VAT & disbursements in accounts

SA.06 — VAT & Disbursements in Solicitors' Accounts (FLK2)

Governed by the SRA Accounts Rules 2019 and VAT law. Analyse two separate questions: who receives the third-party supply for VAT purposes, and how the money must be held and withdrawn under the Accounts Rules. Paying from client account does not itself determine VAT treatment.

Disbursements: the two types

A disbursement is a payment the firm makes on the client's behalf. There are two classes, with a specific concession for counsel's fees; confusing the two classes is the classic trap.

• Ordinary agency / true VAT disbursement: ordinary disbursement treatment excludes the payment from the value of the firm's supply only where all eight HMRC conditions are met: the firm pays as the client's agent; the client actually receives and uses the supply; the client is responsible for paying; the client authorises payment; the client knows a third party supplies it; the charge is separately itemised; the exact amount is passed on; and the supply is additional to the firm's own services (VAT Notice 700, 25.1.1). The firm adds no output VAT to that amount and cannot deduct any supplier VAT as its own input tax. Statutory charges such as court fees may qualify, but the label alone does not establish the conditions.
• Counsel's fees: specific concession. This is a concessionary procedure agreed between HMRC, the Law Society and the Bar Council when VAT was introduced in 1973; it is a practice, not a statutory rule. Under it a solicitor may elect to treat counsel's service as supplied directly to the client where the fees are paid into and kept in client account. The fee note is amended to identify the client, either replacing the solicitor's details or adding the client's name and address with 'per' before the solicitor's details. The receipted note passes to the client. The fee is then settled as a disbursement: the solicitor does not reclaim that VAT or add its own VAT to the fee; any client recovery depends on the normal conditions. The concession does not apply to insurance companies and their clients. If the solicitor does not elect, the general rule applies and counsel's fee is treated as a cost of the firm's own service (next bullet) (Bar Council Taxation Handbook, 10th edition, paras 282-287; LAA Costs Assessment Guidance for the 2024 Standard Civil Contracts, Version 1, September 2024, paras 4.18 and 4.23). Account withdrawals remain subject to the Accounts Rules.
• Costs of the firm's own service: where the firm receives the supply for use in providing its legal service, recharging the cost is part of its own supply, even at cost and separately itemised. For an ordinary standard-rated legal service the firm accounts for its own output VAT on the recharge. VAT on the purchase is deductible only subject to the normal input-tax and evidence conditions (VATA 1994, ss.19, 24-26; VAT Regulations 1995, reg.29). The firm's travel and bank-transfer costs are examples, even if the supplier charged no VAT.
• Property searches: the former postal-search concession was withdrawn from 1 December 2020. A search is not a VAT disbursement merely because it was obtained by post. Where the firm uses the result to provide its own professional service, the search cost forms part of that service. The withdrawal does not change the VAT liability of the underlying local-authority or HM Land Registry charge (HMRC Revenue and Customs Brief 6 (2020)).

Paying disbursements: the money rules

• Pay from client money only if the firm holds enough of that client's money — you cannot create a debit balance on a client ledger (Rule 5.3 / no overdrawn client accounts).
• If client funds are insufficient, pay from the business account (firm funds), then recover from the client.
• Identify who actually receives the third-party supply under the arrangements. An invoice is relevant evidence, not a substitute for that question or the eight conditions. Input-tax recovery also requires the statutory conditions and supporting evidence; do not decide it from the invoice addressee alone.

VAT on the firm's professional fees

The firm's own bill (profit costs) carries output VAT at 20% if the firm is VAT-registered (registration threshold £90,000 turnover). For the Accounts Rules, fees include their VAT element (SRA Glossary). A payment of a delivered bill for the firm's fees, including VAT, is business money. Money held or received for fees and VAT before delivery of a bill is client money (Rule 2.1(d)). It must normally be paid promptly into client account under Rule 2.3, subject to Rule 2.2 and the exceptions in Rule 2.3. If paying the firm's costs from money already in client account, satisfy Rule 4.3 before transfer: give the bill or other written notification of costs incurred, transfer only its specific sum, and have enough held for that client or third party.

Common traps to nail

• True disbursement and recharge are different VAT treatments. Client authority, separate itemisation and recovery at cost do not alone make a payment a true disbursement: ordinary disbursement treatment requires all eight conditions; the specific counsel-fee concession is separate.
• Do not classify fees-plus-VAT by the VAT label alone: distinguish payment of a delivered bill from money held or received before a bill. Apply Rules 2.1(d), 2.2, 2.3 and 4.3 as appropriate.
• Do not overdraw a client ledger to fund a disbursement.
• Re-charging at a mark-up destroys true-disbursement treatment — output VAT then applies.
• Who receives the supply matters. If the firm receives it for its taxable legal service, any allowable supplier VAT is the firm's input tax and the net recharge forms part of its own taxable supply. If the client receives it and the true-disbursement conditions hold, the firm does not reclaim the supplier's VAT.

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