Andrew Needham looks at the VAT recovery position when a business pays somebody else’s costs.
There are many instances in which a business pays another person’s costs, for example:
- a business loses a court case, and is ordered to pay the other party’s costs;
- a business approaches its bank for a loan and the bank insists on having its accountants carry out due diligence checks before it grants a loan and makes the business pay for it; or
- a tenant wishes to assign a lease and the landlord makes them pay their legal costs.
VAT recovery
The fact that a business pays an expense does not necessarily mean that it is incurred for the purpose of its business. The business may be legally liable to pay, but there may not have been a supply to them. This means that they will not have the right to deduct the input tax.
When the loser of a legal dispute pays the costs of the other side, the legal services are supplied to that opponent and not to the person who actually pays for them and is, therefore, not recoverable.
If the opponent is VAT registered and the case involves a business dispute, they can recover the VAT they are charged by their lawyers on their own VAT return, so the loser should only pay the net amount. If a business cannot claim its input tax, you should obtain written confirmation of this before paying over the VAT element.
A similar situation arises if a business rents premises that it no longer needs and wishes to get out of the lease by assigning it to another business. Normally, it cannot do this without permission of the landlord.
Under the terms of the lease, the landlord is entitled to demand that, as a condition of granting permission to assign the lease, the business pays the legal costs generated by the request, i.e. the expense of checking the credentials of the proposed tenant and preparing the assignment.
The solicitor’s invoice may well be addressed to the business, and it will include VAT if the landlord cannot recover this because the rent is exempt. However, that VAT is not recoverable by the tenant because the service was supplied to the landlord, not to the tenant, even though it is required to pay.
Cases where input VAT could be claimed
In the case of Cloud Electronics Holdings Ltd v HMRC [2012] UKFTT 699 (TC), the appellant claimed input tax relating to professional fees rendered prior to their incorporation.
HMRC decided that the input tax claimed related to advice commissioned by the management buyout team and was disallowed on the grounds that the supply had not been made to the business.
The business argued that the benefit of the services was received by them, they paid for them and, therefore, should be able to recover the input VAT on the basis that they received the services.
The tribunal concluded that services were supplied to the business, and the input tax claim was allowed.
In a House of Lords case, Redrow took part-exchange houses and engaged estate agents to sell them. They claimed the VAT back on the sales cost and HMRC disallowed it as they said that the actual supply was to the house owner. Redrow won the case because it had not only paid the bill, but it had engaged and instructed the estate agents from the outset.
Practical Tip:
If you pay somebody else’s costs you do not have an automatic right to reclaim the VAT. It is only reclaimable if you show that there is a business purpose and a direct and immediate link to the taxable supplies that you make.
