VAT Input Tax basics: legal expenses
To work out if input tax can be claimed on legal costs you need to decide whether the legal services were:
- for the purpose of the business; or
- for the taxpayer (or employee) in a personal capacity.
Defence against criminal charges is unlikely to be for the purpose of a business. This applies even if the conviction of an individual would lead to serious difficulties for, or even the closure of a business. This principle was upheld in Rosner (FW) (t/a London School of International Business) - see VIT61360.
There must normally be a direct connection between:
- the substance of the legal action; and
- the activities of the business
if legal services are to be regarded as having been obtained for the purpose of a business. This principle is equally applicable to legal costs incurred in respect of civil action. This was confirmed by the Tribunal decision in Rashid Anwar - see VIT61360.
The extent to which the substance of an action relates to the activities of a business is a matter of judgement - see P&O European Ferries (Dover) Ltd VIT61330. Every case is unique and HMRC will need to think about all the details before reaching a conclusion.
A court may order one party to a case to pay costs to the other party. Normally this will be the party in whose favour judgment has been given (the winner). This is a contribution towards the winner’s expenses in bringing the case. The amount of this contribution may be:
- agreed by the two parties; or
- by reference to tables of fixed cost; or
- by an official of the court - a taxing master.
This sum is not consideration for any kind of supply. There is no liability for output tax on the part of the winner. Nor is there any entitlement to recover input tax on the part of the losing party.
When it decides how much the losing party should pay to the winner the court will take into account VAT charged to the winner by his/her solicitor. The amount awarded is a contribution towards the expenses incurred by the winner in bringing the action. If the legal action was for the purpose of the winner’s taxable business and there is entitlement to recover input tax the court will order no contribution in respect of VAT.
In some cases, notably those involving debts, the solicitor acting for the creditor may receive from the Court a sum in respect of fixed costs (an amount determined by reference to a published scale) and bill their client for the balance of his charges. When this happens the value for tax purposes of the supply of legal services to the creditor is:
- the amount charged by the solicitor direct to the client; plus
- the amount the solicitor receives by way of costs awarded against the debtor.
The solicitor must charge an amount for tax on the total value of the supply of their services.
A client may appeal to a taxing master or the Law Society against the amount of the fee charged to him by their own solicitor. The amount of a fee may be reduced after a solicitor has issued a tax invoice to the client. When this happens the solicitor will issue a credit note to the client and adjust their VAT account.