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Court of Appeal casts further doubt on treatment of VAT on disbursements

Keri Pay, Partner, VAT
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A recent case in respect of a claim for costs involving British Airways (British Airways Plc v Prosser [2019] EWCA Civ 547) appears to have created worrying binding precedent for law firms. 

Many firms have relied on the Brabners decision being only a First Tier Tribunal, therefore did not consider it to have a direct effect on them. Whilst this indicates HMRC’s view on the treatment of search fees as a disbursement, the Brabners decision did not require all law firms to agree and adopt its findings where their own facts were distinguishable from those in Brabners. In particular differences in terms and conditions were held out as a primary distinguishing feature. The British Airways (BA) case brings that distinction into doubt.

Whilst the BA case, released on 2 April 2019, addressed a broader principle as to whether VAT should form part of a costs claim, it also focussed on whether VAT is chargeable on medical reports bought in from 3rd parties upon which the solicitor then makes comment. HMRC has long accepted, following the 2011 case in Barratt, Goff and Tomlinson v Revenue and Customs Commissioners, that as the reports belong to the client (as being private medical records protected by statute), the solicitor could only ever obtain them “on behalf of the client”. This decision also gave firms the potential defence against an assessment based on Brabners if the legal relationships were clear and unequivocal. The judge in the Brabners case indicated that altered terms and conditions to this effect may have given rise to a different judgement.

The BA decision turns this premise entirely on its head and suggests that the only differentiating factor in the matter of the treatment of disbursements is whether or not the solicitor acts as a “post-box”. This will rarely, if ever, be the case as the judge stated with some clarity in the decision.

In addition, the judge pointed out that in UK contract law, there would rarely, if ever, be a relationship between the provider of the records and the client and as solicitors will generally have contracted as a principal and therefore, as a matter of domestic law, will not have acted merely as an agent of the client.

In comments that resonate with the Brabners’ decision, the judge stated that the solicitor obtained the report in order to advise the client on the merits of the claim and/or to facilitate his pursuit of the client's claim. Consideration of the report was part of the solicitor's broader supply of legal services to his client. The solicitor's role was not merely to forward the report to the client but the report was supplied to the solicitor to enable him effectively to perform a service to his client. It did not matter to whom the reports belonged, other than where the solicitor is clearly a conduit or delivery facilitator.

What action should firms take?

This decision has a broader impact on the treatment of disbursements, indicating that the contractual position may not reflect the economic reality. In short, in the view of the court, any disbursement incurred on anything other than a “post-box” basis will be incorporated within the supply of services by the solicitor who is acting as principal. If the solicitor is acting as principal, will that mean that the default for HMRC is that no items currently treated as disbursements can ever be incurred “on behalf of the client”?

Law firms will need to consider their own treatment of all disbursements recognising that relying on differentiators from Brabners will no longer be sufficient. This decision is binding on all taxpayers and will only lead to more firms facing questions and assessments from HMRC where they continue to treat disbursements as VAT-free which could, to any degree, be seen to form part of the solicitor’s services.

We consider that there are broadly now four categories of disbursements that require consideration by all firms. The key question is whether the firm receives a service as opposed to paying a statutory fee and what the firm does with that information once it has been received:

  1. Costs incurred on non-statutory fees and any services from third parties
    The judgement suggest that it is rare that these costs will be true disbursements as it is unlikely that there is a contract with the client by the provider and in most cases the costs are incorporated within the supply of legal services. Where a law firm receives any service from a third party, it is likely that those will not be considered as disbursements and VAT is due on the recharge of such costs to the client.

  2. Statutory fees forming part of the legal services 
    These will be those similar to the Brabners decision where a third party cost such as a search fee are consumed within the supply of legal services. The key point being that the client expects to receive and obtains advice relating to that cost, and the law firm applies its resources to considering the impact of that information supplied by the third party.

  3. Statutory fees not forming part of the legal services 
    We expect that some fees will still be accepted by HMRC as being true disbursements where it is clear that the law firm is nothing other than a conduit for payment. This might include a court fee payable for lodging papers. The difficulty is that this decision would suggest that such fees may not qualify if they are incorporated within the services provided. For example the client expects it to happen and the law firm adds value to the process by filling in, checking and submitting the forms as part of an all-encompassing service. We consider that this area will require further clarification in the coming months and we will advise of further developments as they arise.

  4. Payment of clear client obligations 
    The decision does not impact on instances where a solicitor pays a client’s obligations on a matter such as stamp duty on the purchase of a home. This is a clear case where the solicitor receives no service, and is merely transferring client monies. 

To discuss this topic in more detail or for help in reviewing your firm’s position contact Robert Marchant, Keri Pay or your usual Crowe contact.

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Robert Warne
Rob Warne
Partner, Head of VAT and Customs Duty services