VAT change
VAT change: Reversion of the standard rate to 17.5 per cent – 15 December 2009
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.
1.2 What is the issue?
In his Pre-Budget Report on 24 November 2008, the Chancellor of the Exchequer announced a temporary reduction in the standard rate of Value Added Tax (VAT) from 17.5 per cent to 15 per cent, between 1 December 2008 and 31 December 2009.
The standard rate of VAT returns to 17.5 per cent on 1 January 2010. However, 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 rules surrounding the change.
2. Applying the 17.5 per cent rate from 01 January 2010
You should charge VAT at the rate of 17.5 per cent on all supplies of services you make on or after 01 January 2010.
You should use the 17.5 per cent rate for all VAT invoices that you issue on or after 01 January 2010 and 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.
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.
2.2 Actual tax point
The basic tax point may be overridden if an actual tax point is created.
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 creates 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.
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 the VAT Business Centre for your area to extend the 14 day rule. 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 may also be 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.
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 01 January 2010 will be liable to the 17.5 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 01 January 2010 for work that was completed before 01 January 2010 you may account for VAT at 15 per cent.
- Where work commenced before 01 January 2010 but will not be completed until on or after 01 January you can apportion the supply between that liable to 15 per cent and that liable to 17.5 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.
3.1 Services provided before 01 January 2010
The change of rate rules may be used where you perform services before 01 January 2010 and raise a VAT invoice and, in some cases, receive a payment after the rate change.
For example, if you issue a VAT invoice after 01 January 2010, for services that you completed before 01 January 2010, you may apply the 15 per cent rate.
You can decide to apply these rules even after you have issued a VAT invoice showing 17.5 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 14 February 2010. 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 2009, when the VAT rate is 15 per cent. On 4 January 2010 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 17.5 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 15 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.
3.2 Services provided after 01 January 2010
You may opt to use the special change of rate rules where you receive a payment or raise a VAT invoice before 01 January 2010 for services you will be providing on or after that date. Under the normal rules you should account for VAT at 15 per cent but see section 3.4 about anti-avoidance rules.
You may also account for VAT at 17.5 per cent, not 15 per cent, on the payment received or amount invoiced before 01 January 2010 . You may find it more convenient to do this and to issue a VAT invoice for the 17.5 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.
3.3 Supplies that are in progress on 01 January 2010
The normal rule is that where an invoice is issued or a payment received after 01 January 2010 VAT is due at 17.5 per cent even if part of the supply was undertaken before that date. Where work commenced before 01 January 2010 but will not be completed until on or after 01 January you can apportion the supply between that liable to 15 per cent and that liable to 17.5 per cent.
If you think there is the possibility of a dispute over the value to be placed on services performed before and after 1 January 2010, you may issue a bill prior to 01 January to demonstrate the amount performed prior to the change of VAT rate.
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 an invoice is issued or a payment is received, whichever happens first. You may account for VAT at the 15 per cent rate on that part of the supply made before 01 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 15 per cent on the value of the services actually performed before 1 January 2010, and at 17.5 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 2009 to 31 January 2010 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 17.5 per cent because the invoice is issued after 01 January 2010 . However, you can, if you wish, charge VAT at 15 per cent on the payment for November and December 2009. As the insurance company cannot recover the VAT that it incurs using the special rules will result in a VAT saving for them.
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 01 January 2010 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 01 January, the whole supply should be charged at the 17.5 per cent rate under the normal rules. However, you may if you wish, charge VAT at 15 per cent on the work done up to 31 December 2009 and 17.5 per cent on the remainder. You will have to be able to demonstrate that the apportionment between the two amounts accurately reflects the work done in each period.
Example:
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 2009 and will not conclude until eviction has taken place in January 2010. How do you calculate the VAT?
You may account for VAT at 15 per cent on the work carried out before 1 January 2010 and 17.5 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:
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 2006. The case is settled in December 2009 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 2010. 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 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 17.5 per cent. Under the special rules, provided that that no interim 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 should apportion your costs so that:
- 17.5 per cent VAT is charged in relation to your costs for the period being due from September 2006 to 30 November 2008
- 15 per cent is charged for the period from 1 December 2008 to 31 December 2009, and
- 17.5 per cent is charged for the period from 1 January 2010 to March 2010 .
If you have issued interim 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:
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 2006. The case is settled in December 2009 on the basis that each party pays their own costs and you issue an invoice to your client in January 2010. How do you calculate the VAT?
As you completed your work for your client in December 2009, this is when the tax point arises. Under the special rules you may decide to charge the 15 per cent standard rate of VAT for the costs incurred up to and including 31 December 2009 . In accordance with guidance issued by HMRC in November 2008 in relation to the temporary reduction of VAT, where you make a single supply of a service which is nevertheless carried out over a period of time which spans the change in rate on 01 December 2008 the whole supply prior to 01 January 2010 can be charged at the 15 per cent rate. There is no need for you to apportion the cost of your services that span the 1 December 2008 rate change.
3.4 Artificial arrangements to avoid the increased VAT rate
VAT anti-forestalling legislation was introduced as part of Finance Act 2009. This prevents artificial arrangements being entered into which seek to benefit from the reduced 15 per cent standard rate in respect of supplies made after the standard rate returns to 17.5 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 01 January 2010 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 01 January 2010, you supply the right or option to receive services from you on or after that date, free of charge or at a discount.
Detailed guidance is provided in the HMRC website.
3.5 Disbursements
The rate of VAT charged in respect of disbursements will depend on the tax point. This is the date on which the invoice is issued, regardless of when the disbursement was incurred.
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 01 January 2010 will be liable to VAT at 17.5 per cent. However, if you pay fees after 01 January for cases completed before that, these can still be subject to VAT at 15 per cent. Similarly, if you pay a fee after 01 January 2010 which covers services partly performed while the 15 per cent VAT rate applied, these the fees may be apportioned so that the rate of 15 per cent applies to those fees accrued before0 1 January 2010 . You should clarify the VAT treatment of the fees with Counsel's clerk before payment.
4. Applying an incorrect VAT rate
If a 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.
4.1 Correcting rates in invoices to clients
If you continue to charge 15 per cent VAT on invoices raised on or after 1 January 2010 , you will need to account to HMRC for the correct amount, that is, 17.5 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 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.
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. And 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.
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, i.e. 15 per cent for bad debt relief on invoices issued before 01 January 2010.
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 01 January 2010 will attract a 15 per cent VAT rate
- All cases reported as concluded on or after 0 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.
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.
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
The rate that is in force at the tax point will be the rate that applies.
7.1 Calculating NPV
If the effective date of the grant of a lease is up to and including 31 December 2009, the applicable rate of VAT will be 15 per cent. This will be the case even if the rent payable by reference to which SDLT is calculated relates to a year in which the rate of VAT is 17.5 per cent.
When the rate changes back to 17.5 per cent on 01 January 2010 it will apply to all leases with an effective date on or after 01 January of that year.
7.2 Repayments of tax paid on rent
HMRC will view the effect of the VAT changes since 1 December 2008 as rendering such rents variable or uncertain. HMRC will treat such rent as becoming certain when the VAT rate returns to 17.5 per cent again on 01 January 2010.
HMRC will therefore consider repayments of overpaid tax in light of the Finance Act 2003 Schedule 17A paragraph 8, which deals with cases where rents cease to be uncertain. You may submit a claim for an overpayment due to the VAT rate being calculated at 17.5 per cent, if the amount of rent payable becomes certain within the first five years of the term of the lease.
7.3 Making an SDLT claim
HMRC do not intend to make any repayments before 01 January 2010.
However, if the end of the fifth year of the lease falls on or before 31 December 2009, any claim for repayment of overpaid tax should be made within 30 days of the date when the rents for the first five years of the term become certain.
It is unlikely that claims for SDLT repayment will be for large sums, for example, an estimate repayment on an annual rent of £1m would be less than £250. Interest will be paid on such repayments on the usual basis. Claims should be made in writing to the Birmingham Stamp Office.
8. More information
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
The rate that is in force at the tax point will be the rate that applies.
8.1 Legal and other requirements
- Value Added Tax Act 1994
- Finance Act 2009
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.
8.2.3 HMRC Guidance
- VAT - reversion of the standard rate to 17.5 per cent: A detailed guide for vat-registered businesses (PDF)
- VAT - Anti-forestalling guidance (PDF)
- Business Payment Support Service
Further information is available at the HMRC website: www.hmrc.gov.uk/vat/index.htm.
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.
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.
9. Acknowledgements
The Society acknowledges the contributions of the VAT & Duties Sub-committee Chair in developing this practice note.