When is a disbursement really a disbursement?
The question of when a payment is capable of being a disbursement and when it is merely part of a firm’s overhead or charge continues to be a difficult one. It can also, if not correctly addressed, be a question likely to lead firms into potential confrontation with HM Revenue and Customs (HMRC), the Solicitors Regulation Authority (SRA), the courts and, not least, the client.
The problem that most solicitors face is that there seems to be no single, clear definition of what constitutes a disbursement. Even the SRA are not clear on when a payment is a disbursement (despite there being many references to how disbursements are to be treated in the SRA Accounts Rules 2011) and some definitions, such as the one applied by HMRC, are so draconian in their application that there is disagreement as to whether or not they are correct.
What is a disbursement?
So where do we start? One possible starting point for the definition of a disbursement is the Solicitors Act 1974. This states at section 67 that:
Not a great help as it does not shed any light upon what is regarded as “properly incurred”. It would, however, appear on the face of it to be a fairly strict definition and limit the term “disbursement” to costs payable to others such as barristers, expert witnesses, the Land Registry and so forth.
The dictionary definition of a disbursement is “a payment by an agent or professional on behalf of a principal or client who is presented with a bill for its reimbursement.”
In other words, payments made by a person undertaking work on behalf of the client – possibly defined as money that the client would have had to spend had he or she been doing the work rather than instructing a third party to do it.
HMRC, however, take a stricter approach. So strict, indeed, that the Law Society in their excellent practice note “VAT on disbursements“ (www.lawsociety.org.uk/support-services/advice/practice-notes/vat-on-disbursements/) takes issue with HMRC’s own guidance on the topic.
The HMRC position stems from the 2006 VAT Directive (2006/112/EC ) (http://eur-lex.europa.eu/legal-content/EN/ALL/?uri=celex%3A32006L0112), which states in Chapter 2 (Supply of goods and services) at Article 73:
and goes on to state at Article 78 that the taxable amount shall include:
and at Article 79(c), that the taxable amount shall not include:
Thus, overheads such as packing and transport costs are not deemed to fall outside of the charge to VAT and thus not considered a true disbursement, no matter how the supplier views them, whereas payments to third parties on behalf of the client are.
The position is summarised by HMRC in their guidance note of 1 July 2014 “VAT: costs or disbursements passed to customers” (www.gov.uk/guidance/vat-costs-or-disbursements-passed-to-customers) which provides:
You might be able to leave out these payments from your VAT calculations because it’s the customer, not you, who buys and receives the goods or services; you’re just acting as their agent.
To treat a payment as a disbursement all of the following must apply:
- you paid the supplier on your customer’s behalf and acted as the agent of your customer
- your customer received, used or had the benefit of the goods or services you paid for on their behalf
- it was your customer’s responsibility to pay for the goods or services, not yours
- you had permission from your customer to make the payment
- your customer knew that the goods or services were from another supplier, not from you
- you show the costs separately on your invoice
- you pass on the exact amount of each cost to your customer when you invoice them
- the goods and services you paid for are in addition to the cost of your own services’
The HMRC note goes on to provide that incidental costs incurred by the business are not disbursements and must therefore be included in VAT calculations when clients are invoiced. Examples would include travelling expenses and postage costs. These are regarded as costs incurred by the business so as to enable it to deliver a service and bought by the business itself rather than by the business as agent of the client. Importantly – and we shall return to this shortly, this includes ‘a bank transfer fee paid when transferring money from your business account to a client’s account – even though the bank’s fee is exempt from VAT.’ Thus if you recharge the fee you must charge VAT, because it was for a service provided to your business and not to your client.
The Law Society Definition
The Law Society take the view that HMRC’s definition is too limiting and, in the practice note “VAT on disbursements“ referred to above, offer the advice that the statement by HRMRC is ‘guidance and not the law. If the expense incurred by you meets the requirements of Article 79(c) then you should treat the expense as a disbursement for VAT purposes.’ The practice note goes on to state:
- Your client should have either requested that you obtain the service on their behalf or authorised you to do so.
- In the case of a report or a search result, the final report should be sent to your client either by you or the supplier. You can retain a copy.
- The amount you charge your client should be exactly the same as the amount charged to you by the supplier.
- The expense should be separately itemised on the invoice you send to your client.
- The supplier should be aware that the service is being provided to a third party, i.e. your client.’
The Law Society provide further guidance on what should not be described as a disbursement in their practice note “Publicising Solicitors Charges” (www.lawsociety.org.uk/support-services/advice/practice-notes/publicising-solicitors-charges/) where they state that overheads should not be described as disbursements and that:
- annual subscription costs and transaction fees for using online solutions to manage business processes. This would not preclude such costs being passed on to clients, for example through an administration charge (as opposed to as a disbursement)
- petty charges such as postage, photocopying and faxes, and
- professional indemnity insurance
- the costs of undertaking client due diligence, including identification checks for anti-money laundering purposes. However, if the costs is particularly high (eg overseas company search), this cost may be charged to the client with client consent and explanation to the client of the likely cost”
The SRA Definition
So what view does the SRA take? The SRA do not directly express an opinion as to what specifically constitutes a disbursement. The glossary to the SRA Handbook defines a disbursement merely as “in respect of those activities for which the practice is regulated by the SRA, any sum spent or to be spent on behalf of the client or trust (including any VAT element).”
The SRA Accounts Rules 2011 offer no real assistance either and indeed if anything confuse issues by including within a definition of disbursements in the guidance note to Rule 17 ‘travel agents’ charges, taxi fares, courier charges or Land Registry search fees’ – thus confusing payments which could (subject to the circumstances) fit within the HMRC definition of a disbursement, such as search fees, with those that would not such as taxi fares. So no real help there then.
Possibly the closest the SRA come to defining what a disbursement is comes from Indicative Behaviour IB (8.8) in the SRA Code of Conduct 2011 where they state what should NOT be described as a disbursement. This states that solicitors must not describe “overheads of your firm (such a normal postage, telephone calls and charges arising in respect of client due diligence under the Money Laundering Regulations 2007) as disbursements in your advertisements”.
So, how should disbursements be treated for VAT purposes?
For the purposes of VAT, charges which are not proper disbursements must of necessity be profit costs and as such subject to a charge to VAT. Thus, even if you choose to list them separately, then you should, if you are registered for VAT, be charging VAT on them.
You may, therefore, from a VAT perspective, need to separate out those charges which you make which are recovering overheads from those which are genuinely disbursements.
As an example, your charges for undertaking a matter might include your costs for doing the work, the cost of travelling a substantial distance to a client’s office to take instructions and the cost of paying for a local authority search. If you elect to show the travelling expenses separately from the costs of undertaking the work then you will need to charge VAT on the total of costs for doing the work and cost of travelling. Only the amount paid to the local authority for the search will potentially be free from VAT charge.
However, even that is not entirely clear-cut. Strictly, in order for the cost of a local authority search to be exempt from VAT, it should be being obtained for the client and not simply for so that your firm can give the client an opinion on whether there are issues of which the client should be aware. Thus, to be certain, you should supply a copy of the report to the client so that it becomes money you have spent on behalf of the client rather than costs that your business incurs itself when supplying goods or services to clients, which are not disbursements for VAT. Thus in a conveyancing transaction where a mortgage is involved, if the original of the local search is placed with the title documents that are sent to the mortgagee then a copy should be given to the client as well together with an explanation that the original is being held by the mortgagee pending discharge of the mortgage. This may seem onerous but it is advice which the Law Society also give in their “VAT on disbursements“ practice note.
What about the non-VAT position?
If the VAT position is open to some confusion, the regulatory position is even less clear.
We have already seen that the SRA has stated in IB (8.8 )that “overheads of your firm (such a normal postage, telephone calls and charges arising in respect of client due diligence under the Money Laundering Regulations 2007)” are not to be regarded as disbursements. However, even that is open to doubt.
Take for example the position as to charges for due diligence under the Money Laundering Regulations. Although IB (8.8) excludes due diligence from being a disbursement, nevertheless in a Question of Ethics from October 2015, the SRA has stated that:
As a general rule, we would expect such charges to form part of your overheads. However, there may be circumstances where the cost of the due diligence is particularly high (for example, when you have to carry out an overseas company search on a foreign firm) and you wish to agree with your client that the cost will be payable by the client. In order to comply with Outcomes (1.12) and (1.13), you should explain the likely cost with your client and obtain your client’s informed consent at the outset of the retainer.
If your client agrees to bear the cost, it should be listed in your bill as part of your profit costs.
Some firms undertake due diligence for all clients as a matter of course, irrespective of the nature of the retainer and thus, whether it is a requirement of the Money Laundering Regulations. Whilst there may be good reasons for doing this, it is questionable as to whether there would ever be justification for passing the cost on to the client where such checks are not a requirement, even if the client agrees.
The positive way of expressing this is possibly that it is not being described as a disbursement but as a discrete element of the firms costs. What it does not become is a VAT exempt payment because the charge is to enable the firm to undertake the work it does not a charge incurred on behalf of the client. Thus even if the firm lists the charges separately, they must still bear VAT.
Another area where there appears to be some ambiguity is in relation to things such as postage costs and copying charges. In the general run of things, the SRA would not expect to see a firm including day-to-day postage and copying charges included as a separate disbursement – especially where the fact that such a charge might be made had not been brought to the attention of the client. However, if there was to be an exceptional level of copying charges or postage costs then it might be appropriate for those costs to be shown separately on the bill – provided that the client had been made aware that such costs would not be absorbed into a general charge. This would be in line with the requirements set out in Indicative Behaviour IB(1.14) which requires that a solicitor clearly explains their fees and IB(1.15) which requires a solicitor to provide a warning about any other payments for which the client may be responsible. Here also, VAT would normally be chargeable on any cost incurred by the firm unless it could be shown that an outside copying agency had been used and that the cost was a cost incurred on behalf of the client rather than a cost incurred to enable the solicitor to do his or her work. Strictly, the invoice from the copying agency would need to show that it related specifically to work undertaken for a named client.
Bank Transfer Charges
Telegraphic Transfer Fees have long been a source for problems for firms.
HMRC have long taken the view that a bank transfer fee is not a disbursement for the purposes of VAT as it is a charge for a service provided to your business and not to your client. Thus, subject to the points below, if you do show it separately on your bill then you must add VAT to the charge.
Whether you can show the charge separately or not depends upon what you have told the client beforehand and how the charge is described. The matter is considered in the Law Society practice Note “Telegraphic transfer fees” (www.lawsociety.org.uk/support-services/advice/practice-notes/telegraphic-transfer-fees/) .
Thus, if you describe a bank transfer fee as a disbursement without explaining to the client that it is a charge made to the firm by the bank then strictly speaking you are likely to be in breach of the SRA Code of Conduct. Furthermore, if the charge is described as a bank transfer fee but is actually a composite charge made up of a fee charged by the bank plus an administrative uplift added by the firm, then this is likely to be regarded as a secret profit and leave the firm open to further disciplinary action.
Another grey area for solicitors is in relation to travelling costs.
The general rule with travelling costs is that normally they should be included as part of a firm’s overall charge and not shown separately as a disbursement. This was certainly the view that the court took in the case of Rowe & Maw v. C&E Commissioners  STC 340. The court held that the costs of travel were services purchased by the solicitor to “enable him effectively to perform the service supplied to his client, in this case to travel to the place where the solicitor’s service is required to be performed. In such case, in whatever form the solicitor recovers such expenditure from his client, whether as a separately itemised expense or as part of an inclusive overall fee, value added tax is payable because the payment is part of the consideration which the client pays for the service supplied by the solicitor.”
Thus, as with copying charges and bank transfer charges care must be taken to ensure that the client is aware that a charge for travel will be made and that it is described as a part of the charge for services rather than a payment on behalf of the client.
Other payments and fees
The Law Society practice note “VAT on disbursements“ referred to above contains a list of different fees and expenses and how they should be dealt with. This includes search fees, court fees, witness fees, translation fees, medical reports and more.
Firms need to be very careful about what they describe as a disbursement – both from the perspective of HMRC who will expect VAT to be charged on any additional charges which are not genuine disbursement and from the perspective of the SRA Code of Conduct which requires that solicitors be open with their clients as to costs and not try and hide overheads and expenses of the firm in a disbursement item.
The general rule of thumb is that charges which are not for services supplied to the client are not disbursements and should therefore bear VAT and not be shown on the solicitors bill as a disbursement.