As part of their handling of a 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. This can include, for example, medical reports for personal injury claims or property searches in conveyancing work. Over the last 18 months there has been increasing uncertainty as to the correct value-added tax (VAT) treatment of disbursement charges made by law firms.
Recent U.K. VAT case law is calling into question the situations where the “VAT free” disbursement rules can be applied when the law firm passes on these costs to its client.
In late 2017, the First-tier VAT Tribunal provided a decision in the Brabners LLP v Revenue and Customs case in relation to online search fees that led to a number of law firms receiving challenges from HM Revenue & Customs (HMRC) and in April 2019 the Court of Appeal provided a judgment in the British Airways Plc v Prosser case, which casts further doubt as to the correct VAT treatment of disbursements in the legal sector.
Decision in the British Airways Case
The British Airways case, while addressing a broader principle as to whether VAT should form part of a costs claim, has focused on whether VAT is chargeable on medical reports bought in from third 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.”
The British Airways case 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 states with some clarity in the decision.
In addition, the judge points out that in U.K. contract law there would rarely, if ever, be any relationship between the provider of the records and the client. As such, the default will be that the solicitor 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 earlier Brabners decision, the judge stated that the solicitor will have 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 will have been part of the solicitor’s broader supply of legal services to his client. The solicitor’s role will not merely have been to forward the report to the client and the report will be supplied to the solicitor to enable him effectively to perform the service supplied to his client. It did not matter to whom the reports belonged, other than where the solicitor is clearly a mere conduit or delivery facilitator.
In the world of VAT the word “disbursement” has its own meaning separate from the ordinary one. A VAT disbursement is a service or cost incurred by an organization on behalf of its client, whereby the organization is only the agent and vehicle for payment.
Where these conditions are met, the charge does not form part of the consideration for services and will be outside the scope of VAT. If the organization uses 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.
The direction of travel in both the Brabners and British Airways cases is that law firms are using the bought in costs (online property searches and medical reports in the cases) as part of their legal service, so VAT falls to be due on the recharges when the legal service itself is subject to VAT.
There has been inconsistency in the VAT treatment applied by law firms. The Brabners case was a First-tier Tribunal decision and as a result was not binding on any other taxpayer. Some law firms felt able to distinguish their own facts and/or legal position from those of Brabners. However, the British Airways decision is binding law as it has been provided by the Court of Appeal.
To date, HMRC are yet to provide any public comment and it is interesting that they declined to join the proceedings. Law firms will now need to consider the VAT treatment of all their disbursement charges and seek specialist advice if they are uncertain of how to proceed.
Robert Marchant is VAT Partner at national audit, tax, advisory and risk firm, Crowe.
He may be contacted at: firstname.lastname@example.org
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