The issue of whether or not a cost is a disbursement for VAT purposes has been problematic for some time.
A 2017 VAT Tribunal case ruled that search fees incurred by a solicitor as part of their conveyancing services do not qualify as disbursements for VAT. This resulted in an assessment in excess of £66,000.
From a VAT point of view, a disbursement is a cost for a supply made to and for the benefit of the client, which is paid for on the client’s behalf. When the law firm fulfills the required criteria when recharging to the client, it does not form part of the law firm’s supply. As such, the recharge appears after the net and VAT figures on the client’s invoice.
For example, a train fare purchased for a solicitor to travel to a client is not a disbursement for VAT purposes, because the solicitor “enjoys” the train travel.
However, the costs of local authority searches have been seen as an example of a disbursement for VAT purposes. The result of the 2017 VAT tribunal case now throws doubt on this view.
Details of the legal ruling
The legal firm involved had appointed a third party search agency to make online searches (referred to imaginatively as “electronic services”).
Until early 2017, the search agency did not charge VAT for their services.
HMRC argued that the recharges to the clients were not disbursements and thus subject to VAT.
The Tribunal Judge made reference to HMRC’s internal guidance, which allowed for search fees to be treated as disbursements if they were “passed on by the agency without analysis or comment”.
(Note that HMRC’s internal guidance is just that; guidance, not legislation).
The Tribunal Judge decided that the general terms of business in question meant that the recharges were not disbursements for VAT purposes.
The Law Society’s view was that there was no distinction between a postal search and an electronic search. As postal searches are treated as a disbursement, it would be inconsistent to treat electronic searches differently for VAT purposes.
This view was rejected and therefore, the Tribunal found in favour of HMRC.
As local authorities have been charging VAT on their search fees since early 2017, the Tribunal’s ruling is not a pressing issue for current transactions. VAT charged by the local authority is reclaimed by the law firm (if the invoice is addressed to them) and the net cost is billed on, plus VAT. The VAT “washes through”.
However, the real issue relates to historic treatment, which is where potential risk lies. For transactions that did not carry VAT, the imposition now of VAT on the recharge to the client creates only output tax for the law firm.