Electronic search fees do not qualify as disbursements

The first tier tax tribunal (FTT) has held that the cost of obtaining electronic searches by solicitors on property transactions cannot be treated as a disbursement for VAT purposes: Brabners LLP v HMRC [2017] UKFTT 666. According to the FTT, the correct analysis is that the cost is part of the cost of providing the legal service to the client and as such is subject to VAT on the same basis as other consideration for legal services.

The decision is out of step with the agreement between the Law Society and HMRC as regards the VAT treatment of “postal searches”. As such, it is to be hoped that the Law Society will engage proactively with HMRC to produce an agreement on the correct approach to all search fees.

Background

Brabners are a firm of solicitors which provide inter alia conveyancing services. As part of its services, it routinely obtains local authority and local land charge searches concerning properties. Brabners would then normally use the information in the searches to provide a property report to the buyer or seller concerned. Practice varied as to whether a copy of the search itself would be provided to the buyer or seller.

Brabners treated the fees for such services as disbursements and, therefore, did not charge VAT on them. This was the case whether the searches were “postal searches” (made direct to the local authority by postal application) or electronically using the services of a third party provider (in this case, Searchflow).

In relation to postal searches, there is a long-standing concession between the Law Society and HMRC that the search fee may be treated as a disbursement. However, HMRC considered that the electronic search services were essentially used by Brabners to provide their services to clients and, as such, could not qualify as a disbursement.

Decision

The FTT has agreed with HMRC that the search fees recharged did not qualify as disbursements and should be treated as part of the consideration for the supply of legal services by Brabners.

HMRC pointed to the list of eight conditions in VAT Notice 700 which need to be met for a payment to qualify as a disbursement. In this case, HMRC contended that the search fees could not be disbursements as the information in the searches was typically used by Brabners to give advice to clients, often in the form of a property report. As such, the fees were not simply “repayment of expenditure incurred in the name and on the behalf of the customer”. The tribunal agreed with this analysis. From an EU perspective, it could not be said that “the taxable person is merely an intermediary used to facilitate payment” in this case (De Danske).

Brabners, supported by the Law Society, argued that the act of obtaining the search results and providing advice on those search results were separate aspects. However, the tribunal rejected that argument as involving an “artificial disaggregation”.

Moreover, the tribunal considered that it made no difference whether or not Brabners did provide a property report or sent on the search results to the client. Brabners supply conveyancing services and as part of this it is their duty to take reasonable care. Doing so necessarily requires Brabners to review the search results to identify any risks, whether or not a report is produced.

But what of the different VAT treatment of “postal searches”? The tribunal refused to be drawn on whether that treatment was concessionary or not. In addition, any arguments as regards inconsistency between the VAT treatment of postal and electronic searches would involve a question of “rationality or legitimate expectation” and was, therefore, outside the jurisdiction of the FTT.

Comment

From early 2017, local authorities have been required by HMRC to charge VAT on search fees. To the extent that local authority search fees incurred by law firms are now subject to VAT (unlike the situation the subject of this appeal), it may be more sensible not to treat the fees as disbursements in any event (treatment as a disbursement being most beneficial where the supplier has not charged VAT). Instead, VAT on the search fees will be recoverable input VAT by the law firm and the net cost added to the overall charge for legal services (subject to VAT). As such, the decision of the FTT in this case may actually be more important from a VAT past compliance perspective, rather than the treatment of such fees in the future.

Nevertheless, the differing treatment of postal searches and electronic searches is clearly inconsistent and seems unlikely to last. If the existing agreement between HMRC and the Law Society is indeed concessionary, then it will need to be reviewed in the light of this decision.

However, the case perhaps begs the question whether the terms of business could have been adapted to ensure that fees were treated as disbursements. In this case, Brabners retainer simply included general wording regarding the expenditure of monies on “disbursements” such as search fees. Perhaps clearer contractual wording might possibly have produced a different result. For example, wording specifically stating that: (i) a solicitor will obtain searches on behalf of a client and pass those searches onto the client and (ii) the client authorises the solicitor to use the clients search results for the purposes of providing advice.

Clearly, however, this is a matter for the Law Society to engage with HMRC generally on behalf of the profession with a view to ensuring clear and consistence practice generally.