VAT risk for law firms handling insurers’ claims work

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VAT: Updated guidance

New guidance on delegated authority claims handling by lawyers may create additional VAT costs for law firms and lead to disputes with their insurance clients, a leading firm of accountants has warned.

Many law firms are contracted by insurers to undertake claims-handling work when third parties have made claims against policy holders by way of defendant delegated authority.

RSM said HM Revenue & Customs (HMRC) has been conducting a long review of the VAT liability of these contracts; as insurers cannot recover the VAT incurred on their costs, they can achieve a saving if a law firm’s services are treated as being VAT exempt.

In an effort to provide clarity and improve the quality of guidance to affected law firms, HMRC updated its internal guidance last week.

It took the view that there were two distinct stages to the claims handling services provided by law firms: pre-litigation, “the stage up until it has been decided to litigate a claim through the courts”, which HMRC regarded as exempt (provided specific conditions were met); and post-litigation, which it said was taxable.

The update said HMRC regarded post-litigation services as taxable because:

• Unlike insurance claims-handling services, they could only be provided by regulated law firms;
• They fell under the regulation of the Solicitors Regulation Authority, as opposed to the pre-litigation services, which fell within the Financial Conduct Authority regulatory rules applicable to insurance claims-handling services;
• Whilst much of the post-litigation services may be carried out by non-legally qualified claims handlers, unlike pre-litigation work they must be carried out under the supervision of qualified lawyers; and
• Even though post-litigation claims often settled before court, and the level of specialist legal input varied accordingly, they were still governed by the regulated legal process.

HMRC sets out various fee structures and the expected VAT treatment. Where a single fee is payable for both pre- and post-litigation work, it says this should be split into the two elements using “a fair and reasonable apportionment method”, and VAT should be charged only on the post-litigation element.

Ian Carpenter, head of VAT at RSM, said such an apportionment was “likely to create further uncertainty for law firms and potential disputes with their insurance clients as to how much VAT should be charged”.

He said there was no specified implementation date for these changes, and could not rule out the possibility that HMRC would seek to apply them retrospectively. This could lead to assessments for underpaid VAT going back four years.

Further, the changes may require significant changes to accounting systems so even an immediate prospective change “could prove challenging”.