The Law Society has now published guidance on how to treat disbursements in the light of Obiter comments from the Court of Appeal on a case relating to the award of costs (British Airways v Prosser). The comments reaffirms the advice Armstrong Watson has previously provided to law firms as a result of the Brabners first tier tribunal case on the question of whether an expense incurred can be treated as a disbursement or not.
British Airways v Prosser
This case was 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 commented that VAT was properly charged on the full amount of the supply. The principal reason is 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
HMRC have not provided any additional guidance in respect of these cases and they therefore must be of the opinion that their existing guidance on disbursements is robust. The overriding aspect that HMRC will consider and base any judgement on is the line of supply.
Therefore in analysing a disbursement transaction, it is important to ask 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 taxable 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. Stamp Duty Land Tax is probably the most clear cut example of a genuine disbursement I can think of.
The Disbursement Rules
It is always worthwhile reminding ourselves of the rules as they appear in HMRC guidance. In order to treat a disbursement as a disbursement and therefore not charge VAT on to your client, all of the following needs to apply:
you acted as the agent of your client when you paid the third party
your client actually received and used the goods or services provided by the third party (this condition usually prevents the agent's own travelling and subsistence expenses, telephone bills, postage, and other costs being treated as disbursements for VAT purposes)
your client was responsible for paying the third party (examples include estate duty and stamp duty payable by your client on a contract to be made by the client)
your client authorised you to make the payment on their behalf
your client knew that the goods or services you paid for would be provided by a third party
your outlay will be separately itemised when you invoice your client and you recover only the exact amount which you paid to the third party; and
the goods or services, which you paid for, are clearly additional to the supplies which you make to your client on your own account.
Stephen Ferrie is a VAT Consultant at top 30 UK accounting firm, Armstrong Watson LLP. Stephen works with the specialist legal sector team that advises law firms throughout the UK on tax, strategic, structural and other business improvement issues as well as providing efficient accounting, tax and SRA accounts rules services. Further information can be found at: www.armstrongwatson.co.uk/legalsector
This article is a general guide to the issues that we see in practice. It is not a substitute for professional advice which takes account of your personal circumstances. No responsibility can be accepted for any loss occasioned by any person acting or refraining from action on the basis of this article.
The Law Society has exclusively endorsed Armstrong Watson LLP for the provision of accountancy services to law firms.
If you have any concerns relating to disbursements and how you are accounting for VAT on them please contact Steve on 01228 690194 or email stephen.ferrie@armstrongwatson.co.uk.
