Neil Warren explains why Praesto Ltd was permitted to reclaim VAT paid on legal bills made out to the director’s own name and provides practical tips concerning input tax recovery.
I received a phone call from an accountant last year in a bit of a panic: “I’ve got a limited company client that employs ten salespeople and we’ve just discovered that all of the hotel invoices for their overnight stays are in the name of the employees and not the company. Does this mean that the company needs to repay HMRC all of the input tax claimed in the last four years? Or should we ask the hotels for new invoices made out to the company?”
The answer to both of these questions is ‘no’. See HMRC’s manual: VAT Input Tax VIT13400.
I was reminded of the above story after reading the Court of Appeal judgment in Praesto Ltd v HMRC  EWCA Civ 353.
The dispute was around whether input tax could be claimed by Praesto on the legal fees it paid to defend its sole director against criminal proceedings taken against him by his former employer Customer Services Plc (CSP).
Without going into detail, the main issue in dispute was whether the director had removed confidential information when he left CPS and used that material to the commercial advantage of his new company. The invoices for the legal fees in question were made out to the director personally and also sent to his home address, just like the hotel bills in my example. Could the input tax be claimed by Praesto?
For any input tax challenge, the relevant legislation to consider is VATA 1994, s24(1). This specifies that the expenditure on goods or services must be for ‘the purpose of any business’ and only relevant to ‘the supply to him of any goods or services’ (‘to him’ being the VAT-registered business).
For the input tax claim to be valid, the lawyers had to be supplying services to the company and not the individual director and the expenses also had to be linked to Praesto’s business activities. The FTT decided this was the case and allowed the appeal, but the UT disagreed.
Although the Court of Appeal ruled in favour of the taxpayer, the margin of victory was 2-1, with one of the judges dissenting because the invoices were made out to the director personally. The other two judges agreed that Praesto Ltd had a direct interest in preventing CPS’s claim and the legal services therefore related to its own taxable services and input tax could be claimed.
A balanced approach
You may be thinking: if the judges disagree after hours of analysis and debate, how can we be expected to get things right acting for clients?
I cannot give clearcut answers but here are three tips about deciding the business/private use issue regarding input tax on legal fees:
- Fully consider the implications on the business if the court decision goes against the business: will this either reduce or threaten to reduce taxable sales in the future? Will it have such an adverse effect on the company’s reputation that its potential business development will be affected?
- Make a note on purchase invoices as to why the lawyer’s letter of engagement is with the individual employee rather than the business. Also, confirm that all legal fees were paid for by the company rather than the individual director.
- Review the landmark case that went in favour of the taxpayer involving P&O European Ferries (Dover) Ltd (VTD7846), where the tribunal ruled that input tax could be claimed when the company paid the legal costs of defending a charge of manslaughter against itself and seven employees, following the Zeebrugge disaster.
After considering the above points, your decision to claim or not claim input tax may be clearer!
About Neil Warren
Neil Warren is an independent VAT consultant and author who worked for Customs and Excise for 14 years until 1997.