Under-charging VAT is one of the most common – and costly – mistakes we see from small business owners.
And the tricky part?
Most people don’t realise they’re doing it.
VAT isn’t just about whether you’re registered. It’s about what you’re charging VAT on, when you should be charging it, and how costs are passed on to customers. If any of those are wrong, HMRC can come knocking with a backdated bill.
Let’s break this down.
How businesses accidentally under-charge VAT
Here are some of the most common situations we see:
- You’ve gone over the VAT threshold but didn’t realise
- You registered for VAT late
- You’re charging VAT on some things… but not others
- You’re recharging costs incorrectly
- You’re treating costs as disbursements when they’re not
That last one is huge, so let’s talk about it properly.
Disbursements vs recharged costs (this is where VAT often goes wrong)
We see a lot of confusion around disbursements, and it’s one of the easiest ways to under-charge VAT without meaning to.
What is a disbursement?
A disbursement is a cost you pay on behalf of your customer, not for your own business, and then pass on at cost, with no markup.
To be treated as a true disbursement, all of the following must apply:
- You paid as an agent for your customer
- Your customer received and benefited from the goods or service
- Your customer was responsible for the cost, not you
- You had their permission to pay it
- They knew the supplier wasn’t you
- The cost is shown separately on your invoice
- You recharge exactly what you paid
- The cost is additional to your own services
If (and only if) all of this applies:
- ✅ You do not charge VAT on the disbursement
- ❌ You cannot reclaim VAT on it
This is straight from HMRC guidance and something we regularly help clients evidence correctly.
What is not a disbursement?
Here’s the important bit.
Costs that belong to your business, even if you pass them on to your customer, are not disbursements.
These usually include:
- Travel or mileage
- Postage
- Bank charges
- Admin costs
- Software or subscriptions
These are called recharges, and if you’re VAT registered:
👉 You must charge VAT on them, even if:
- Your supplier didn’t charge VAT
- You’re not making a profit on them
This is one of the biggest reasons businesses accidentally under-charge VAT.
How to show this correctly on your invoice
To stay compliant and avoid issues later:
- Disbursements should be shown separately and excluded from the VAT calculation
- Recharged costs should be included in the VAT calculation and have VAT added
Simple example:
- Your services: £2,500 → VAT charged
- Travel costs (recharge): £300 → VAT charged
- Hosting paid on behalf of the client (disbursement): £150 → no VAT
Getting this wrong can mean:
- Owing VAT you didn’t collect
- HMRC penalties and interest
- Very awkward conversations with customers
Why under-charging VAT is risky
HMRC doesn’t see under-charging VAT as a “small mistake”.
If they review your records, they can:
- Backdate VAT you should have charged
- Add penalties
- Charge interest
- Expect you to pay it – even if you can’t recover it from customers
This is why it’s always better to check early rather than fix it later.
Already VAT registered? This still matters
Even if you’ve been VAT registered for years, rules around:
- disbursements
- recharged costs
- VAT rates
are commonly misunderstood.
We regularly review VAT setups for businesses that thought everything was fine – and spot issues that could have become expensive down the line.
If you want to read more about common VAT issues, you might also find this helpful:
👉 VAT and common return mistakes
Not sure if you’re charging VAT correctly?
If you’re unsure whether:
- You should be charging VAT
- You’re charging it on the right things
- You’re treating disbursements correctly
👉 Please ask.
VAT is one of those areas where guessing can cost you far more than getting advice.
We’re always happy to check things over and explain it – no judgement, no jargon.
Need help with VAT?
Pop us a message and let’s make sure everything is set up properly.