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.”
Links to updated Law Society practice notes on VAT on disbursements and VAT increase to 20%, and Bar Council guide on VAT increase now available via the VAT section on Legal Costs Central.
The issue of the correct VAT rate to apply to claims for legal costs appears to be continuing to cause law costs draftsmen and the courts all kinds of difficulties. With VAT about to increase to 20% it is time for defendants to put an end to this nonsense.
Gibbs Wyatt Stone has therefore put together a skeleton argument that should do the trick. It is available to view, along with links to all the relevant guides, on the VAT section of Legal Costs Central. You can have this for free (although standard Disclaimer obviously applies).
Let's see if there are any claimant representatives out there who are brave enough to stick their necks out and produce a skeleton argument in response.
I had hoped never to have to mention the dread subject of VAT again.
But the inevitable has happened and the budget has raised VAT to 20% from 4 January 2011.
At the risk of repeating myself, this will mean that from 4 January 2011 bills of costs should usually be drafted with up to 4 sections and different rates claimed for each, regardless of when the matter settles:
Before 1 December 2008 – 17.5%
Between 1 December 2008 and 31 December 2009 – 15%
Between 1 January 2010 and 3 January 2011 – 17.5%
From 4 January 2011 – 20%
Of course, if you are lucky enough to be drafting a bill where some of the work stretches back to 1991 you will have a further period with 15% applying pre-1 April 1991. A bottle of champagne to the first reader who sends me a copy of a bill next year with 5 different VAT rates applied.
The amounts now at stake make it crucial to get this right.
One well known firm of law costs draftsmen (who shall remain nameless) has only just removed from the “latest news” section of their website information about the change in VAT rate. And they were referring to the 1 December 2008 decrease, not the 1 January 2010 increase.
Apparently, the other day at a detailed assessment, the thorny issue of the correct approach to VAT arose and the Legal Costs Blog was mentioned by one of the law costs draftsmen present (not someone from my firm) and the Regional Costs Judge duly proceeded to print off a copy of my last post on the subject for all to study.
I’m not sure quite what benefit was obtained from this but it reminds me of the story of the judge who had heard lengthy submissions from one of the advocates and informed him: “I’ve listened carefully to all you have to say but I am none the wiser”. To which the barrister replied: “Quite possibly Your Honour but you are now considerably better informed”.
My post on Tuesday, concerning the change in VAT rates, confirmed two things. Firstly, how mind numbingly boring a topic it is. Secondly, how much difficulty this is causing law costs draftsmen, solicitors and others. The number of comments, both on the Legal Costs Blog and in emails I received, indicates that some readers are still not convinced by the analysis I gave. Whether dealing with a high value claim or large volumes of low value claims, this extra 2.5% is important.
I will therefore make one final attempt to set out the basic position as I understand it and hope never to have to write on the subject again.
I am going to make one important assumption here (and readers may think this is sensible or not), namely, that the Law society and Bar Council have got the basic position right.
I think the problem that many have with this issue is getting themselves bogged down in worrying over issues concerning the “basic” tax point and “actual” tax point. These issues are no doubt important under ordinary circumstances, but a change in VAT rates results, at least on this occasion, in special “change of rate rules”. This is the important issue to understand.
The Law Society Practice Note is clear on this:
“Under the normal rules, standard rated supplies with tax points created by payments received or VAT invoices issued on or after 01 January 2010 will be liable to the 17.5 per cent rate. However, there are optional change of rate rules that you may wish to apply:
- Where you issue a VAT invoice or receive a payment on or after 01 January 2010 for work that was completed before 01 January 2010 you may account for VAT at 15 per cent.
- Where work commenced before 01 January 2010 but will not be completed until on or after 01 January you can apportion the supply between that liable to 15 per cent and that liable to 17.5 per cent.”
Therefore, for a typical CFA funded case, with no interim invoices, you can charge VAT at 15% for the work done during the period the rate was 15%.
The Bar Council has issued a Guide for barristers that deals with the matter in a similar manner:
“There is, however, a special rule that applies on a change of rate. This applies where a service is provided before the change of rate but, under the special rules above, the tax point falls after the change of rate. The barrister may then elect for VAT to be applied at the original rate. In other words, a barrister who receives a fee on or after 1st January 2010 for work done before that date (but after 1st December 2008) can choose whether to charge 15% or 17.5%. A barrister paid after 1st January 2010 for work done before 1st December 2008 (the date on which VAT decreased to 15%) would have to charge 17.5%.
In practice, this means as follows:
(a) Where the fee is received between the 1 December 2008 and 31 December 2009 in respect of work carried out during that period, VAT will be due at 15%.
(b) Where the fee is received between the 1 December 2008 and 31 December 2009 in respect of work carried out before the 1 December 2008, then VAT can be charged at 15% or at 17.5%.
(c) Where the fee is received on or after 1st January 2010, VAT will be due at 17.5% unless:
i) The relevant work was carried out before 1st January (and on or after 1st December 2008); and
ii) The barrister so elects.”
Again, ignoring issues of tax points, if the work was undertaken between 1 December 2009 and 1 January 2010 it is possible to charge at 15% for that work, regardless of when the invoice is raised or paid.
Both the Law Society and Bar Council refer to being able to opt/elect as to which rate to apply. This is where we come back to CPD 5.8:
“It will be assumed, unless a contrary indication is given in writing, that an election to take advantage of the provisions mentioned in paragraph 5.7 above and to charge VAT at the lower rate has been made. In any case in which an election to charge at the lower rate is not made, such a decision must be justified to the court assessing the costs.”
This is no more than a reflection of the principle that a party should mitigate their losses. If a lower rate can be charged, it normally should be. It is hard to imagine where it would be reasonable to charge the higher rate.
One reader of the earlier post on this subject commented:
“It’s interesting to note that this has only become an issue for defendants since the VAT rate has reverted to 17.5%!!!!!!!! Nothing at all was heard about breaches of the CPD / defective bills etc whilst claims for costs were being presented to paying parties with VAT claimed at 15% throughout even when the work done covered pre and post 01.12.09!!!!!!! Strange that!!!!"
Not particularly strange, although no doubt true. When the rate was 15%, a receiving party could elect to charge 15% on all work if the claim settled between 1 December 2009 and 1 January 2010, including work undertaken before 1 December 2009 (assuming no interim invoices). Although a bill not drafted showing the split between the various periods was still, probably, technically defective, there was no point in complaining from a paying party’s perspective. The issue that arises now is that bills wrongly claim VAT at 17.5% throughout but then fail to split between the relevant periods. How is the poor Court meant to deal with this come assessment? Count every letter to see what pre-dates or post-dates the various changes so as to apply the correct rate? That is why the bill needs to be drafted properly and why defendants are now complaining when it is not.
I've posted links to the various VAT guides on Legal Costs Central.
I previously tried to give a simple summary of the impact of the recent VAT change in an earlier post.
However, a regular reader of the Legal Costs Blog recently got in touch asking me to mention this issue again. As my patience is slowly disappearing over the number of defective bills of costs I keep seeing, I will oblige.
CPD 4.2(4) reads:
“Where value added tax (VAT) is claimed and there was a change in the rate of VAT during the course of the proceedings, the bill must be divided into separate parts so as to distinguish between;
(a) costs claimed at the old rate of VAT; and
(b) costs claimed at the new rate of VAT.”
CPD 5.9 mirrors this:
“All bills of costs, fees and disbursements on which VAT is included must be divided into separate parts so as to show work done before, on and after the date or dates from which any change in the rate of VAT takes effect.”
You will note these are mandatory requirements. If you prepare your bill in one part, where the work covers a change in VAT rate, the bill is defective.
The CPD deals with what rate should be claimed in more detail:
“5.7 Where there is a change in the rate of VAT, suppliers of goods and services are entitled by ss.88 (1) and 88(2) of the VAT Act 1994 in most circumstances to elect whether the new or the old rate of VAT should apply to a supply where the basic and actual tax points span a period during which there has been a change in VAT rates.
5.8 It will be assumed, unless a contrary indication is given in writing, that an election to take advantage of the provisions mentioned in paragraph 5.7 above and to charge VAT at the lower rate has been made. In any case in which an election to charge at the lower rate is not made, such a decision must be justified to the court assessing the costs.”
This means that if a receiving party can take advantage of the lower rate then that is what they should do.
The Law Society has issued a detailed Practice Note on the VAT change (see link). I will repeat one of the examples they give in full:
You have been instructed by your client to undertake court proceedings to recover damages for clinical negligence. Instructions were received and your retainer commenced in early September 2006. The case is settled in December 2009 on the basis that the opposing party pay your client's costs and a bill of costs is drawn up. The amount of the costs are not agreed or assessed until March 2010. How do you calculate the VAT?
Under the normal VAT rules, where one party is ordered to or has agreed under a settlement to pay the other's costs, the settling of the costs in these circumstances is part and parcel of your overall supply to your client. In such circumstances, the basic tax point arises when the costs have been agreed between the solicitors or the assessment of costs procedure is complete and the costs will be liable to VAT at 17.5 per cent. Under the special rules, provided that that no interim invoices have been raised or payments received over the entire course of the supply, which would be the case if there was a conditional fee agreement, then you should apportion your costs so that:
• 17.5 per cent VAT is charged in relation to your costs for the period being due from September 2006 to 30 November 2008
• 15 per cent is charged for the period from 1 December 2008 to 31 December 2009, and
• 17.5 per cent is charged for the period from 1 January 2010 to March 2010.
If you have issued interim invoices to your client during the course of the supply, then the rate you charge to the other party will be the same as that on the invoices you have issued.”
Based on this advice, unless interim invoices have been raised (which would be highly unlikely with a claimant’s case funded by way of a CFA) you are not meant to claim VAT at 17.5% throughout. Please stop.
Legal costs practitioners are still struggling to work out exactly how the most recent VAT change impacts on what level of VAT to apply to different periods in bills of costs. What news do we now receive? Both Labour and the Conservatives are apparently considering a VAT increase to 20% to help fill the massive public deficit. Are they deliberately trying to torture us?