VAT recovery on non-staff members’ expenses

Many businesses use self-employed workers in their businesses to do specific projects or on contracts – what happens to the VAT when they incur expenses and claim them back from your business?

Staff expenses

When a business’s staff incur expenses that the business pays for, it is entitled to recover the input tax on those costs even if the staff have paid for them and the supply was made to them. For example, overnight hotel expenses, travel costs and subsistence.

Who counts as an employee?

In most cases, someone will only count as an employee if they are on the payroll, or are a director, partner or, in the case of a sole trader, they own the business. Therefore, pensioners, former staff, and job applicants do not qualify because they are not on the payroll; nor does a shareholder unless also an employee, nor do the business’s auditors or other advisers working on their premises.

VAT groups

If companies form a VAT group registration, they can claim back the VAT on expenses incurred by staff from any companies within the VAT group. This is because ‘employees’ include the staff of all companies within the same VAT group. Therefore, there is no disallowance when a company pays for lunch or for a hotel bill for people visiting it from another company in its VAT group.

Self-employed

In most cases, a business cannot reclaim VAT on expenses incurred by people who are not employed by the company. However, in Notice 700/65 (February 2012) Business entertainment, HMRC says in para 2.3 that:

“… employee includes self-employed persons (subsistence expenses only)—treated by you in the same way for subsistence purposes as an employee.”

Firstly, HMRC does not define subsistence, but it obviously means to restrict the concession to accommodation and meals used by the self-employed person and paid for by the client whilst away on its business.

The phrase “treated by you in the same way for subsistence purposes as an employee” seems to restrict the recovery of input tax to those cases in which the consultant travels away from the base office. In most cases, if the sub-contractor claims the expenses on the company expenses form, input tax recovery will be allowed.

Other costs incurred by the sub-contractor will normally form part of the base cost of their supply and be invoiced on to the business, and input tax recovered on any expenses charged to the client on their invoice.

The May 1996 version of Notice 700/65 referred to a self-employed person working for a single ‘employer’, who used tools provided and was paid on a fixed-rate basis associated with the trading profits of the business. Therefore, the concession was, at that time, intended to refer only to such circumstances as someone working under a long-term contract or, perhaps, as a labour-only subcontractor on a building site. In those circumstances, it had a limited application and, usually, too small expenses anyway. The potential application of the wording now used appears much wider.

HMRC’s latest guidance states that the following people count as employees for VAT reclaims:

• self-employed people who are treated as employees (you cannot reclaim travel expenses for this group).

The latest position, therefore, is that a business can claim the VAT back on any reasonable expenses claimed through the company’s expenses system, with the exception of travel expenses.

Practical tip

If a business uses self-employed staff, it can claim back the VAT on expenses claimed through the business’s expenses procedures, with the exception of travel costs.