.

Part 3: Corporate Tax Implications – Impact on Your P&L

The classification also has a direct impact on your company’s revenue and expenses for UAE Corporate Tax purposes.

Corporate Tax Treatment of a Recharge

When you recharge a cost, it flows through your Profit & Loss statement:

• Revenue Impact: The amount you charge the client for the expense is recognized as taxable revenue for your business.
• Expense Impact: The original cost you paid to the third party is recognized as a deductible business expense (subject to normal deductibility rules).

The net effect on your profit is often zero (if you don’t add a markup), but both the revenue and expense lines on your P&L are increased. This is crucial for financial analysis and for meeting the arm’s length principle in transactions between related parties.

Corporate Tax Treatment of a Disbursement

A true disbursement should be neutral to your P&L. It is a balance sheet movement.

• When you pay the cost, you create a receivable from your client (e.g., Dr. ‘Client Disbursements Receivable’, Cr. ‘Bank’).
• When your client reimburses you, you clear this receivable (e.g., Dr. ‘Bank’, Cr. ‘Client Disbursements Receivable’).
• The transaction does not hit your revenue or your expense accounts. Therefore, it has no impact on your taxable profit calculation.

Part 4: The Role of Contracts, Invoices, and Technology

Given the strict rules, documentation and systems are your best defense against non-compliance.

The Power of Clear Contracts

Your engagement letter or contract with your client should explicitly state how third-party costs will be handled. Specify whether you will be acting as a principal (and will recharge costs with VAT) or as an agent (and will handle disbursements). This clarity, established upfront through proper business consultancy, prevents disputes and provides evidence of intent to the FTA.

Systems for Segregation: Zoho Books

Your accounting system must be able to handle both types of transactions correctly. A platform like Zoho Books is essential for this. You can:

• Create specific expense and income accounts for recharges that flow through your P&L.
• Use balance sheet clearing accounts for managing disbursements, keeping them separate from your operational results.
• Utilize the ‘Billable Expenses’ feature to track costs incurred for a client and ensure they are correctly added to the next invoice with the appropriate tax treatment.

Proper accounting system implementation ensures these workflows are set up correctly from the start.