A common query posed to VAT advisers is: can a particular cost be recharged without VAT as a disbursement? Well, that depends. The recent case of Barratt, Goff & Tomlinson (BGT) [MAN/2009/0219] highlights just how muddy the issue of disbursements has become.

The appellant was a law firm that treated the recharge of medical records and report fees to its personal injury clients as VAT-free disbursements. However, HM Revenue & Customs took a different view, seeing the charges as further payment for the firm's legal services, and sought under-declared VAT.

The tribunal preferred the taxpayers' argument, its persuasiveness bolstered by what the judge called a ‘somewhat unusual’ written intervention from the Law Society.

The case essentially turned on the role of the firm. Was it an agent acting on behalf of and in the interests of its client? Or was it simply buying in supplies to 'consume' as part of its own supply of legal services?

In the legal world, the term 'disbursement' has wide application, covering costs and expenses billed in addition to time. In the VAT world, we have a narrower focus. Perhaps deceptively, 'disbursement for VAT purposes' means one which can be recharged without the addition of VAT by the supplier. HMRC has issued guidance to steer us towards eligible recharges, and BGT had attempted to follow it.

The HMRC guidance (notice 700, paragraph 25) lays down eight conditions that have to be met for treatment as a disbursement:1. You acted as agent of your client when you paid the third party;2. Your client actually received and used the goods or services provided by the third party;3. Your client was responsible for paying the third party;4. Your client authorised you to make the payment on their behalf;5. Your client knew that the goods or services you paid for would be provided by a third party;6. Your outlay will be separately itemised when you invoice your client;7. You recover only the exact amount which you paid to the third party; and8. The goods or services, which you paid for, are clearly additional to the supplies which you make to your client on your own account.

In separate guidance intended for solicitors (manuals V1-5, section 2B), HMRC refers to ‘Charges eligible for disbursement treatment’ and states ‘the following charges are usually eligible to be treated as disbursements by solicitors on behalf of their clients: charges for the professional services of a third party… The fees of notaries, surveyors, or witnesses, and charges for police and medical reports may also fall into this category.

This is read by many to mean that medical reporting fees can be treated as disbursements. However, the position is not so straightforward that these cited examples qualify without the need for further consideration – the eight conditions still need to be met. HMRC argued that BGT failed conditions one and eight – in its eyes BGT was not an agent and the medical information was not clearly additional to the legal services. Separation of the two, according to HMRC, would be an ‘artificial dissection’.

While acknowledging that it ‘used’ the documents, BGT successfully argued that obtaining and providing them to the client, and its own perusal of them to determine the legal position, were two separate acts. This was strongly supported by the fact that the documents remain the property of the client. Should a client wish to disengage a firm and take his custom elsewhere, he takes that bundle of evidence with him.

The situation was compared to that of a motor dealer recharging vehicle registration duty to a car buyer. Case law had already established that paying such fees to a third party is for administrative convenience, as that approach suits all parties and the client could meet the costs directly if he wished. The tribunal agreed that, in doing this, BGT was acting in the client's interest and not its own.

HMRC has until mid-March to decide whether to appeal against the BGT decision.

So, that's all nice and neat then – we know exactly where we stand. Well, not quite.

This case does set some useful precedents. The services from third-party experts – despite HMRC's attempts to distinguish its own guidance – remain 'good candidates' for VAT-free disbursement treatment, and comfort is certainly provided where facts follow those in BGT.

However, is that always the best approach?

Since May 2007, medico-legal experts have entered the world of VAT, with their reports becoming subject to the tax. Some are escaping the trauma because their trade is below the VAT-registration threshold. Others took early retirement to avoid it. Most now add VAT to their charges. However, when dealing with private clients it is worth remembering that it makes no odds to them or their insurers if you recharge the gross amount incurred, or the net amount plus VAT. The cost to them is exactly the same because they are unable to reclaim the VAT either way. For clients in business, charging as a disbursement for VAT purposes would preclude them from VAT recovery and so may not be the best option.

Another spanner to throw in is the burgeoning use of medical reporting agencies to procure reports and records. BGT did not use such agencies, so the issue was not considered at the tribunal. It may not be so straightforward to assume that the involvement of that type of agency leaves the VAT treatment unchanged. Could they perhaps break the agency chain by virtue of the charging structure? That is something that will need further consideration.

And just a quick point on using overseas experts – bringing the place of supply of services rules into legal billing and disbursements needs a whole article all to itself.

Jenni Christy is a VAT manager specialising in professional practices with Grant Thornton (UK)