HMRC has issued guidance on delegated authority claims handling by lawyers, which may create additional VAT costs for law firms and lead to disputes with their insurance clients, RSM has warned
Many law firms are contracted by insurers to undertake claims handling work when third parties have made claims against policy holders by way of defendant delegated authority.
HMRC has been conducting a long review of the VAT liability of these contracts, which has created a great deal of uncertainty in the sector, RSM says. This matter is particularly important as insurers cannot recover the VAT incurred on their costs, and so a saving can be achieved if a law firm’s services are treated as being VAT exempt.
In an effort to provide clarity on its position, and improve the quality of guidance to affected law firms, HMRC has updated its internal guidance.
This states that there are two distinct stages to the claims handling services provided by law firms: pre-litigation, the stage up until it has been decided to litigate a claim through the courts which HMRC regards as exempt, provided specific conditions are met, and post-litigation, which HMRC regards as taxable at the standard rate. This is regardless of whether some elements of the claims handling services commenced in the pre-litigation stage continue to be carried out.
HMRC guidance states that post-litigation services are considered as taxable because unlike insurance claims handling services, they can only be provided by regulated law firms.
They fall under the regulation of the Solicitors Regulation Authority (SRA), as opposed to the pre-litigation services which fall within the Financial Conduct Authority (FCA) regulatory rules applicable to insurance claims handling services.
Whilst much of the post-litigation services may be carried out by non-legally qualified claims handlers, unlike pre-litigation work, they must be carried out under the supervision of qualified lawyers.
The guidance also states: ‘Whilst we understand that the claims that go into the post litigation stage are often settled without the need to go to court and the level of specialist legal input varies accordingly, all the post litigation services are governed by the applicable regulated legal process and the day to day administration and management of these claims is provided in support of that process.’
In its updated guidance HMRC sets out various fee structures and the expected VAT treatment. There is no specified implementation date for these changes.
RSM says that were the changes applied retrospectively, this could lead to assessments for underpaid VAT going back four years. Further, they may require significant changes to accounting systems so even an immediate prospective change could prove challenging.
Ian Carpenter, head of VAT at RSM said: ‘This updated guidance throws up almost as many questions as it does answers.
'Most concerning is that where a single fee is charged covering both pre and post-litigation services HMRC states that this fee should be apportioned between the two elements. This is likely to create further uncertainty for law firms and potential disputes with their insurance clients as to how much VAT should be charged.'
Report by Pat Sweet