VAT on legal aid work

1.Introduction

1.1 Who should read this practice note?

All solicitors and their legal cashiers who account for VAT on payments received under a legal aid contract or certificate.

1.2 What is the issue?

The legal aid contracting system has evolved since monthly payment arrangements were first introduced by the Legal Services Commission (LSC), including the terminology used. The system now refers to regular payments rather than standard monthly payments (SMPs).

The new rule 21(2) of the Solicitors' Accounts Rules 1998 changed the treatment of these regular payments. This new rule came into effect on 1 May 2005. You must now pay these into your office account, rather than choosing to pay them into either your client or office account.

There is now a simplified method of accounting for VAT. This practice note outlines the process.

Note: VAT calculations contained within this practice note assume a VAT rate of 17.5 per cent.

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2. Types of legal aid

There are several categories of legal aid with varying accounting procedures applicable.

The categories are initially broken down in to two levels, higher and lower. ?Contract' work is at the lower level with ?licensed' (often referred to as ?certificated' work), and ?LGFS' (Litigator Graduated Fee Scheme) at the higher level. You should understand which type of legal aid is applicable in order to account for these payments.

Table of legal aid categories

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2.1 Licensed

The Legal Services Commission (LSC) issues a public funding certificate after a successful application to them. Claims are paid twice a month via a statement for the following payments:

• disbursements
• billed costs
• on account of costs

Most certificated work claims relate to billed costs.

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2.2 Litigator Graduated Fee Scheme (LGFS)

The LGFS was implemented on 14 January 2008 . Under this scheme litigators are paid a graduated fee for cases that are not contracted as Very High Cost Cases (VHCC).

The LGFS has fixed fees for certain hearings arising out of non-Crown Court cases, such as Committals for sentence and appeals from the Magistrates' Court.

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2.3 Contract

There are two types of contract: criminal and civil. It is possible to have both or either contracts. Both provide regular payments, called standard monthly payments (SMPs).

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3. VAT tax points and payment

This is based on the normal VAT rules as they apply to solicitors. When the VAT tax point arises is a question of fact to be decided on a case-by case basis.

• Basic Tax Point ? The basic tax point will occur when the work is completed and an invoice should be issued within 14 days of the work being completed.
• Actual Tax Point ? If a basic tax point has not already occurred an actual tax point would be triggered by either the issuing of an invoice or payment being received for the service, w hichever happens first . If a basic tax point has occurred an actual tax point would be triggered by the issue of a VAT invoice within 14 days or, in some cases, 30 days.

You must account to the HMRC for the tax due on the consideration payable for your services at the end of the quarter in which the tax point falls. This consideration is the total amount payable to you, including taxable disbursements.

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3.1 Licensed and LGFS work

This is relatively simple:

• The tax point date arises once the matter is concluded.
• You must then raise a CLS CLAIM 1 or or LF 1 (LGFS) and submit this to the LSC.
• The LSC will pay a few weeks later.

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3.2 Contract work

VAT is due on regular payments to the extent that they represent either:

• advance payment for cases not yet started
• cases started but not yet completed

The proper application of the VAT regulations for solicitors is consistent with the way other businesses account for VAT. Under the regulations, two possible scenarios arise:

• Where the claim submitted to the LSC is for a sum greater than the regular payment amount, VAT is payable on the amount of the submitted claim.
• Where the claim submitted to the LSC is for a sum less than the regular payment amount, VAT is payable on the full amount of the regular payment.

3.2.1 Calculation of regular payments

Regular payments are initially calculated on the expected level of work for the coming year, subject to review by the Legal Services Commission.

As individual cases are completed, you must both:

• bill the fees, disbursements and VAT to the client's ledger
• withdraw the funds from the LSC contract ledger account and post them to the client's ledger account

This means that the amounts received from the LSC may exceed or fall short of the value of completed cases at any given time, depending on the progress of individual cases. The regular payments may also be adjusted by the LSC to take account of fluctuations in the actual level of cases undertaken.

In April 2008 an agreement struck between the LSC and the Law Society was designed to keep changes to a firm's Standard Monthly Payment (SMP) to a minimum. This has been implemented by the introduction of reconciliation bandings, allowing a firm to be overpaid or underpaid by a percentage before a change to the SMP is made.

3.2.2 VAT and disbursements

Regular payments are consideration for services to be supplied, or already supplied, to clients qualifying for legal aid funding.

The payments include a VAT element and fall within the scope of VAT when the payment is received, unless VAT is already accounted for because the case has been completed. The only exception is where you can show that an element of the payment is for non-vatable disbursements.

To do this, and provide a more accurate representation of the VAT accountable to HMRC, you must both:

• discharge any non-vatable disbursement as it becomes liable and is rightfully due
• post out the payment from the relevant LSC contract ledger account once payment has been drawn and debited against the client's ledger account

This ensures any residual over or under payment balance remaining on the LSC contract ledger account would relate to pure costs, vatable disbursements and VAT itself. This method provides a more accurate representation of the VAT accountable to HM Revenue & Customs.

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4. Accounting treatment

Rule 19(4) of the Solicitors' Accounts Rules 1998 (the accounts rules) says you must generally hold money paid on account of costs in a client account. For a privately paying client, VAT is not payable until the work has been completed and billed. This is because you are in effect holding money on your client's behalf. This money is likely to include money for several purposes other than payment of the solicitor's fees, such as paying stamp duty taxes and buying property.

HMRC says money held in this way cannot be said to have been received by you until the accounts rules permit you to transfer them to the office account. Until then, it is as if the money were held in the client's own bank account. However, HMRC says that regular payments you receive under a contract with the LSC do not fall into this category. This is because regular payments are intended to represent consideration for work to be undertaken under the contract from the outset. So, receiving regular payment amounts to the receipt of a payment for VAT purposes.

Under rule 21(2)(a) of the accounts rules , you must pay regular payments into an office account at a bank or building society in England and Wales. These payments are office money and you must record them on the office side of a client ledger account.

Rule 19(5) also stipulates that an agreed fee must be paid into an office account . An 'agreed fee' is one that is fixed - not a fee that can be varied upwards, nor a fee that is dependent on the transaction being completed.

As with all types of work, you must both:

• open a ledger account for each client
• open an LSC ledger account to record regular payments received under your contract. See rule 32(4) and note (v) to rule 32 .

Below is an example ledger card which would be opened to record regular payments relating to a general criminal contract.

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4.1 Licensed and LGFS work

You should raise an invoice once work is concluded, as with private paying work. The LSC will send you a statement detailing the number of payments made to you in the one combined sum. You must pay this money directly into the client's ledger account, where the bills should already be waiting for payment.

Rule 21(1)(b) of the accounts rules says you may pay money for costs from the LSC into an office account at a bank or building society in England and Wales, if you either:

• transfer all money for paying disbursements to a client account within 14 days of receipt
• pay the disbursements within 14 days of receipt

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4.2 Contracted criminal work

A regular payment is received each month. You must record them on the office account side of your LSC client ledger account. You must then report the following to the LSC each month:

• who you have represented
• the work undertaken
• the costs you are claiming

This gives the LSC a record of the expenditure level under the contract.

You must account for VAT on completed cases at the basic tax point. This is the date when the supply of services is completed.

To account for the correct VAT amount, you must determine whether the payment received is a fixed fee that is inclusive or exclusive of VAT.

You must raise a bill in accordance with the actual value of the claim due against the criminal contract and posted to the client's individual ledger card.

To pay the bill, you must allocate money from the LSC contract ledger account to the client's individual ledger account. This will clear the recorded time and disbursements from the firm's work in progress figures. Posting of the bill will also automatically post the correct amount of VAT for that matter to the system VAT Output Account. This is because VAT will be charged on profit costs and disbursements, such as travel, which are subject to VAT. Similarly, billing disbursements will automatically adjust the VAT liability where they are either:

• treated as disbursements for VAT purposes, such as court fees
• a vatable disbursement being treated by the firm on the agency basis

Example:

A firm has had a criminal contract for some time and is currently holding a balance of £2,365. They receive another regular payment under their general criminal contract for £1,175. The firm subsequently has claims for three clients:

• Mr Jones' case concluded on 4 Jan for £269.45.
• Mr Smith's case concluded on 8 Jan for £89.45.
• Mrs Thomas' case concluded on 12 Jan for £121.44.

Example accounting entries for those transactions:

With a criminal contract, the amount of VAT you report each month to the LSC is the same value you account to the HMRC. Once the work has been completed, you should then submit this amount collectively to the LSC on a monthly basis.

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4.3 Contracted civil work

As with the criminal contract, a regular payment is received each month. You must record them on the office account side of your LSC client ledger account. You must then report the following to the LSC each month:

• who you have represented
• the work undertaken
• the costs you are claiming

This gives the LSC a record of the expenditure level under the contract.

You must account for VAT on completed cases at the basic tax point. This is the date when the supply of services is completed.

A civil contract has a fixed fee allocated to specific categories and levels of work. The amount paid for each case under this scheme is called a tailored fixed fee (TFF). The TFF is paid regardless of the value of work actually undertaken. Although you report to the LSC the actual value of work undertaken, a bill is only raised for the value of the TFF. So sometimes you will have done more or less work than the value of the TFF.

The TFF is published on the LSC's website. You should refer to this to be able to reconcile the contract correctly.

To pay the bill, you must allocate money from the LSC contract ledger account to the client's individual ledger account. This will clear the recorded time and disbursements from the firm's work in progress figures. Posting of the bill will also automatically post the correct amount of VAT for that matter to the system VAT Output Account. This is because VAT will be charged on profit costs and disbursements, such as travel, which are subject to VAT. Similarly, billing disbursements will automatically adjust the VAT liability where they are either:

• treated as disbursements for VAT purposes, such as court fees
• a vatable disbursement being treated by the firm on the agency basis

Example:

A firm has had a civil contract for some time and is currently holding a balance of £1,587. It receives another regular payment under its general civil contract for £587, and subsequently has claims for three clients:

• Mr Moore's case concluded on 5 Jan and has a reported value of £196.79, although the TFF for this particular case of work is £94, excluding VAT.
• Mr Howells' case concluded on 10 Jan and has a reported value of £72.18, although a TFF for this particular case of work is £221, excluding VAT.
• Mrs Picton's case concluded on 20 Jan and has a reported value of £589.62, including a disbursement of £5. A TFF for this particular case of work is £370 (excl. VAT).

The accounting entries would look similar to this:

Under the civil contract you must report the following:

• to the LSC - the value of work undertaken
• to HMRC - the amount actually received under the Tailored Fixed Fee (TFF) scheme

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4.4 Accounting for re-coupments

It is common for payments on account of profit costs and disbursements to be made upon the issue of a public funding certificate (licensed work). An internal invoice should subsequently be raised to account for the VAT element for any such payments.

For information relating to re-coupments spanning a VAT rate change see section seven.

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4.5 Accounting for VAT - contract

The tax point for regular payments is the date the payment is received. Some of the regular payments include payment for work already completed. Before you complete your VAT return, you must therefore calculate your liability for any additional output tax.

Example:

Using the example given under the accounting treatment for contracted criminal work in section 4.2, we will examine the VAT implications arising from those transactions in January. The following invoices were raised and you should have recorded the VAT listed below in your VAT journal as output tax due to HMRC.

In addition, you received a regular payment from the LSC on 3 Jan for £1,175. This has triggered a tax point, so there is potential VAT liability of £175, even though you have not raised an invoice for this sum as a total. There are two ways of calculating this liability to HMRC:

1. Subtract the amount you have already accounted for in your VAT journal (£71.53) from what you know is due to HMRC as a result of your regular payment (£175). £175 less £71.53 = £103.47 . You must pay over to HMRC this additional £103.47 when you complete your VAT return.
   
2. You received £1,175 in payment on your crime contract. The three invoices you have raised total £480.34, (£269.45 plus £89.45 plus £121.44). £1,175 less £480.34 gives you a net unbilled balance of £694.66. This is not currently reflected in your VAT journal as output VAT. When you complete your VAT return you must pay over to HMRC the VAT element of £694.66, which is £103.46 .

You may either:

• manually adjust your VAT calculation
• raise an invoice for the amount so that your VAT journal balances to the amount being paid over to HMRC

Either way, you must remember to reverse the entries before completing your next VAT return.

Example:

The above scenario is based on the commencement of a contract. Where a contract passes its first VAT quarter, an additional calculation may be required. You must also calculate the VAT element to be paid over on this balance if you still have an excess, ie a credit, on your contract ledger card. In this case, divide it by 47 and multiply it by 7.

There are two ways of calculating the liability to HMRC:

1. £175 is due to HMRC as a result of the regular payment. You have already accounted for £71.53 in your VAT journal. You still have a credit balance of £382 not allocated to costs from the previous quarter. The VAT element included in this is £56.89. Add together the amount due from the regular HMRC payment to the VAT element of the credit balance. Then subtract the money already accounted for in your VAT journal. This is £175 + 56.89 - £71.53 = £160.36 . You must pay £160.36 to HMRC when you complete your VAT return.
   
2. You received £1,175 in payment of your crime contract. You should subtract the three invoices you have raised, (£269.45, £89.45 and £121.44). This gives a net balance of £694.66, which has not been billed. You should add this to your current balance of £382 on your crime contract. Neither figure is currently reflected as output VAT in your VAT journal. These figures added together are £1,076.66. When you complete your VAT return you must pay the VAT element of £1,076.66 = £160.36 to HMRC.

Example:

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5. Refunds

If you must repay some, or all, of a regular payment to the LSC, eg where the amount of work undertaken falls, then the amount refunded ceases to be consideration for a supply. You may adjust accordingly at that time the VAT previously accounted for on the amount to be refunded .

In addition to a refund, you may also find your regular payments are insufficient to cover the work undertaken. You should therefore make no adjustment before your VAT return.

Example:

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6. Cash accounting scheme

To use this, you must meet the conditions for the scheme as explained in VAT notice 731 - cash accounting .

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7. Change of VAT rate

The standard rate of VAT was temporarily reduced to 15 per cent on 1 December 2008 and it will return to 17.5 per cent on 1 January 2010. For any sales of standard-rated services that you make on or after 1 January 2010 you must charge VAT at the rate of 17.5 per cent. For more information see the Law Society Practice Note ' VAT - Reversion of the standard rate to 17.5 per cent'.

The general approach the LSC will take is as follows:

• All cases reported or concluded before 1 January 2010 will attract a 15 per cent VAT rate
• All cases reported as concluded on or after 1 January 2010 will attract a 17.5 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 .

Any re-coupments will be made at the VAT rate in which it was paid.

Example

The LSC provide an on account payment to you on 1 March 2009 in the sum of £200 plus VAT at 15 per cent (£30.00). The matter concludes after 1 January 2010 and a final payment is received on 1 February 2010 from the LSC for the work undertaken in the sum of £960 plus VAT at 17.5 per cent.

The VAT in relation to the on account payment (£30.00) would have been paid over to HMRC within the VAT period which covered 1 March 2009 . The remaining VAT due to HMRC in the sum of £138 would subsequently be paid over to HMRC within the VAT period covering 1 February 2010 .

The accounting entries on your ledger would be reflected as follows:

Where software systems prohibit an organisation from entering in a non standard VAT element then an internal credit and debit note could be raised to facilitate the net effect required within your books of accounts. See the following example for drafting purposes.

Example

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8. More Information

8.1 Legal and other requirements

• Value Added Tax Act 1994

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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 0870 606 2522 from 09:00 to 17:00 on weekdays.

Visit the Practice Advice Service website.

8.2.2 Other Law Society materials

• Practice Note on VAT: reversion of rate to 17.5%

8.2.3 Law Society publications

Order the following titles from our bookshop:

• Solicitors' Accounts Manual: 12th edition
• Solicitors and the Accounts Rules: A Compliance Handbook
• Understanding Legal Aid: A Practical Guide to Public Funding
• Making a Success of Legal Aid: Better Days for the Practitioner

8.2.4 Other Guidance and training

• HMRC website
• Institute of Legal Cashiers and Administrators
• Legal Services Commission
• CPD course: Solicitors Accounts Rules 1998

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8.3 Status of this practice note

HM Revenue and Customs has endorsed this practice note.

The best practice advice in this practice note replaces the Society's 2001 interim guidance.

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

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

Should - good practice for most situations. If you deviate from this, you must be able to justify why this is appropriate, either for your firm, 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 firm, client or retainer. You must be able to justify why this was an appropriate option to oversight bodies.

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8.5 Acknowledgements

The Society acknowledges the considerable assistance received from the Institute of Legal Cashiers and Administrators in updating the advice given in this practice note and the co-operation from HM Revenue and Customs (HMRC).

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