Law firms face a variety of challenges from a VAT perspective, one of which is the question of whether to account for VAT on disbursements charged to clients. This is a common problem area, as there are many different types of recharges which are commonly described as disbursements, but only some can be treated as disbursements for VAT purposes (referred to as ‘VAT disbursements’ below, for simplicity).
Where a law firm recharges a VAT disbursement, it should not reclaim any VAT charged by the supplier and should not account for VAT on the recharge to the client. This is because the supplier’s service is supplied direct to the client. The law firm has simply facilitated the supply.
Alternatively, where a recharge is not a VAT disbursement, the law firm should reclaim any VAT charged by the supplier (subject to the normal rules) and, in most cases, treat the amount recharged to the client as further payment for the law firm’s services. So, if the firm’s fees are subject to standard rate VAT, the same VAT treatment would apply to the recharged cost, even if it is described as a ‘disbursement’ on the face of the invoice and even if the supplier did not charge VAT.
The key question, when determining whether a recharge is a VAT disbursement, is whether the law firm has:
- received the supplier’s service and used it in the course of making its own supply of services to its client (i.e. not a VAT disbursement); or
- simply acted as the client’s agent in facilitating the supply of services direct from the supplier to the client (i.e. a VAT disbursement).
HMRC’s VAT Notice 700, Section 25.1 sets out eight conditions, which it says must be satisfied in order for a recharge to be a VAT disbursement.
A common example is the recharge of travel expenses to a client. Although separately itemised as a disbursement on the invoice issued to the client, the recharge cannot be treated as a VAT disbursement. This is because it is the law firm that received and used the travel service in the course of providing its service to the client. The recharge is simply further payment for the provision of the law firm’s services. If the firm’s fees are subject to standard rate VAT, the recharged travel expenses follow the same VAT treatment.
The recent First-Tier Tribunal decision in the case of HMRC v Brabners LLP (TC06093) highlighted the difficulty of determining the correct VAT status of recharged costs. The case concerned the recharging of electronic search fees to clients, which the Tribunal found were not VAT disbursements and, therefore, were subject to standard rate VAT. This was because the law firm used the searches in the course of making its own supply of services to the client. This case has caused considerable concern about the VAT treatment of disbursements. The Law Society has published interim guidance following discussions with HMRC.
The position is further complicated by the fact that HMRC, at least for now, allow certain recharges to be treated as VAT disbursements by concession, even though such treatment would not be possible under the normal rules.
The above is one example of the challenges faced by law firms from a VAT perspective. A sound understanding of the VAT issues affecting law firms, HMRC’s policy and recent developments is essential in maximising VAT efficiency and minimising the risk of costly VAT mistakes.
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