Must VAT be Levied on Recovered Third Party Costs?
28 July 2020
Often the question arises whether VAT must be levied on costs that are recovered from third parties. This is especially relevant when no VAT was incurred on the expense. Examples of such recoveries are rates and taxes, salaries or where a consultant recovers certain costs from its client on which no VAT was initially incurred e.g. private travel costs.
Although the issue of cost recoveries is most prevalent in the services industry, it could also impose certain risks for companies as part of a group where cross-charges are applicable or inter-group services supplied.
It is important to establish whether the person recovering the cost is acting as agent or principal. This is a factual situation and is generally agreed between the parties. An example is where a service provider incurs costs on behalf of its client. In such scenario, the costs are incurred in the capacity as agent for an on behalf of the client. In these circumstances the recovery of costs will not be subject to VAT in the hands of the service provider and the costs will be deemed to be incurred by the client as principal. The service provider will recover the actual cost incurred and should not claim any input tax or account for output tax on the recovery.
The position is less clear where the service provider recovers costs it incurred such as travel costs when attending meetings e.g. fuel or rate per kilometre. Since there is no VAT charged on fuel, the myth is that the recovery should also not be subject to VAT. Similar uncertainty exists where one group company recovers salary costs or similar expenditure from other companies within the group.
In terms of the Value-Added Tax Act (“the VAT Act”), a vendor levies VAT on the supply of goods or services in the course of furtherance of its enterprise. The VAT is calculated at the applicable VAT rate on the consideration received for the supply. It is consequently imperative to establish what the nature of the supply is.
The supplies in the abovementioned examples are services the service provider supplies to its client. The supplier does not supply fuel as part of its service but merely is an element of its costs to supply the service. It follows that the supply of the service cannot be zero rated but is a taxable supply of a service and VAT at the relevant rate should be levied on that supply.
Similarly, when a company recovers salary costs from another company within the group and the employee is employed by the company recovering the cost. The cost recovery does not represent salaries as the employee is not employed by the other recipient company within the group. The recovery of a cost incurred by the employer of supplying a service to the recipient company within the group. The recovery will consequently constitute a taxable supply of a service. This principal would also apply to other expenses incurred and recovered from other companies within a group.
Various court cases confirmed this view and SARS supported the courts view in previously withdrawn rulings. Where a landlord recovers municipal rates and taxes (now zero rated) as part of the total rental consideration, the landlord should levy VAT on the recovery of the cost. This view is based on the interpretation that the landlord is not the supplier of the municipal services and the recovering thereof forms part of the consideration for the rental service supplied.
It is therefore important for suppliers such as service suppliers and group companies to closely scrutinise whether they are appropriately accounting for VAT on the costs recovered.
Read more BDO Insights