Important VAT change to disbursements

• More VAT to be charged,
• procedures to be changed and
• possibility of HMRC retrospective assessments

Issue

A recent First Tier VAT Tribunal decision (5 Sept) has created a lot of concern, particularly for firms of solicitors.

A disbursement in VAT terms is often described by way of the classic example of a solicitor paying a search fee on behalf of his client.  Such search fees were usually paid to local authorities and typically did not carry VAT. The solicitor would simply pass on the fee at cost, label it a “disbursement” for VAT purposes and no VAT would be applied on the invoice.

In the case of Brabners LLP, this was exactly the scenario under appeal.

The judge ruled that:

a) The search fee was a cost-component of the solicitor’s onward supply of a report (to his client on the risks re the property being purchased).  In such circumstances, the solicitor must treat this as part of his charge for legal services and apply VAT.
b) Interestingly, the  judge went on to say that, even if the solicitors do not prepare a separate report on the searches and passes them on, the solicitor’s charge for the searches again is not a disbursement, but VATable, presumably as it is seen as a necessary cost component of the solicitor’s work of advising on the property.*

* The latter could be a contentious point going forward, however it seems logical at this juncture.

VAT Treatment Changes and Impact

• The VAT point is that statutory search fees (from local authorities etc) were traditionally not VATable.  Therefore, by passing these costs on as a disbursement, without VAT, the solicitor was maintaining the VAT-free status of these costs for the end consumer, and didn’t suffer VAT himself.
• However, from 1 January 2017 HMRC have insisted that local authorities charge VAT on such search services, at least on standard CON29 and CON290 property searches.  Thus the solicitor now suffers VAT on these costs, which should be claimable as a cost component of his onward charge for his services. The search fees should now be charged on by the solicitor, with VAT either as a recharge or simply as additional payment for the solicitor’s services.
• As VAT is charged now at source by the local authorities, it is also preferable for the solicitor to charge on plus VAT, to safeguard his own entitlement to VAT recovery.  If the solicitor simply absorbed the VAT cost and continued with the disbursement approach, hidden VAT would be built-in to the search fee disbursement, raising the cost to the end customer regardless.
• In some cases the solicitor’s clients (if VAT registered businesses) will be able to reclaim the VAT the solicitor charges, so this will not be an additional cost.  In most cases search fees are a minimal portion of the solicitor’s overall charge, however disbursements can add up over time (four years – see below*) and the VAT element could become sizeable.

Practicalities and Issues

Legal firms, and indeed others in the advisory and other sectors should review their approach to disbursements with a view to applying VAT in future.

There are some key concerns:

1. The cost & disruption of undertaking a significant exercise on updating procedures, accounts system re-coding etc;
2. When re-working procedures, how will billing staff determine what is and isn’t a disbursement vs a VATable charge?;
3. When should such procedural changes take effect – from September 2017, 1 January 2017 or earlier?; and
4. * Will HMRC take this decision as an opportunity to assess legal firms and others for past VAT under-charged on disbursements, which could lead to assessments going back four years and create real costs?

Timing of Actions

We are still awaiting HMRC commentary on this decision as well as guidance from the Law Society.

It would be sensible to review this before undertaking any large scale procedural changes, so some delay is anticipated.

Where HMRC decides to pursue retrospective VAT assessments for under-charged VAT, consideration should be given to what defences may be available and whether the Brabners decision might be appealed & stood behind by interested parties.