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VAT change

24 November 2010

1. Introduction

1.1 Who should read this practice note?

Solicitors and their legal cashiers who deal with invoicing, making and receiving payments which include VAT.

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1.2 What is the issue?

In the Budget on 22 June 2010, the Chancellor of the Exchequer announced that the standard rate of Value Added Tax (VAT) would increase from 17.5 per cent to 20 per cent on 04 January 2011. This was brought into effect by section 3 Finance (No. 2) Act 2010 on 27 July 2010.

There are special rules for supplies which span the change of rate, and for continuous supplies of services.

This practice note provides an overview of the application of the rules surrounding the change and its contents have been approved by HMRC.

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2. Applying the 20 per cent rate from 04 January 2011

You should charge VAT at the rate of 20 per cent on all supplies of services you make on or after 04 January 2011.

You should use the 20 per cent rate for all interim VAT invoices that you issue on or after 04 January 2010 and those which are issued within 14 days of you providing your services, or any longer period for invoicing which you have agreed with HMRC.

You must account for VAT in the tax period in which the supplies are made and there are rules to assist you to work out when the time of the supply, known as the 'tax point', occurs. The tax point is either 'basic' or 'actual' and these rules are particularly important when the VAT rate changes.

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2.1 Basic tax point

The basic tax point arises when the supply of services, excepting the time spent preparing your client's invoice, is known to be completed. Usually this is decided on a case-by case basis.

For example, a client instructs you in the preparation of a will. The will is drafted, amended and finally signed. Your firm's supply is complete and a basic tax point is created.

This is the basic occasion of charge, and the tax on the consideration due for your services, i.e. the total amount payable to you including taxable disbursements, must, in most cases, be accounted for at the end of the quarter in which the tax point falls.

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2.2 Actual tax point

The basic tax point may be overridden if an actual tax point is created.

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2.2.1 Tax point prior to the basic tax point

Sometimes a tax point may be created prior to the basic tax point. If you either issue a VAT invoice or receive payment, whichever is earlier, this will create a tax point. Tax then has to be accounted for at the end of the quarter on the amount invoiced or received.

For example: You receive a standard monthly payment from the Legal Services Commission. The receipt of this payment can create an actual tax point which must be accounted for at the end of the quarter. For more information see the practice note on VAT on legal aid work.

The value of a supply is deemed to be a sum which, when added to the VAT payable, is equal to the consideration. In other words, the default position is that the sum charged is VAT inclusive.

Note: A payment tax point is not established if money is received and simply held in client's account pending delivery of a bill, because the money remains the property of the client.

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2.2.2 Tax point after the basic tax point

Provided you have issued a VAT invoice within 14 days after the completion of your legal services, for example, 14 days of completing your client's will, the actual tax point will arise on the date of issue.

If you issue invoices to your clients monthly for certain types of work, for example: for regular debt collection work for a large organisation, or in relation to a contract to provide legal advice to customers of an insurance company's legal expenses policy, you may need to apply to the VAT Business Centre for your area for an accommodation tax point. You should make this application in writing, giving your reasons for the extension. In your application you must say whether you want to take the last day of the month or the date of issue of the VAT invoice as the tax point. Whichever you decide, you must be consistent if the extension is approved.

The 14-day period is extended to three months where the fee is not ascertained or ascertainable at or before the time the services are completed. Provided you issue the VAT invoice no later than three months after completion of your services the date of the invoice will be the tax point. Failure to issue a VAT invoice within the extended period will cause the actual tax point to revert to the basic tax point.

Further information on VAT invoice extensions can be found on the HMRC website.

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3. Special change of rate rules

Under the normal rules, standard rated supplies with tax points created by payments received or VAT invoices issued on or after 04 January 2011 will be liable to the 20 per cent rate. However, there are optional change of rate rules that you may wish to apply:

  • Where you issue a VAT invoice or receive a payment on or after 04 January 2011 for work that was completed before 04 January 2011 you may account for VAT at 17.5 per cent.
  • Where work commenced after 01 January 2010 and before 04 January 2011 but will not be completed until on or after 04 January you can apportion the supply between that liable to 17.5 per cent and that liable to 20 per cent.

You can apply the rules selectively to different clients and you can adopt them without notifying HMRC. If your client is VAT registered and able to recover the VAT charged in full, the use of the special rules will not save them any tax.

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3.1 Services provided before 04 January 2011

The change of rate rules may be used where you perform services before 04 January 2011 and raise a VAT invoice after the rate change.

For example, if you issue a VAT invoice after 04 January 2011, for services that you completed before 04 January 2011, you may apply the 17.5 per cent rate.

You can decide to apply these rules even after you have issued a VAT invoice showing 20 per cent VAT. If you do, you must issue a special credit note giving credit for the extra 2.5 per cent VAT, within 45 days of the rate change, i.e. by 18 February 2011. The credit note details required are given in section 5 below. You must not cancel the original invoice.

Example:

Following a period of negotiation, a compromise agreement was finalised and signed by your client in relation to an employment matter on 28 December 2010 , when the VAT rate is 17.5 per cent. On 5 January 2011 you issue a VAT invoice in respect of the work in dealing with the compromise agreement. What rate of VAT should you charge?

Under the normal tax point rules 20 per cent VAT is due as the invoice was issued after the increase in the rate and within 14 days of the completion of your services. However, under the special rules you may decide to charge the 17.5 per cent standard rate of VAT which was in effect when the agreement was completed. This will reduce the amount of VAT you are liable to account for.

If your client was the employer, then they may be VAT registered. If so, they will be able to recover the VAT you charge in full and the use of the special rules will not save them any tax.

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3.2 Services provided after 04 January 2011

You may opt to use the special change of rate rules where you receive a payment or raise a VAT invoice before 04 January 2011 for services you will be providing on or after that date. Under the normal rules you should account for VAT at 17.5 per cent but see section 3.4 about anti-avoidance rules.

You may also account for VAT at 20 per cent, not 17.5 per cent, on the payment received or amount invoiced before 04 January 2011. You may find it more convenient to do this and to issue a VAT invoice for the 20 per cent rate in cases where your client can recover all the VAT you charge them. You may wish to agree this with them first.

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3.3 Supplies that are in progress on 04 January 2011

The normal rule is that where an invoice is issued or a payment received after 04 January 2011 VAT is due at 20 per cent even if part of the supply was undertaken before that date. Where work commenced before 04 January 2011 but will not be completed until on or after 04 January you can apportion the supply between that liable to 17.5 per cent and that liable to 20 per cent. If you choose to do this you will have to be able to demonstrate to HMRC that the apportionment is fair.

If you think there is the possibility of a dispute over the value to be placed on services performed before and after 04 January 2011, you may issue a bill prior to 04 January to demonstrate the amount performed prior to the change of VAT rate.

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3.3.1 Continuous supplies

For many supplies of legal services, it will be clear when the matter is completed and a basic tax point has been created. A continuous supply of services is more likely to arise in a situation where you are retained to carry out ongoing services, for example the administration of a trust, or acting under a general power of attorney. In these circumstances, there is likely to be a continuous supply of services for VAT purposes.

For a continuous supply of services, a tax point will be created for VAT when a VAT invoice is issued or a payment is received, whichever happens first. You may account for VAT at the 17.5 per cent rate on that part of the supply made before 04 January 2010. This is the case, even if the normal tax point occurs later, for example: where a payment is received in arrears of the supply.

If you decide to do this, you should account for VAT at 17.5 per cent on the value of the services actually performed before 04 January 2011 , and at 20 per cent on the value of the services actually performed after.

Example:

You are retained by an insurance company, to provide advice to clients who have taken out legal expense insurance to cover the costs that may be incurred pursuing motor accident claims. It is agreed with the insurers that you shall be paid a retainer fee of £1000 per month which is billed quarterly in arrears. The bill for the quarter covering 1 November 2010 to 31 January 2011 is £3, 000 plus VAT. How much VAT should be charged?

The normal rule is that the entire £3,000 fee is liable to VAT at 20 per cent because the VAT invoice is issued after 04 January 2011. However, you can, if you wish, charge VAT at 17.5 per cent on the payment for the period form 1 November up to and including 03 January 2011. As the insurance company cannot recover the VAT that it incurs using the special rules will result in a VAT saving for them.

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3.3.2 Single supplies carried out over a period of time

You may make a single supply of a service which is nevertheless carried out over a period which commences before 04 January 2011 but is not completed until after that date, for example, during a property transaction. Unless you have received payment or issued a VAT invoice before 04 January, the whole supply should be charged at the 20 per cent rate under the normal rules. However, you may if you wish, charge VAT at 17.5 per cent on the work done up to 03 January 2011 and 20 per cent on the remainder. You must be able to demonstrate that the apportionment between the two amounts accurately reflects the work done in each period.

As similar change of rate rules applied when the VAT rate was temporarily reduced to 15 per cent on 01 December 2008 and again when it reverted to 17.5 per cent on 1 January 2010, you may also wish to consider applying similar apportionment rules to work that either:

  • spans the period 01 December 2008 to 31 December 2009, or
  • commenced prior to the reversion to 17.5 per cent on 1 January 2010.

Practical examples

Example 1:

You have been instructed by your client to undertake court proceedings to remove squatters from their residential premises. Instructions were received and your retainer commenced in early November 2010 and will not conclude until eviction has taken place in late January 2011. How do you calculate the VAT?

You may account for VAT at 17.5 per cent on the work carried out before 04 January 2011 and 20 per cent on the remainder. You will need to be able to show that your calculation is accurate. If you have a time recording system or charge an hourly rate then you should be able to use these to demonstrate the accuracy of your apportionment.

Example 2:

You have been instructed by your client to undertake court proceedings to recover damages for clinical negligence. Instructions were received and your retainer commenced in early September 2007. The case is settled in December 2010 on the basis that the opposing party pay your client's costs and a bill of costs is drawn up. The amount of the costs are not agreed or assessed until March 2011. How do you calculate the VAT?

Under the normal VAT rules, where one party is ordered to or has agreed under a settlement to pay the other's costs, the settling of the costs in these circumstances is part and parcel of your overall supply to your client. In such circumstances, the basic tax point arises when either the costs have been agreed between the solicitors. or the assessment of costs procedure is complete and the costs will be liable to VAT at 20 per cent. Under the special rules, provided that that no interim VAT invoices have been raised or payments received over the entire course of the supply, which would be the case if there was a conditional fee agreement, then you may apportion your costs so that:

  • 17.5 per cent VAT is charged in relation to your costs for the period being due from September 2007 to 30 November 2008
  • 15 per cent is charged for the period from 01 December 2008 to 31 December 2009,
  • 17.5 per cent is charged for the period from 01 January 2010 to 03 January 2011, and
  • 20 per cent is charged for the period from 04 January 2010 to March 2011.

If you have issued interim VAT invoices to your client during the course of the supply, then the rate you charge to the other party will be the same as that on the invoices you have issued.

Example 3:

You have been instructed by your client to undertake court proceedings to recover damages for clinical negligence. Instructions were received and your retainer commenced in early September 2007. The case is settled in December 2010 on the basis that each party pay their own costs and you issue an invoice to your client after 04 January 2011 . How do you calculate the VAT?

As you completed the work for your client in December 2010, this is when the basic tax point arises. Under the special rules you may decide to charge the 17.5 per cent standard rate of VAT for the costs incurred up to and including 31 December 2010.

Example 4:

In August 2008 you began acting for a client in a personal injury claim, funded by a CFA. The claim ends successfully in January 2011, so the work spans the VAT rate changes. You wish to apply the 'special rules? and charge VAT at 15 per cent in respect of work done between 01 December 2008 and 31 December 2009 and at 17.5 per cent in respect of the work done before and after that up to 03 January 2011, as in the Example 2. How should you deal with the success fee of 50 per cent?

The success fee can be treated in the same way as the base costs. So you should apply the percentage uplift to each apportionment and then calculate the VAT. On fees of, say £50,000, the calculation would be as follows:

  • Aug 08 to 30 Nov 08: £4,000 x 50per cent uplift = £6,000 + VAT of 17.5 per cent
  • 01 Dec 08 to 31 Dec 09: £20,000 x 50per cent uplift = £30,000 + VAT of 15 per cent
  • 01 Jan 10 to 03 Jan 11: £25,000 x 50per cent uplift = £37,500 + VAT of 17.5 per cent
  • 04 Jan 11 to 25 Jan 11: £1,000 x 50per cent uplift = £1,500 + VAT of 20 per cent

You will need to show the apportionment and the rates applied to each on your invoice.

Example 5:

You acted for a claimant in relation to a modest RTA personal in jury claim. Your fees are based on CPR predictive costs. Upon conclusion of the matter in November 2010 you send a schedule of costs to the defendant insurer who had agreed to pay your client's costs with a request for payment. The VAT applied to the costs in the schedule was 17.5 per cent.

The defendant insurers fail to deal with the costs until after 04 January 2011 when they agree with you the amount of costs (net of VAT) they will pay. The insurers suggest that the VAT rate applicable remains 17.5 per cent not the new rate of 20 per cent as that was the rate applicable when the schedule of costs and demand for payment was sent to them.

As the costs are based on CPR predictive costs and not calculated based on time spent on the matter, it is not easy to apportion the costs. What is the correct position?

As in example 2, the basic tax point does not arise until the costs have been agreed between you and the insurers. If agreement on the amount is not reached until say 28 January 2011 , then this will be the date of the tax point and under the normal VAT rules the applicable rate of VAT will be 20 per cent. As the special change of rate rules are only optional, you do not have to apply them and the insurers will have to pay VAT at 20 per cent.

Example 6:

You have been acting in relation to a probate matter which commenced in April 2010 and concludes in February 2011. Your firm's standard practice is to calculate your fees at an hourly rate for the time spent on the matter, plus a value element calculated as a percentage of the value of the estate. You intend to apportion the hourly rate work (VAT of 17.5 per cent on work carried out in 2010 and VAT of 20 per cent on work carried out in 2011) but how should the value element of the fees be treated for VAT purposes?

The value element becomes due when the matter completes and therefore the tax point will depend on the date of the invoice. As you will invoice your client in February 2010 then the value element of your fees will be subject to the VAT rate of 20 per cent.

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3.4 Artificial arrangements to avoid the increased VAT rate

VAT anti-forestalling legislation was introduced as part of Finance (No. 2) Act 2010. This prevents artificial arrangements being entered into which seek to benefit from the 17.5 per cent standard rate in respect of supplies made after the standard rate increases to 20 per cent, where the recipient is not able to recover all of the input tax on supplies you make to them.

The legislation will affect you if you receive a payment or issue a VAT invoice before 04 January 2011 for services that you are to provide on or after that date, and one of the following conditions is met:

  • you supply the services to a connected person, such as another business controlled by you; or
  • you provide or arrange funding of your client's payment; or
  • you issue a VAT invoice to your customer that does not have to be paid in full within six months; or
  • the payment or VAT invoice is in excess of £100,000, and this is not normal commercial practice.

Where these conditions are met you will be obliged to make a supplementary VAT charge on your supply to bring the total VAT charged to the equivalent of the new higher standard rate.

The legislation may also affect you if, before 04 January 2011 , you supply the right or option to receive services from you on or after that date, free of charge or at a discount.

The legislation applies to transactions entered into on or after 22 June 2010. However, no extra tax will become due under this legislation until 04 January 2011.

Detailed guidance is provided on the HMRC website

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3.5 Disbursements

The rate of VAT charged in respect of disbursements will depend on the tax point. This is normally the date on which the invoice is issued, regardless of when the disbursement was incurred.

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3.6 Counsel's fees

Normally, the tax point for Counsel's services will be determined by payment and not delivery of a fee note. On payment, Counsel's clerk will add the VAT number of Counsel and other particulars required under Regulation 13 of the VAT Regulations 1995 to constitute a document as a VAT invoice so that the receipted fee note is a VAT invoice.

Fees received on or after 04 January 2011 will be liable to VAT at 20 per cent. However, if you pay fees after 04 January for cases completed before that, these can if Counsel opts to do so still be subject to VAT at 17.5 per cent. Similarly, if you pay a fee after 04 January 2011 which covers services partly performed while the 17.5 per cent VAT rate applied, these fees may, if Counsel opts to do so, be apportioned so that the rate of 17.5 per cent applies to those fees accrued before 04 January 2011 . You should clarify the VAT treatment of the fees with Counsel's clerk before payment.

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4. Applying an incorrect VAT rate

If you discover that you have made any mistakes in applying the standard rate of VAT, you should correct them through the normal error correction procedures, either in your current VAT return or, for larger mistakes, by submitting a form VAT 652. See Notice 700/45 - How to correct VAT errors and make adjustments or claims.

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4.1 Correcting rates in invoices to clients

If you continue to charge 17.5 per cent VAT on invoices raised on or after 04 January 2011, you will need to account to HMRC for the correct amount, that is, 20 per cent. But if you discover that you have charged the wrong rate you should issue your client with a credit note to cancel the original invoice and issue a new invoice showing the correct rate of VAT.

A credit note should contain all of the following details:

  • the identifying number and date of issue of the credit note;
  • your name, address and VAT registration number;
  • your customer's name and address;
  • the identifying number and date of issue of the VAT invoice;
  • a description which identifies the goods or services supplied; and
  • the amount of VAT being credited.

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4.2 Penalties

HMRC will be operating a 'light touch' in dealing with errors made in the first VAT return after the change, where the error relates to a change of rate issue. This means that they will not target change of rate errors that are unlikely to lead to any material net revenue loss. If they find errors which relate to a change of rate issue they will not seek an adjustment unless they have reason to suppose that there is an overall revenue loss.

In situations where HMRC do need to adjust they will issue an assessment, taking into account any difficulties you have faced in adjusting to the change in considering whether penalties apply.

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5. Claims for bad debt relief

Any bad debt relief you claim on unpaid invoices must be at the same rate of VAT as that charged, ie 17.5 per cent for bad debt relief on invoices issued before 04 January 2011.

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6. Legal Services Commission payments

The Legal Services Commission (LSC) makes payments to providers using fixed fee and non-fixed fee charging schemes. The general approach the LSC will take is as follows:

  • All cases reported or concluded before 04 January 2011 will attract a 17.5 per cent VAT rate
  • All cases reported as concluded on or after 04 January 2011 will attract a 20 per cent VAT rate

More detailed guidance about the changes to the LSC systems and processes to accommodate the change in the VAT rate can be found on the LSC website .

The VAT treatment of SMPs for legal aid work will depend on the extent to which each payment relates to completed cases. The tax point for regular payments is the date the payment is received. For more information on SMPs please refer to the Law Society's VAT guide for legal aid work .

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7. VAT on leases for Stamp Duty Land Tax (SDLT) purposes

The changes will affect calculation of the net present value (NPV) of rent payable under a lease, where VAT is charged on the rent.

In calculating VAT, the tax point for rental payments is either:

  • the date on which a VAT invoice is issued, or
  • a payment is received, whichever is the earlier

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7.1 Calculating NPV

HMRC's view is that the amount to be brought into the chargeable consideration should reflect the VAT rate position known at the effective date of the transaction. How VAT will be treated for SDLT purposes will depend on whether the effective date of the lease is before, on or after 27 July 2010 which is the date the legislation giving effect to the increase came into force.

7.1.1 Lease with an effective date on or after 27 July 2010

HMRC states that:

The calculation of Net Present Value (NPV) should take into account VAT at the rates applicable to the appropriate proportions of the first five years of the lease. The VAT on the rent payable for the period from the effective date to the day preceding the first rent payment date on or after 4 January 2011 should be calculated at 17.5 per cent. The VAT element on the rent payable on and from the first rent payment date on or after 4 January 2011 should be 20 per cent.

So, for example, if the rent is payable on the usual quarter days, the whole of the December 2010 quarter's rent (and the earlier rent) can be included at 17.5 per cent as the tax point will be 25 December 2010 (or earlier), i.e. before the VAT increase on 4 January 2011.

If you have submitted a SDLT return and have not taken into account the increase in VAT when calculating the NVP, you should contact Birmingham Stamp Office.

7.1.2 Lease with an effective date before 27 July 2010 - but after 4 January 2006

HMRC states that:

A further return is not required just because the rate of VAT has changed, because Finance Act 2003 Schedule 17A(7) (leases with variable or uncertain rent) is not activated by a change in the VAT rate.

However, for any lease with variable or uncertain rent, a return will usually be required in line with the normal rules.

In those circumstances, the review required by Schedule 17A paragraph 8 should include the rents paid inclusive of any VAT (Schedule 4 paragraph 2) by reference to the actual rate of VAT applying at the respective times. The calculation will use the highest rent actually paid for any 12 month period in the first 5 years of the term for the whole of the remaining term (Schedule 17A paragraph 7(3)).

Any return resulting from such a review has a revised effective date: the end of the fifth year of the term or, if earlier, the date at which the rent payable in the first five years of the term becomes certain. This applies for all purposes apart from interest, where the effective date remains the original effective date (Schedule 17A paragraph 8(4) and Section 87(5)). Interest will be charged on underpayments and added when tax overpaid is repaid.

If you have any queries you should write to the Technical and Guidance Team at the HMRC Stamp Taxes Birmingham Office:

Birmingham Stamp Office
9th Floor
City Centre House
30 Union Street
Birmingham
B2 4AR
DX: 15001 Birmingham 1

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8. More information

8.1 Legal and other requirements

  • Value Added Tax Act 1994
  • Finance Act 2009

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8.2 Further products and support

8.2.1 Practice Advice Service

The Law Society's practice advice service provides support for solicitors on a wide range of areas of practice. Practice Advice can be contacted on 020 7320 5675 from 09:00 to 17:00 on weekdays.

Visit the Practice Advice Service website.

8.2.2 Practice Advice Service

  • Practice note on legal aid VAT.

8.2.3 HMRC Guidance

Further information is available at the HMRC website.

8.2.4 Events and training

8.2.5 Law Society publications

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8.3 Status of this practice note

Practice notes are issued by the Law Society for the use and benefit of its members. They represent the Law Society's view of good practice in a particular area. They are not intended to be the only standard of good practice that solicitors can follow. You are not required to follow them, but doing so will make it easier to account to oversight bodies for your actions.

Practice notes are not legal advice, nor do they necessarily provide a defence to complaints of misconduct or of inadequate professional service. While care has been taken to ensure that they are accurate, up to date and useful, the Law Society will not accept any legal liability in relation to them.

For queries or comments on this practice note contact the Law Society's Practice Advice Service.

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8.4 Terminology in this practice note

Must - a specific requirement in the Solicitor's Code of Conduct or legislation. You must comply, unless there specific exemptions or defences provided for in the code of conduct or relevant legislation.

Should - good practice for most situations in the Law Society's view. If you do not follow this, you must be able to justify to oversight bodies why this is appropriate, either for your practice, or in the particular retainer.

May - a non-exhaustive list of options for meeting your obligations. Which option you choose is determined by the risk profile of the individual practice, client or retainer. You must be able to justify why this was an appropriate option to oversight bodies.

HMRC - Her Majesty's Revenue and Customs

CFA - conditional fee agreement

Predictive costs - costs calculated in accordance with civil procedural rule (CPR) 45 for low value road traffic accident claims. CPR 45 calculates the costs recoverable from the other party on the basis of a fixed fee plus an additional element based on a percentage of the amount of damages recovered. CPR 45 also prescribes the disbursements that can be recovered and the amount of the success fee if a CFA is entered into.

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9. Acknowledgements

The Society acknowledges the contributions of officials at HMRC (Corporation Tax and VAT) and the VAT & Duties Sub-committee Chair in developing this practice note.

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