Managing Expenses on behalf of Clients

When you work in the service industry it is common to have to spend money in order to deliver the service to your client. In many cases you may be able to charge these expenses back to your client.  This practice goes by many names, including Reimbursements, Recharges, Billable Expenses, Disbursements etc.

The issue comes when you are spending money that you then need to be reimbursed for by a client.  This is complicated when there are multiple sales taxes involved and expense deduction limitations (such as on meals and entertainment).  The question is who claims the sales tax back and who suffers the expense restriction - you, or your client?  And what is your obligation to charge sales tax?

For the sake of this article we will refer to “disbursements” when we refer to any payment that falls into this category.  Examples here assume a $100 expense plus 5% GST and 7% BC PST for a total disbursement of $112.  US Sales taxes and other non-recoverable sales taxes paid should be treated the same as PST for Canadian suppliers.

Are You an Agent?

The first question you need to answer is: Are you acting as an agent of your client when you incur these disbursements?

To be acting as agent for your client you generally need to fulfill the following:

1. Have an agreement with the client that you are authorized to act as their agent in respect to this work.  This may be part of your standard terms of service.  It may be implied, but should ideally be in writing.
2. Ownership of the disbursement passes immediately to the client.
3. It’s something that the client would have incurred whether they performed the action or you did.
4. You are recovering only the amount disbursed (no markups or standard charges).
5. Receipts are provided to the client for the disbursement (not just your invoice, but the actual receipts for the goods or services purchased on their behalf).
6. You are being reimbursed for the exact amount of the disbursement.  If you are building this into a service fee or marking up the transaction then you are not acting as agent but a reseller.

The key thing to note here is that when you are acting as agent you are not treating these disbursements as your revenue or expense - they are simply performed on behalf of the client and for their sole purpose.  In legal terms we might say that these are “in trust.”

The bar to be considered as an agent is pretty high.  A contractor that travels to meet his client and has an agreement that the client will pay an hourly rate plus expenses if probably not acting as an agent.  A builder that purchases wood to build a house on a fixed price contract is not acting as agent for this purchase (ownership doesn’t pass until the project is complete), but that same builder that files for a permit on behalf of the customer is acting as agent (the permit is usually in the name of the land owner and for their sole benefit).  Also, you may be an agent for some disbursements but not all.  Whether or not you are an agent does not change if your client is unable to claim back any sales taxes.  Just because your client is out of the country and can’t claim back GST doesn’t automatically mean that you are acting as Agent or vice-versa.  Your own mileage claim can’t be treated as an agent payment - you can’t pay yourself and seek reimbursement as agent!  This is a service charge that must follow the non-agent rules.

How to account for Disbursements as an Agent?

If you are acting as an agent for a particular disbursement then you should:

1. not claim the GST/HST/QST on your GST return (it doesn’t belong to you)
2. itemize the disbursement on your invoice and state that it is inclusive of sales tax
3. charge the exact amount of the disbursement with no tax added (if you spent $112 including GST and PST then you will invoice $112 with no taxes added - Tax Exempt status)
4. provide a copy of the disbursement receipt for their accounting records (they can’t claim the Input Tax Credit for GST/HST/QST without it).

In your accounting system we recommend that you set up two accounts:

• Other Revenue: Client Disbursements Recovered (Tax Exempt)
• Direct Expenses/COGS: Client Expenses to be Reimbursed (Tax Exempt)

When you record the initial disbursement you code it to the “Client Expenses to be Reimbursed” account (you can use Xero’s Billable Expenses module to tag this as something to re-bill to the client).

When you invoice the client code the spending to “Client Disbursements Recovered”. You don’t necessarily have to itemize each particular disbursement, but you should at least categorize them and split out meals & entertainment as a separate line (as there are limitations).  You should provide receipts to the client.

In a perfect world you should see that the Other Revenue account and the Direct Expenses/COGS account would match (every dollar disbursed is billed to a client).

Alternatively, you could code both the disbursement and invoice lines to the same account code with the same Tax Exempt tax code.

Ideally you do not mark up these disbursements.  If you do charge a handling fee then this should be listed as a separate line on your invoices and the appropriate sales tax rate applied.  For example, if you charge a 10% handling fee and you have processed $1000 + taxes ($120) in reimbursable expenses as agent then we would expect to see one line on your invoice for “Reimburseable Expenses (includes taxes, receipts attached) $1120.00; and a second line “Handling Fee for reimbursable expenses” $112.00 + GST.

Please note that you are passing all GST recovery obligations on to your client.  They may have limitations on their ability to recover GST and must abide by entertainment limitations.

How to account for Disbursements when NOT an Agent?

When you are not acting as agent then the disbursement is your expense, and the re-charging is your revenue.  You claim the Input Tax Credit for GST/HST and must charge the appropriate sales tax to your client.

The most common here are meals and accommodation for your team who travel.  You may even increase the amount charged to cover administration costs etc.  This category applies to all internal charges such as photocopying, mileage, admin fees and the like.

In this case the expenses are yours and you claim the refundable sales tax (GST/HST/QST), absorb the non-refundable sales tax (PST/RST/US Sales Tax) and suffer the effect of any non-deductible expenses (such as meals).  When you record the expense you would code it to the appropriate code on your Income Statement and use the appropriate tax rate for the purchase.  If you paid a non-refundable sales tax then you would add this to the expense you record.  For example, if you paid $100 + 7% PST + 5% GST (total of $112) then you would record the expense as $107 + $5 GST.  Be sure that expenses with restricted deductions (such as meals) are coded to the correct expense account.  You may want to use a "Client Disbursements" direct costs account for everything except Meals (as this has limitations and needs to kept separate from other expenses).

When you charge your client you would charge the appropriate LOCAL sales tax rate for your customer, regardless of what tax rate you actually paid.  The fact that you didn't pay sales tax is irrelevant - if you are registered for sales tax and this item would be taxable if you were to have sold it locally then you will need to add the tax.  If you paid a non-refundable sales tax (such as Canadian PST or US Sales Tax) then you would add this to the amount that you charge the client.  For example, if you paid $100 + 7% PST + 5% GST (total of $112) then you would charge the client in Ontario  $107 + HST of $13.91 for a total of $120.91.  When you invoice this you should have a Revenue Code such as "Expenses Oncharged".

This view ensures that all expenses are recorded as expenses, input tax credits are claimed by you correctly and all revenue is coded as revenue with the correct sales tax rate applied.  It is the most audit-safe scenario.

Remember that in Canada (and most jurisdictions) there are limitations on tax deductions for meals and entertainment as well as GST/HST limitations on meals & entertainment, as well as possibly other limitations.  As these are your expenses you are required to properly account for them when filing your GST/HST/Income Tax returns, so proper coding and documentation is necessary.  Special rules may apply here if you supplied meals and entertainment to your client as part of the service.

CRA has a useful guide on Out-of-Pocket Expenses (GST/HST Info Sheet GI-197).