I recently received an email from a client asking for some advice about VAT and directors’ costs and when to charge VAT when sharing the costs between associated companies.
The VAT liability of payments between associated businesses is the same as between any third party businesses. But the role of directors can be a bit different so it’s a good idea to discuss the subject of VAT and directors’ costs and when such recharges are liable to VAT.
Is the recharge payment for good or services?
The first thing to consider is whether the recharges are simply a way for one business to charge another business for services. Payments between associated businesses can be made for a variety of reasons, including loans, sharing of group costs, payments for goods or services. So we need to know the exact reason for sharing directors’ expenses between associated businesses.
A lot of associated businesses, whether corporate groups or sole traders/partnerships set up agreements for management services, or the provision of other services between the businesses concerned. For the purposes of this article, I’ll refer to “holding companies”, as this is often the company which “employs” the directors. In these cases, “group” costs are allocated between the businesses and the recharge of the costs is normally referred to as a “management charge”. VAT incurred by the holding company on directors’ costs can be claimed on the basis that it is attributable to the taxable supply of services to the associated businesses.
HMRC usually accept this arrangement on the basis that the “management charge” is a way of calculating the amount each business should pay for services from the holding company. The actual amount might be based on sharing the cost of shared premises or the costs of directors and employees who work for more than one company. In this situation, the holding company can claim VAT on directors’ costs under the normal rules, in the same way as any other expenditure*.
*N.B. Just to clarify one important point is that VAT on directors’ domestic accommodation can’t be claimed even if the company bears the cost. See VAT Notice 700, The VAT Guide, section 12.2 for more information http://tinyurl.com/lsebnc9.
However, the role of directors is quite unique because, as well as working in the business concerned, they are appointed by shareholders to look after the affairs of the shareholders. So it’s important to understand that the role of directors falls into 2 separate categories.
Fiduciary role: directing the activities of the companies on behalf of the shareholders
In fact, the primary reason that directors are appointed BY SHAREHOLDERS is to look after the affairs of the company on behalf of the the shareholders. This is to ensure that the company’s business strategy is followed and that the company generate a good return on investment for the shareholders. This “fiduciary” role is quite distinct from any other because the “services” are provided directly by the director as an individual to the shareholders of the company concerned.
This means that any payment received by the director for this role are outside the scope of VAT.
In some cases, the director may be an independent individual, sometimes an employee or director at an associated company. It’s normal practice for holding companies to appoint directors to subsidiary companies. Payments made to the director by the subsidiary company for acting in this role are therefore not liable to VAT.
Provision of services: expertise
Very often directors have a dual role. They are often also employed by one of the companies concerned, using their professional expertise employed as an in-house solicitor or accountant for the company concerned, or the directors’ legal or accountancy practice may be engaged to provide legal or accountancy services to the company.
If a director who is an accountant is employed by a company to fill the role of finance director, this is separate to the director’s role of monitoring and directing the company’s activities. This means that payments between companies for the professional services of the director concerned – e.g. to assist in financial matters – would be liable to VAT under the normal rules. It doesn’t matter how the value is calculated, for example based on a share of the directors’ costs, including salary, pension, travel costs etc .
You can find more information about this subject in VAT Notice 700/34: Staff, section 4http://tinyurl.com/zcto72r.
The simplest way to deal with VAT on intra-group transactions is to set up a VAT group registration. Under this arrangement, there is only one VAT registration number and return for the whole group, while transactions between group members are not liable to VAT. It means that VAT doesn’t have to be charged when sharing directors’ costs
But it’s not just directors’ costs that benefit from this treatment. Group registrations are a very good way of simplifying VAT accounting on intra-group transactions. The group registers under the name of one of the companies (often the group holding company) and associated companies are included under the same registration number. It means that you don’t have to worry about whether to charge VAT on directors’ costs or other situations where costs are shared among associated companies. And the good thing about group registrations is that the facility is available to businesses of all sizes, including SMEs. Whether it’s directors’ costs, sharing out telephone bills or the even just the cost of running the staff coffee machine, group registrations can help to save time and hassle dealing with VAT.
So can a company claim VAT on directors’ costs?
Finally, it’s important to clarify one fundamental issue. This concerns the VAT incurred on the original cost itself; for example the costs of running a director’s office, telephone bills, travel and subsistence costs.
The principle is that VAT on directors’ costs is treated the same as VAT on any other business cost incurred by the company concerned. In other words, if the business makes taxable supplies for VAT purposes, then the company can claim VAT on the directors’ costs in the same way as any other cost. If the business makes exempt supplies, or a mixture of taxable and exempt supplies, then the business may only be able to claim a proportion of VAT on directors’ costs, according to the terms of the business’s partial exemption method.