Value Added Tax

Introduction

**Value Added Tax ('VAT')** is a tax on the supply of goods and services. It is examined in SQE1 FLK2 alongside the SRA Accounts Rules because a law firm, like any other business, must **charge VAT on its supplies of legal services** and account for it to **HM Revenue & Customs ('HMRC')**. This chapter explains the **general mechanism** of VAT (output tax v input tax), the special treatment of **disbursements**, the bookkeeping entries for **non-disbursements and disbursements**, **VAT on a lender's costs** in a conveyancing transaction, and the recovery of VAT on **bad debts**. The governing statute is the **Value Added Tax Act 1994 ('VATA 1994')**, supplemented by **HMRC VAT Notice 700**.

Assessment focus

For SQE1 FLK2 (Solicitors Accounts) you must understand the **mechanics of VAT** and how they are recorded in a firm's accounts. You need to distinguish **output tax** (charged by the firm to its clients) from **input tax** (charged to the firm by its suppliers), and to know that a taxable person generally **deducts input tax** from the output tax it accounts for to HMRC under **s.25(2) VATA 1994**. The single most heavily tested point is the **disbursement**: candidates must be able to identify whether a payment to a third party is a true disbursement (no VAT charged by the firm) or merely an **overhead** forming part of the firm's own supply (VAT must be charged). You should also know the **two accounting methods** for disbursements (agency method v principal method) and the rule that VAT on a **bad debt** may be recovered once the debt is **at least six months old** and has been **written off**. Questions are single best answer (SBAQs) set in realistic firm scenarios; this is a closed-book assessment.

Study tips

1) Lock in the core mechanism: **output tax** is charged to customers; **input tax** is charged to the firm by suppliers; the firm pays HMRC the **difference** (s.25(2) VATA 1994). 2) The **standard rate has been 20% since 4 January 2011** — there is also a **reduced rate** and a **zero rate**, and some supplies are **exempt**. 3) Remember the difference between **zero-rated** (a taxable supply — input tax IS recoverable) and **exempt** (NOT a taxable supply — input tax is NOT recoverable). 4) A **disbursement** is a payment the firm makes **as agent** for the client, where the client receives the supply and is responsible for paying the third party — the firm charges **no VAT** on it (VAT Notice 700). **Overheads** such as postage, telephone and the solicitor's own travel are **NOT** disbursements (Rowe & Maw v Customs and Excise Commissioners). 5) **Bad debt VAT relief**: the debt must be **at least six months old** (measured from when payment was due) **and written off** in the firm's accounts before the VAT element can be recovered.