Conveyancing
VAT on electronic searches: firms are no 'middle man'
Nicola Laver considers the VAT treatment of property search fees in the light of a recent First-tier Tribunal (Tax Chamber) decision.
About the author
Nicola Laver is a legal journalist, legal writer and former solicitor.
Law firms are not a ‘conduit or post-box ’ through which electronically obtained local search results are merely passed onto property clients; in addition, search fees are not a disbursement, they are a taxable supply for VAT purposes (Brabners LLP v Commissioners of HM Revenue and Customs [2017] UKFTT (TC) para 50). This is the resounding, but unwelcome, message for residential property lawyers following a significant ruling in favour of HM Revenue & Customs (HMRC) in Brabners LLP v HMRC in September 2017.
The tribunal judge in the First-tier Tribunal (Tax Chamber) case decided that a law firm’s electronic searches were not a disbursement, but formed part of the firm’s overall service to clients and were, therefore, a taxable cost. The firm now faces a £64,000 VAT bill. Unless the firm appeals successfully, conveyancers should now be charging their clients VAT on electronic searches in residential property transactions.
Let’s turn back the clock to 1991, when the Law Society and HMRC formed an agreement (that still stands) under which HMRC allows postal searches to be treated as disbursements. This was to reflect that the fee for the search is charged for the supply of access to the oÿcial record, therefore, it is the solicitor not the client who receives this service.
Fast forward to May 2012, the beginning of a period of just over three years which became the focus of HMRC’s assessment for VAT liability against north west of England firm, Brabners. During this period, the firm procured routine online property searches from an external search agency, SearchFlow. SearchFlow did not charge Brabners VAT on these searches, and then Brabners passed on that cost, VAT free, to the client – in line with the HMRC concession and Law Society guidance on VAT on disbursements.
However, HMRC assessed the firm as liable to pay VAT on those search fees on the basis that the search fees were not disbursements, despite its concession on postal searches.
The issues for the tribunal were simple:
- Was the electronic search cost a disbursement for tax purposes?
- What was the proper VAT treatment of the charges made for these electronic searches?
This was absolutely not a case of tax avoidance or evasion, and there was no criticism of Brabners’ probity. Nor was there any suggestion of misconduct or bad faith on the part of the firm or its staff.
Brabners argued that HMRC did not apply the provisions of articles 73 and 79 of Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax correctly, in relation to the specific facts of the disputed search fees. The firm argued that it was entitled to treat the charges as ‘excluded from the taxable amount’ (para 20).
The Law Society supported Brabners in its appeal, and made written submissions to the tribunal. An important strand of its submissions was that there is no apparent difference between postal searches and electronic searches, so it would be inconsistent or anomalous for electronic search fees to be treated differently from postal search fees (which attract the VAT concession).
Unfortunately, the tribunal rejected this argument on the basis that the appeal did not concern the validity of the concession for postal search fees. At issue was whether or not the firm’s VAT treatment of the electronic search fees was correct as a matter of law. HMRC argued that search fees can only be treated as a disbursement if it satisfies the eight 'disbursement conditions' in VAT Notice 700 para 25.1, thus:
- You acted as the agent of your client when you paid the third party.
- Your client actually received and used the goods or services provided by the third party (this condition usually prevents the agent's own travelling and subsistence expenses, phone bills, postage, and other costs being treated as disbursements for VAT purposes).
- Your client was responsible for paying the third party (examples include estate duty and stamp duty payable by your client on a contract to be made by the client).
- Your client authorised you to make the payment on their behalf.
- Your client knew that the goods or services you paid for would be provided by a third party.
- Your outlay will be separately itemised when you invoice your client.
- You recover only the exact amount which you paid to the third party.
- The goods or services, which you paid for, are clearly additional to the supplies which you make to your client on your own account (para 21).
Furthermore, HMRC relied on an internal manual ('VTAXPER') §47000 - Issues to consider: identifying disbursements in particular areas and trades: search fees, which stated that VAT would not be chargeable by either the search company or the solicitor if the search information was passed on ‘without analysis or comment’ (para 24). HMRC argued that the search fees went beyond simple repayment of expenditure incurred in the name and on behalf of the customer, but formed part of their charges for the services performed by the firm.
The tribunal ruled in HMRC’s favour. As Judge Christopher McNall stated succinctly:
When the appellant obtains search results, and prepares a separate report, the appellant is using that information as part and parcel of its overall service. When that has happened, then the search fees should not have been treated as disbursements, and VAT should have been charged. The payment is part of the overall consideration which the client pays for the service supplied by the solicitor (para 53).
The judge found that the search fees paid to SearchFlow were incurred by the firm in the course of making its own supply of services to clients, as part of the overall services rendered to the client. Brabners was neither a ‘conduit’, nor a ‘post-box’, nor a ‘middle man’ for search results (paras 50 and 57 respectively). Furthermore, the firm has a duty to clients to take reasonable care and skill to identify any risks or other factors adversely affecting the subject property, so that they can identify if the transaction can go ahead safely.
The judge also observed that sometimes the search results are not actually sent out to clients, and this was ‘indicative of the identity of the true consumer of the search results’ (para 58). In other words, Brabners was the true consumer, not the client.
It is diÿcult to argue with the judge’s rationale, though those on the ground find it highly unfair. Matthew Roach, associate and Chartered Legal Executive at Anthony Collins Solicitors, agrees that searches are obtained and reviewed by lawyers as part of the service provided: ‘It is not the case that we simply obtain them and forward them on for the client to review.’
But he adds: ‘The decision seems wholly unfair as many law firms may now face huge tax bills for tens or even hundreds of thousands of pounds. Clearly, had it been better understood by law firms that this was the HMRC’s stance, then VAT would have been charged at the time. No doubt had law firms been charging VAT on searches which had not attracted VAT on the purchase price, clients would have quite rightly queried this - so the matter is complex to say the least.’
Adrian Randall, ACILEx and conveyancing executive at New Forest District Council, does not accept the ruling as either right or fair. He explains: ‘I do not agree with the judge’s decision and take the Law Society stance that the concessionary treatment of postal searches is correct and that there is no apparent difference between postal searches and electronic searches. In the light of this, I do not consider that this is a fair decision for law firms as it creates a two-tier quoting system.’
Clients’ costs will increase and, says Matthew Roach, ‘most private clients will not be able to reclaim VAT and indeed, most of my clients, the majority of which are housing associations will not be able to reclaim the VAT’. He adds that this will simply serve to increase the financial burden on many purchasers in what is already an expensive process.
Former residential conveyancer Rob Hailstone, now CEO of Bold Legal Group, also concurs with the judge’s rationale: ‘Simply sending a search result to a client, be it a postal or electronic search, without comment on the contents would be ridiculous. Most clients would struggle to understand most of the search questions, let alone the replies.’
But he does not think the decision is particularly fair either, and highlights the lack of clarity raised by the ruling: ‘It would
appear that the judge’s view is that this ruling extends to all searches. However, the actual decision only appears to refer to electronic searches.’ As for Brabners’ argument that, given the 1991 concession from HMRC, electronic searches should be treated in the same manner, Rob Hailstone says: ‘This vagueness cannot be considered fair.’
As Beverley Sheehan, Chartered Legal Executive at Sheehan Legal, explains: ‘When a firm acts in any transaction, they act on the general terms of business and upon the instructions of the client. They advise the client on which searches to undertake in any property transaction, based upon not only the location of the property but upon any peculiarities pertinent to that property. The firm also has a duty under the [Council of Mortgage Lenders] to any mortgage lender.
‘I always submit the results of the searches to the client, whilst retaining a copy for my records, and of course, checking through and pointing out in my report, the findings. The usual procedure is that the client is informed and advised which searches should be undertaken. The client then pays upfront the search fees and the law firm pays out as agent to the search provider, the search fees. In my experience and without exception, all disbursements are paid up front by the client and are not recharged to the client, thus the conditions for treating as a disbursement are met.’
On this basis, Beverley Sheehan’s view is that ‘the proper analysis is that the search fees are not part and parcel of the firm's services to the client, and that therefore the fees are not incurred by the firm as principal but as agent for the client’.
Brabners could appeal the ruling but, in the meantime, there are serious implications for conveyancing law firms. First, conveyancing departments must make sure they are charging their clients VAT on electronic searches, reflecting this additional element in their client care letters. Postal searches - for now - can still be treated as disbursements given that the 1991 concession remains in place.
Of more serious concern is the possibility - or even likelihood according to some commentators - that HMRC will now decide to target firms across the UK for under declarations of VAT in relation to the recharge of electronic search fees to their clients. This would seem to be a rather hard-line approach in the light of the long-standing concession on postal searches, but it could happen.
Rob Hailstone points out: ‘If HMRC were to look to assess for historic VAT, for non-deliberate errors HMRC are entitled to go back four years. As this is an output VAT error, as of 28th September 2017, HMRC could go back as far as the quarter ending 30th September 2013 to assess for any perceived errors.’
In the light of the Brabners decision, Rob Hailstone advises law firms, and suppliers of services and products to conveyancers, to now review their current and historic position around disbursements. He says: ‘As there is now a heightened expectation that HMRC will look to target law firms for VAT inspections, it would be advisable to consider a VAT health check review of one’s business to ensure that all areas of VAT accounting are compliant.’
Furthermore, HMRC could well revisit the 1991 agreement with the Law Society. Adrian Randall has ‘no doubt that HMRC will bring an end to the concession for postal votes and ensure that VAT is payable.
As Rob Hailstone says: ‘I don’t see how HMRC can have two contradictory rules: a VAT concession on postal searches and no VAT concession on electronic searches.’
For its part, the Law Society is currently reviewing the implications of the decision, and its current practice note on VAT and disbursements.* The fallout from Brabners LLP v HMRC is clearly not over by any stretch.
‘The Brabners LPP case brings all manner of headaches, for conveyancers and consumers alike, by effectively creating a two-tier quoting system at a time when the industry is striving to provide transparency and certainty in response to the Competition and Markets Authority legal services market study. We are approaching the other trade and representative bodies to see if we can agree a consistent approach to searches and VAT which will minimise the impact and confusion that this would inevitably cause to consumers.’ Beth Rudolph, director of delivery at the Conveyancing Association
*The Law Society’s practice note is being reviewed in respect of the VAT treatment of property search fees in the light of a recent First Tier Tribunal decision. The Law Society is reviewing the implications of this decision for ss3.2, 4.1 and 4.2 of the note and will issue updated guidance shortly.
- Rob Hailstone comments in conjunction with Armstrong Watson, a firm of accountants, business and financial advisers. Armstrong Watson is currently offering Bold Legal Group members a VAT health check at preferential rates. For details telephone: 0808 144 5575.
- CILEx Journal would like to thank the members of the Conveyancing Specialist Reference Group (SRG) who contributed to this article. The Conveyancing SRG is for CILEx members of all grades working in conveyancing, and for those with conveyancing practice rights. To join, e-mail conveyancing@cilex.org.uk