VAT on insurance defence work set to increase law firms' costs

Insurance law firms undertaking defence work for clients under a delegated-authority agreement could face higher VAT bills and potential disputes with clients, accountants have warned.

Insurers typically contract out claims-handling work to law firms, especially motoring defence work, under what is known as defendant delegated authority.

Accountancy firm RSM say that following a review of the VAT applicable to these contracts, HMRC has now updated its guidance and clarified that it will regard pre-litigation work as exempt. Post-litigation work, on the other hand, will now be taxable.

As VAT rules stand, insurers cannot recover the VAT applied to their costs, so the application of VAT on post-litigation work could wipe out the savings they are currently able to achieve and result in net cost increases.

An even greater risk, RSM suggest, is that HMRC could choose to apply the guidance retrospectively, with assessments for underpaid VAT going back four years.

“This updated guidance throws up almost as many questions as it does answers”, says RSM head of VAT Ian Carpenter (pictured).

What’s more, where a single fee is charged, covering both the work carried out up to when the decision to litigate is taken and post-litigation work, HMRC will now expect firms to split the fee accordingly based on a scale outlined in the guidance.

“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”, says Carpenter.

HMRC’s argument for the change in approach is that, while pre-litigation services may be carried out by non-lawyers, court-based litigation must be undertaken by entities regulated by the Solicitors Regulation Authority.

HMRC said it did not regard as relevant the fact that most claims going into the post litigation stage were often settled without the need to go to court.

“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”, it said.