DEALING WITH VAT

Question 1

GENERAL PRINCIPLES OFVAT

Answer 1

1. VAT is “charged on any supply of goods or services made in the United Kingdom, where it is** a taxable supply made by a taxable person** in the course or furtherance of any business carried on by him”.
2. A taxable person or business
   must register for VAT if **the value of its taxable supplies in the preceding 12 months exceeds £85,000 **(figure through March 2024). Consequently, most law frms must be registered.

Question 2

Aspects of Tax

Answer 2

a.Output VAT
Output tax is charged by a business to its customers. For ex-ample, assuming a law frm is registered for VAT purposes, itwill charge VAT on its professional services and, where appli-
cable, any disbursements paid for and on behalf of the client.
b.Input VAT
Input tax is a tax** charged to a business **by its suppliers of cer-tain goods and services. For example, a furniture company would charge VAT to a law firm for office furniture supplied to the firm, or a law firm could be charged VAT for the service supplied by legal counsel.

As a firm/business must account to HMRC for any output tax charged, it is generally possible for it to deduct any input tax charged to the frm from the amount in which it must account for to HMRC. Therefore, it will account only for the diference between the input and output tax to HMRC.

Question 3

Rate

Answer 3

Since January 2011, the standard rate of VAT has been 20%, which applies to most goods and services. However, the ate of VAT depends on the goods and services supplied.

Question 4

Legal Services and VAT

Answer 4

1. The firm should always quote for a fee ‘plus’ VAT, and if VAT is not stated to be an extra charge, the total sum will be deemed to include VAT. This will mean that the frm will have to account for VAT from the quoted fee, which may result in the frm receiving less money than it expected.
2. Equally, where a firm has been charged VAT it will require a VAT invoice to prove that it has been charged VAT, as only the ‘person’ to whom an invoice is addressed can use the invoice to reclaim input tax.

Question 5

Definition of DISBURSEMENTS

Answer 5

1. When a firm provides legal services, it will frequentlypay expenses on behalf of a client for goods received by the client or services provided to the client.
2. According to HMRC, this payment is regarded as a disbursement and not part of
   the solicitor’s supply of services to the client. Therefore, the cost of such disbursements is simply passed on to the client and not charged to VAT.

Question 6

Conditions for a Disbursement

Answer 6

To treat an item as a disbursement, all of the following conditions must be met:
1. The firm paid the supplier on the client’s behalf and acted as the client’s agent;

2. The client received, used, or had the beneft of the goods or services paid for on their behalf;
3. The client was responsible for paying the third party for the goods or services;
4. The client authorised the frm to make a payment on their behalf; and
5. The client is aware that the goods or services were from another supplier, not the frm.

Question 7

Costs that Are Not Disbursements

Answer 7

*Telephone call charges;
*Travel expenses incurred by the frm whilst working on the client’s matter;
*Postage fees that the frm incurs when sending letters to clients;
*Photocopying charges or even bank transfer fees incurred when transferring money from the client to the business account; and
*Property search fees.
These are treated as general overheads of the firm.

The item is not a disbursement but rather is a normal and necessary part of the supply of legal services, in which case, HMRC requires the firm to charge VAT on them. Most firms will not show sep-arate items on its bill for the above expenses.** It will include them in its overall Profit Costs. Property search fees are the exception**; they will be shown separately on the bill.

Question 8

TREATMENT OF INVOICES ADDRESSED TO CLIENT OR FIRM

Answer 8

1. Where a firm has paid a taxable ‘person’ for a taxable service/supply, for example, a surveyor, accountant, or legal counsel, the payment made by the firm will include a VAT element. The firm simply passes on the whole expense, including the VAT element, to the client, who is not charged any further VAT on it.
2. however, problems may arise if the client themself is registered for VAT and would like to reclaim the VAT element. The method in which this can occur depends on whether the VAT invoice was addressed to the client or to the firm

Question 9

Option 1—Invoice Addressed to Client

Answer 9

If the invoice is addressed to the client, the supply will be treated as having been made to the client. The frm will pay the entire amount of the expense, including VAT using business or client money as appropriate, and record the total sum in its records. This method is more commonly referred to as the Agency Method.

EXAMPLE
On behalf of a client, a firm uses the services of a surveyor totalling £1,200, plus VAT. The surveyor sends a bill to the firm, **addressed to the client **for the £1,200, plus £240 VAT.
The supply will be treated as having been made to the client. The firm will pay the entire amount of the expense, including VAT (£1,440), using client money if enough is available or business money, on behalf of the client. The entries are as follows:
*Debit £1,440 client ledger client account (if the account is in funds)
*Credit £1,440 cash sheet client account
(No entries are made on the firm’s HMRC (VAT) account.)

Question 10

Option 2—Invoice Addressed to Firm

Answer 10

The other option is what is known as** the Principal Method.
This is where the invoice isaddressed to the firm** and the supply is treated as being made directly to the frm.
If we refer to the above example once more, the firm will pay the surveyor’s fee, and the input VAT (£1,200, plus £240 VAT); however,** it must use business money, even if there is enough money in the client account, as the invoice was addressed to the frm. The firm would then have to resupply the service to the client at the same price, and when the firm sends the client its own bill of Profit Costs**, it will include VAT of £240 for the surveyor’s fees along with the VAT that relates to the firm’s Proft Costs. The entries for the payment to the survey-or are as follows:
*Debit £1,200 client ledger business account
*Credit £1,200 cash sheet business account
*Credit £240 cash sheet business account
*Debit £240 HMRC/VAT ledger business account

Exception
There is an exception to the above rule that relates to legal counsel’s fees. If a firm receives an invoice from Legal Coun-sel in the frm’s name, it can now cross out its own name and replace it with the client’s name.