Amendments have been made to Costs Practice Direction, which came into force on 6 April 2011, which are made to clarify how VAT should be treated in relation to payments to a third party that are shown as disbursements by the legal representatives in bills of costs:
“Disbursements not classified as such for VAT purposes
(1) Legal representatives often make payments to third parties for the supply of goods or services where no VAT was chargeable on the supply by the third party: for example, the cost of meals taken and travel costs. The question whether legal representatives should include VAT in respect of these payments when invoicing their clients or in claims for costs between litigants should be decided in accordance with this Direction and with the criteria set out in the VAT Guide (Notice 700) published by HM Revenue and Customs.
(2) Payments to third parties which are normally treated as part of the legal representative’s overheads (for example, postage costs and telephone costs) will not be treated as disbursements. The third party supply should be included as part of the costs of the legal representatives’ legal services and VAT must be added to the total bill charged to the client.
(3) Disputes may arise in respect of payments made to a third party which the legal representative shows as disbursements in the invoice delivered to the receiving party. Some payments, although correctly described as disbursements for some purposes, are not classified as disbursements for VAT purposes. Items not classified as disbursements for VAT purposes must be shown as part of the services provided by the legal representative and, therefore, VAT must be added in respect of them whether or not VAT was chargeable on the supply by the third party.
(4) Guidance as to the circumstances in which disbursements may or may not be classified as disbursements for VAT purposes is given in the VAT Guide (Notice 700, paragraph 25.1). One of the key issues is whether the third party supply (i) was made to the legal representative (and therefore subsumed in the onward supply of legal services), or (ii) was made direct to the receiving party (the third party having no right to demand payment from the legal representative, who makes the payment only as agent for the receiving party).
(5) Examples of payments under (i) are: travelling expenses, such as an airline ticket, and subsistence expenses, such as the cost of meals, where the person travelling and receiving the meals is the legal representative. The supplies by the airline and the restaurant are supplies to the legal representative, not to the client.
(6) Payments under (ii) are classified as disbursements for VAT purposes and, therefore, the legal representative need not add VAT in respect of them. Simple examples are payments by a legal representative of court fees and payment of fees to an expert witness.”