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VAT Voice by Steve Allen

Steve Allen, Director of VAT Solutions (UK) Ltd, explains why deciding whether VAT can be recovered on legal costs is sometimes difficult.In most cases, it is relatively straightforward for a business to know if it can recover the VAT on legal costs that it incurs. The basic rule is that if the legal costs relate to your taxable business, you can recover the VAT. If they relate to a VAT exempt activity or are personal or a third party costs, you cannot recover the VAT.

Example 1

Your business sues a debtor, or incurs legal costs in purchasing a building for use as offices; these clearly relate to your business and you can recover the VAT.

Example 2

You are a sole proprietor, and incur legal costs suing a motorist who crashed into your private car; this is clearly a private action, and your business could not recover the VAT.

But there are many cases when things are less clear cut. Hear are some actual examples of what counts as a business purpose and what does not.

A defence against criminal charges made against an individual is unlikely to be for the purpose of a business, even if the conviction of that individual would lead to serious difficulties for, or even the closure of, the business. This principle was upheld in the High Court judgement in the case of ‘Frederick William Rosner’, who was prosecuted for criminal fraud. The VAT on his legal costs was not recoverable.

In the ‘Rosner’ case, the judgement confirmed the principle that, for legal services to be regarded as having been obtained for the purpose of a business, there must normally be a direct connection between the substance of the legal action and the activities of the business. The mere fact that there would be a benefit to the business by keeping the owner out of prison, is not enough.

However, the legal costs for the defence of employees of P&O European Ferries charged with manslaughter following the Zeebrugge disaster, were held to be recoverable on the basis that the charges resulted from their normal employment.

The above principle is equally applicable to legal costs incurred in respect of civil actions where VAT has been disallowed on legal costs involving partnership disputes, and a director’s dispute with a previous company.
In a court case, the court may order one party to the action to pay costs to the other party, normally the winner. This is a contribution towards the winner's expenses in bringing the case. Although the loser has to foot the bill, the services were not supplied to him, so he cannot recover the VAT on those costs.

This principle also applies where a prospective tenant pays the legal costs of the landlord. The supply was to the landlord, not the tenant, so the tenant cannot recover the VAT.

Tip

Customs will look carefully at any VAT recovered on legal costs to see if they are proper to the business and relate to its business activities, so make sure you have claimed the VAT back correctly, and that you have answers to any questions they may ask you. If you get it wrong, you could end up having the VAT disallowed, and being charged penalties and interest.

Steve Allen
Director, VAT Solutions (UK) Ltd
Email: steveallen@vatsolutions-uk.com

VAT Solutions (UK) Ltd
11 Winmarleigh Street,
Warrington,
WA1 1NB

(T) 01925 242497
(F) 01925 242498
(M) 07810 433927
(W) www.vatsolutions-uk.com

VAT Solutions (UK) Limited is an established independent firm of Chartered Tax Advisers, formed by Andrew Needham and Steve Allen. The company has a cross-section of clients from multi-national companies through to medium-sized and numerous smaller regional firms of accountants and solicitors. They produce a regular publication 'VAT Voice', which can be downloaded directly from the Internet via the following address: www.vatsolutions-uk.com/newsletter.doc