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Law firms: Getting the VAT treatment of disbursements right

Robert Marchant, Partner, VAT and Customs Duty Services
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Summer 2023
In our experience, the VAT treatment of disbursement charges by law firms remains an area where mistakes continue to happen. In recent years it has been a ‘hot topic’ following several court decisions which changed the principles of when the charges could be VAT free. While the case-law has ‘settled’ we continue to receive queries from our clients, sometimes leading to those firms having to make corrections to their processes. This article provides an overview of the case-law and the principles to be applied by professional services firms going forwards.

What is the issue?

As part of their handling of a particular client matter, it is quite common for law firms to pay certain fees on behalf of their clients and/or to arrange for third party specialist input; for example medical reports for personal injury claims or property searches in conveyancing work. Recent VAT case-law called into question the situations where the ‘VAT free’ disbursement rules could be applied when the law firm passed on the costs to its client.

In late 2017, the First Tier VAT Tribunal provided a decision in the Brabners v Revenue and Customs (TC06093) case in relation to online search fees that led to a number of law firms receiving challenges from HMRC and a couple of years later the Court of Appeal provided a judgment in British Airways (British Airways Plc v Prosser [2019] EWCA Civ 547) which cast further doubt as to the correct VAT treatment of disbursements in the legal sector.

What actions should firms take?

The British Airways 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, and so be subject to VAT when supplied to a UK established client.

The British Airways decision increases the prospect of 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. Law firms are therefore recommended to review the treatment of their disbursement charges, recognising that relying on differentiators from Brabners may no longer be sufficient.

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 case-law now suggests 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 is 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 the British Airways 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.

  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. 

The Law Society guidance

The Law Society has issued a comprehensive update to assist law firms in making decisions about what costs may be treated as disbursements for VAT purposes.

The guidance  VAT treatment of disbursements and expenses replaces the former practice note on VAT and disbursements.

Next steps

A VAT disbursement is a service or cost incurred by an organisation on behalf of its client, whereby the organisation is only the agent and vehicle for payment. Where these conditions are met, the charge to the client does not form part of the consideration for services and will be outside the scope of VAT. If firms use the disbursement cost as part of its own supply, then the cost will not qualify as a VAT disbursement and instead represents part of the overall value of the services provided to the client and will follow the VAT treatment of the services provided.

Law firms will need to consider the VAT treatment of their disbursement charges. If you would like to discuss this topic in more detail or would like help in reviewing your firm's position contact Robert Marchant or your usual Crowe contact.

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Robert Marchant
Robert Marchant
Partner, National Head of Tax