Which costs are business-related, and what that means for VAT
When someone asks what costs their company or non-profit can put through the books – in other words, whether a cost is related to the business or the organization's activities – the first question to answer is always: what was this cost for?
After that, you only need two simple rules.
Rule 1: the cost must be tied to what the organization actually does!
– For a company, that means its business, including production or sales. It makes no difference whether it makes or sells goods or services.
– For other organizations (a non-profit, for example), it means the activities in its articles of association – the purpose it was set up for, or the tasks it has set itself. If the non-profit also runs a business, those costs must be kept apart and recorded separately.
– Direct costs are what it takes to make or sell the goods or services: materials, goods for resale, transport and so on.
– Indirect costs, or overheads, are what it takes to run the organization: management, marketing, advertising, development and so on.
Rule 2: if the organization is VAT registered, you need to know which kind of sales the cost was for:
– If the cost relates to taxable sales (sales of goods at 20% or 0% VAT), the VAT on that cost can be deducted.
– If the cost does not relate to taxable sales (the sales are VAT-exempt), or the cost is itself taxable (private use, entertainment costs and the like), the input VAT cannot be deducted.
– A non-profit cannot deduct input VAT on costs of its statutory activities. Nor on costs paid for out of donations.
Yes, of course there are many more rules and finer points when recording costs and calculating taxes – but you always start with these two rules!
If you are unsure, or want to talk through whether a particular cost is related to your business or your organization’s activities, do not hesitate to ask your accountant. Ideally before you incur the cost or sign the contract.
A consultation is always an option!
