Following a recent Court of Appeal case, the Law Society has now published guidance on how law firms should treat disbursements.
A recent case: British Airways v Prosser (2019) EWCA Civ547
This case related to costs awarded in a personal injury claim where part of the legal services supplied required a medical report. The medical report was commissioned by the solicitors and VAT was charged on the report. The argument made was that the services should not have borne VAT as the medical professionals making the report would not have charged VAT, and that the firm supplying the report was acting as an agent of the medical professional so should only have charged VAT on its administration fee.
The Court of Appeal confirmed that VAT was properly charged on the full amount of the supply. The reason being that the supply was made to the solicitor as a principal, rather than being supplied directly by the medical professional to the solicitor’s client with the solicitor acting as an agent of their client. The supply formed part of the solicitor’s services to the client.
Action for law firms now
The key issue to understand when determining the VAT treatment of disbursements is the line of supply. In other words, who is actually receiving the supply?
If it is the law firm receiving the supply then it forms part of their services and follows the liability of their supply to the client, which will normally be subject to VAT at the standard rate. If the line of supply is to the client and the solicitor is simply acting as an agent of the client, then it is correct to treat the payment as a disbursement.
The disbursement rules
HMRC’s published guidance on disbursements sets out their views on the criteria required for a cost to be treated as a disbursement and hence not included within the supply of the solicitor’s services with VAT thereon. It states that all of the following must apply.
– The firm acted as an agent of the client when it paid the third party;
– The client actually received and used the goods or services provided by the third party (this condition usually prevents the firm’s own travelling and subsistence expenses, telephone bills, postage, and other costs being treated as disbursements for VAT purposes);
– The client was responsible for paying the third party (examples include estate duty and stamp duty payable by the client on a contract to be made by the client);
– The client authorised the firm to make the payment on their behalf;
– The client knew that the goods or services the firm paid for would be provided by a third party;
– The outlay was separately itemised on the invoice to the client;
– The firm passed the exact amount of each cost to the client when invoicing them without mark up; and
– the goods or services (which the firm paid for) are clearly additional to the supplies which the firm makes to the client on its own account.
Usually, it is only an advantage to treat a payment as a disbursement if the supplier didn’t charge VAT on it, or if your customer can’t reclaim the VAT back.
A third-party issues you (the law firm) with an invoice plus VAT of £100 net, £20 VAT.
If you are passing this on as a disbursement to your client then you wouldn’t be able to reclaim the £20 back, because when you are ‘disbursing’ the cost to your client, the VAT isn’t classed as your input tax and is ‘sticking tax’ that the end consumer has to pay.
However, the ‘exact cost’ (mentioned in bullet point 7 above) means that you would have to disburse the £120 on to your customer for it to meet the disbursement criteria. In this scenario you wouldn’t suffer any loss as you are merely passing on the cost to the client.
For further information on anything mentioned above or VAT advice, please contact our VAT Manager Steven Cosgrove on 01254 604341 or via email at firstname.lastname@example.org. For advice or guidance relating to law firms, please get in touch with our legal specialist Helen Clayton on 0161 641 8684 or via email at email@example.com.