Law practices and solicitors firms generally expect to charge and account for VAT on all supplies made to UK clients, and some based overseas depending on the service. However, there are circumstances when VAT may not be due, one of which is the making of an exempt supply – such as receiving interest on client monies – which has a direct bearing on whether VAT can ordinarily be reclaimed by the practice.
Solicitors and legal firms obtain funds from clients for several reasons, including items such as:
- Paying bills under a Power of Attorney
- Prepayment for legal services ('on-account' fees)
- Advance costs for 3rd party advisors (such as Barristers)
Below, we consider those circumstances under which VAT would not be due.
Client account interest
The receipt of monies into a designated client account can mean interest is earned. In some cases (such as Power of Attorney work) this may be paid or credited in full directly to the client, per the agreed terms between the practice and the client. Interest which belongs to the client (subject to any small de-minimis limits which may be retained due to cost of transfer) would not expect to be treated as income for the practice, since it will be credited to the client account for future use against new bills. This transfer of interest from the designated account to the client would be outside the scope of VAT and would not expect to be included in any VAT returns filed by the practice.
Non-client account (general account) interest
Where interest is earned on funds held in a general account (for example to settle 3rd party costs), it may be retained by the practice or passed on to the client. Regardless of whether this is retained or transferred, the receipt of interest may be an exempt activity, even if this is passive interest (not earned with the intention of financial gain).
A practice may also receive interest for the use of higher interest accounts or following investments (where this is permitted). This goes beyond passive, as the intention is to earn for financial gain and may include practice own funds as well as client monies.
Lawyers' exempt income
Where a business is receiving exempt income (passive or invested), it may not be entitled to full VAT recovery on its costs. Normally this is determined by the percentage of taxable income over all income it receives (known as the 'standard method' for VAT accounting). This may not be correct or 'fair', however, where a business is in receipt of large sums of exempt monies, but this is not one of its core business activities, nor is it employing individuals for the pursuit of exempt financial activities, the use of the standard percentage may be unfairly reducing the right to VAT recovery on necessary Practice costs.
There are alternative methods of VAT recovery which may be fairer and more reasonable, but these do need to be approved by HMRC prior to use.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
