Disbursement or Reimbursement of Costs
Disbursement of funds is not the same as reimbursement. The term reimbursement” refers to the payment refunded for the original disbursement. When a business sends a disbursement on behalf of a client, the reimbursement is what the client pays to the company as a refund for the original payment. Reimbursement can involve discounts or interest fees, depending on the contract. In general, the difference between a payment and disbursement is that one is the instance or process of disbursing while the other is the act of paying. From the VAT point of view, the two systems are significantly different. That’s because reimbursement payments are subject to VAT, while disbursements are not in most juridictions.
In order to treat a payment as a disbursement, it should meet several criteria which we will discuss below in detail.
An example of simple payments or reimbursement would be the cost of travel, eating out, office supplies, or other out of pocket expenses added by a consultant/contractor. As a result, VAT should be included, as these expenses represent costs that the business incurs for itself. They cannot be considered disbursements. The key consideration between disbursement payments vs. payments is whether the expense belongs to you or your customer. It’s important to get it right. Otherwise, your business could be penalized when audited. It’s also the primary way to ensure employees are paid properly and the taxes align correctly.
An example with cost sharing proposition
Proposition: Co.A and Co.B are intending to enter into an arrangement to share costs of auxiliary costs/functions between them. These costs include IT System Costs, Distribution and Sales, Marketing and Networking, Legal, Finance, HR and Accounts department costs. Co.A already has existing system, contracts with vendors and employees in place to incur those costs. Now, all these auxiliary services / functions are being purposed to be shared with Co.B as well and intends to transfer its costs to Co.B.
Cost Sharing with Disbursement
Description
Co.A and Co.B will enter into a Cost Sharing Agreement and intercompany disbursements will be made through debit notes raised at cost.
Key Aspects
- Co.B should be the direct recipient of the goods/services.
- Co.B should receive the supplier’s invoice in its own name. OR, Co.B should agree to its responsibility for making payment to the supplier of goods/services.
- Co.B should authorize the Co.A to make the payment on its behalf.
- Co.B should preferably prefund Co.A to make the payment on its behalf.
- Co.A should recover the amount from Co.B without a mark-up.
- Co.A should separately itemize the amount in Dr.Note or Invoice to be raised to Co.B.
Accounting
As a rule, all assets and liabilities, and income and expenses are required to be reported separately unless specifically permitted by any specific IFRS. Offsetting in the statements of comprehensive income or financial position, except when this reflects the substance of the transactions or other events, detracts from the ability of users both to understand the transactions (or other events or conditions) that have occurred and to assess the entity’s operation and functions. IFRS has permitted offsetting on gains and losses on
(i) disposal of non-current assets, including investments and operating assets
(ii) expenditure related to a provision that is recognised in accordance with IAS 37 and reimbursed under a contractual arrangement with a third party may be netted against the related reimbursement
(iii) gains and losses arising from a group of similar transactions are reported on a net basis. For example, foreign exchange gains and losses, and gains and losses arising on financial instruments held for trading
IAS 32 requires that a financial asset and a financial liability should be offset as a net amount in the statement of financial position when, and only when, both of the following conditions are satisfied:
(i) the entity currently has a legally enforceable right to set off the recognised amounts of the asset and liability; and
(ii) the entity intends to settle on a net basis, or to realise the asset and settle the liability simultaneously.
However, does a reduction in cost by the reason of cost sharing amount to offsetting under IFRS? No. As this is not a income setting off with cost, but rather a reduction in cost by the reason of cost sharing agreement. So IFRS’s limitation on setting off doesn’t apply in this situation.
Invoicing and Application of VAT
Since Co.A is only recovering the payment made on behalf of the Co.B this doesn’t amount to as transaction as under IT/VAT Act as it doesn’t constitute a supply from Co.A to Co.B. So, Dr. Note / Invoice can be raised without charging VAT.
Application of Withholding Taxes
आयकर निर्देशिका २०६६ (तेस्रो संसोधन २०७७ सहित)
भुक्तानीकर्ताको तर्फबाट हुने खर्चको बिल, भौचर र खर्चको प्रमाण पेश गरेपछि सोधभर्ना गर्ने वा हिसाव फर्छ्यौट गर्ने रकमको हकमा यस्तो रकम भुक्तानी प्राप्त गर्ने संस्था वा व्यक्तिको आम्दानी हुने नभई भुक्तानीकर्ताको तर्फबाट हुने खर्च भएकोले यस्तो भुक्तानीमा अग्रिम कर कट्टी गर्नु पर्दैन ।तर खर्चको सोधभर्ना गर्दा वा हिसाब फर्छ्यौट गर्दा सम्झौता गर्ने अर्को पक्षले आयकर ऐन, २०५८ बमोजिम कर कट्टी गर्नुपर्ने भुक्तानी गरे नगरेको र गरेको भए सो भुक्तानीमा कर कट्टी गरे नगरेको यकिन गर्नुपर्छ । कर कट्टी गरेको भए कर कट्टी गरेको रकम राजस्वमा दाखिला गरेको निस्सा पेश गराउने, कर कट्टी नगरेको भए कट्टी गरी राजस्वमा दाखिला गराउनुपर्छ ।
This could imply that witholding taxes is not applicable on the payment relating to both disbursement and reimbursements. However, this has been interpreted differently in Taragaun Regency Hotel Limited’s case by Revenue Tribunal of Nepal, discussed below.
Cost Sharing with Reimbursement
Description
Co.A and Co.B will enter into a Cost Sharing Agreement and intercompany reimbursements will be made through VAT invoices raised at cost.
Key Aspects
- Co.B should agree to its responsibility for making payment to the supplier of goods/services.
- Co.A should recover the amount from Co.B without a mark-up.
Accounting
As a rule, all assets and liabilities, and income and expenses are required to be reported separately unless specifically permitted by any specific IFRS. Offsetting in the statements of comprehensive income or financial position, except when this reflects the substance of the transactions or other events, detracts from the ability of users both to understand the transactions (or other events or conditions) that have occurred and to assess the entity’s operation and functions. IFRS has permitted offsetting on gains and losses on
(i) disposal of non-current assets, including investments and operating assets
(ii) expenditure related to a provision that is recognised in accordance with IAS 37 and reimbursed under a contractual arrangement with a third party may be netted against the related reimbursement
(iii) gains and losses arising from a group of similar transactions are reported on a net basis. For example, foreign exchange gains and losses, and gains and losses arising on financial instruments held for trading
IAS 32 requires that a financial asset and a financial liability should be offset as a net amount in the statement of financial position when, and only when, both of the following conditions are satisfied:
(i) the entity currently has a legally enforceable right to set off the recognised amounts of the asset and liability; and
(ii) the entity intends to settle on a net basis, or to realise the asset and settle the liability simultaneously.
However, does a reduction in cost by the reason of cost sharing amount to offsetting under IFRS? No. As this is not a income setting off with cost, but rather a reduction in cost by the reason of cost sharing agreement. So IFRS’s limitation on setting off doesn’t apply in this situation.
Invoicing and Application of VAT
VAT Act 2052 of Nepal has not clearly provided on whether VAT invoice should be raised in this regard. However, considering international practice, reimbursements that do not qualify as disbursement are required to be recovered by raising VAT invoice.
Relevant Case Laws:
Application of Withholding Taxes
In paragraph above, in application of withholding taxes on disbursement of costs, Income Tax Directive seems to have exempted both payments relating to both disbursement and reimbursement as not being subject to withholding taxation. However, the
However, as per Taragaun Regency Hotel Limited v/s Inland Revenue Department, withholding taxes are applicable on payment of reimbursable expenses.
Transfer Pricing or Separate Auxiliary Service Company
These are different alternatives but the withholding taxes and implication of VAT on such payments remains same so we will discuss these together.
Under Transfer Pricing Model agreed between Co.A and Co.B, Co.A and Co.B will enter into a Transfer Pricing Agreement and intercompany transfers will be made through VAT invoices raised at appropriate transfer price. Under Separate Auxiliary Service Company Model, a separate company Co.C will be established to provide auxiliary functions to Co.A and Co.B and intercompany transfers will be made through VAT invoice raised at appropriate market prices.
The key considerations applicable in transfer pricing agreement agreed between Co.A and Co.B applicable are: Co.A and Co.B should conduct and intercompany transfer-pricing assessment. Generally the cost that Co.A will transfer to Co.B are already a fair evaluation of transfer price as Co.A has incurred those costs with transaction with independent third party. Thus, the appropriate transfer price agreed between Co.A and Co.B will theoretically be significantly different from the cost that is being transferred from Co.A to Co.B. However, some differences may arise due to the reason of synergy obtained due to intercompany coordination of cost and functions. These benefits of synergy should be evaluated and apportioned between Co.A and Co.B and transfer price should be determined accordingly.
Under Seperate Auciliary Service Company, all the auxiliary costs and functions identified to be shared will be obtained from other auxiliary service company. For accounting purposes, income cannot be set off with the expenses as per IFRS and VAT invoicing is required as per under VAT Act 2052 depending upon the nature of the services. Similarly, withholding taxes is also applicable on payment as per Income Tax Act, 2058 as well.
Disbursement or Reimbursment
Conditions to be fulfilled to qualify as disbursement
Payments you make on behalf of your customers, for goods or services received and used by them may be treated as ‘disbursements’ for VAT purposes. You may treat a payment to a third party as a disbursement for VAT purposes if all the following conditions are met:
- you acted as the agent of your client when you paid the third party
- your client actually received and used the goods or services provided by the third party (this condition usually prevents the agent’s own travelling and subsistence expenses, phone bills, postage, and other costs being treated as disbursements for VAT purposes)
- your client was responsible for paying the third party (examples include estate duty and Stamp Duty payable by your client on a contract to be made by the client)
- your client authorised you to make the payment on their behalf
your client knew that the goods or services you paid for would be provided by a third party - your outlay will be separately itemised when you invoice your client
- you recover only the exact amount which you paid to the third party
the goods or services, which you paid for, are clearly additional to the supplies which you make to your client on your own account
All these conditions must be satisfied before you can treat a payment as a disbursement for VAT purposes. Generally, it’s only advantageous to treat a payment as a disbursement for VAT purposes where no VAT is chargeable on the supply by the third party, or where your client is not entitled to reclaim it as input tax.
An important consideration should be that, if you treat a payment for a standard-rated supply as a disbursement for VAT purposes, you may not reclaim input tax on the supply because it has not been made to you. Your client may also be prevented from doing so because the client does not hold a valid VAT invoice.
If you treat a payment as a disbursement for VAT purposes then you must keep evidence (such as an order form or a copy invoice), to allow you to show that you were entitled to exclude the payment from the value of your own supply to your principal. You must also be able to show that you did not reclaim input tax on the supply by the third party.
Examples
These examples are obtained from UK VAT guidance here.
Examples of disbursements:
- Example A: A registered person supplies standard-rated services to a client for a basic fee of Rs.80. In addition, the supplier incurs Rs.20 expenses which are passed on to the client, but which do not qualify for treatment as disbursements for VAT purposes. The supplier also pays Rs.50 on behalf of the client in circumstances which qualify that payment to be treated as a disbursement. Then VAT is applicable on Rs.100 which is composite of supply / reimbursement but not on Rs.20 which is disbursement.
Examples of reimbursements:
- Example A: A solicitor pays a fee to a bank for the transfer of funds telegraphically or electronically to, or from, the solicitor’s own business or client account. The solicitor cannot treat the bank’s fee as a disbursement for VAT purposes. The service for which the charge is made is supplied by the bank to the solicitor rather than to the client. Although the bank’s supply may be exempt from VAT, the fee when re-charged, even though at cost, is part of the value of the solicitor’s own supply of legal services to the client and VAT is due on the full amount.
- Example B: A solicitor pays a fee for a personal search of official records such as a Land Registry, in order to extract information needed to advise a client. The solicitor cannot treat the search fee as a disbursement for VAT purposes. The fee is charged for the supply of access to the official record and it is the solicitor, rather than the client, who receives that supply. The solicitor uses the information in order to give advice to the client and the recovery of this outlay represents part of the overall value of the solicitor’s supply. The solicitor must account for output tax on the full value of the supply. Where a solicitor pays a fee for a postal search, this may be treated as a disbursement since the solicitor merely obtains a document on behalf of the client. The client will normally need to use the document for their own purposes, such as to obtain a loan.
- Example C: A consultant is instructed by the client to fly to Scotland to perform some work. The consultant cannot treat the air fare as a disbursement for VAT purposes. The supply by the airline is a supply to the consultant, not to the client. The recovery of outlay by the consultant represents part of the overall value of the consultant’s supply of services to the client. The consultant must account for output tax on the full value of this supply.
- Example C: A private function is held at a restaurant. The customer pays for the food, drink and other facilities provided, and also agree to meet the costs of any overtime payments to the staff. The restaurant cannot treat the overtime payments as disbursements for VAT purposes. The supply by the staff is made to the restaurant, not to the customer. The staff costs are part of the value of the supply by the restaurant and VAT is due on the full amount.
- Example D: A manufacturer makes a separate charge to a customer for royalty or licence fees, which were incurred in making a supply to the customer. The manufacturer cannot treat the royalty or licence fees as disbursements for VAT purposes. The recovery of these fees is part of the manufacturer’s costs in making the supply to the customer. The manufacturer must account for output tax on the full value of the supply, including the royalty or licence fees.