How Should a Solicitor Handle Client Disbursements on the Client Account?

Every solicitor in private practice handles client disbursements. The question is whether you are handling them correctly under the SRA Accounts Rules and for VAT purposes. Getting this wrong can lead to an accountant's report qualification, a COFA investigation, or a VAT assessment from HMRC.

This article explains the two critical distinctions every solicitor must understand: the difference between acting as a disbursement principal and a disbursement agent, and the correct VAT treatment for each. We use worked examples with specific figures to show how the rules apply in practice.

What Is a Client Disbursement in a Law Firm Context?

A disbursement is a payment made by a solicitor on behalf of a client in the course of providing legal services. Common examples include court fees, Land Registry search fees, expert witness fees, and stamp duty land tax (SDLT) payments.

The SRA Accounts Rules treat disbursements as client money until they are paid out. Rule 2.1 requires that client money is held in a client account. Rule 4.1 requires that payments from the client account are made only for the specific client matter and only when properly authorised.

But the VAT treatment of a disbursement depends on whether you are acting as principal or agent. This is where many solicitors slip up.

Disbursement Principal vs Disbursement Agent: The Key Distinction

HMRC's guidance (VAT Notice 700, paragraph 25.1) distinguishes between a disbursement and a recharged expense. The distinction turns on who is legally responsible for paying the third party.

Disbursement Agent

You act as agent when you pay a third party on behalf of your client, and your client remains legally liable for that payment. The third party looks to your client, not your firm, for payment if you fail to pay.

Examples include:

• Paying a court fee where the court's contract is with your client (the litigant)
• Paying a Land Registry search fee where the search is ordered on your client's behalf
• Paying an expert witness fee where the expert's engagement letter is with your client

When you act as agent, the payment is a true disbursement for VAT purposes. You do not add VAT to the disbursement when recharging it to your client. The third party's invoice should be addressed to your client, and the third party charges VAT (if applicable) directly to your client.

Disbursement Principal

You act as principal when you are legally responsible for paying the third party. The third party looks to your firm for payment. You then recharge the cost to your client as part of your legal services.

Examples include:

• Paying for a company search through a subscription service your firm uses
• Paying for a professional report where the report is commissioned by your firm
• Paying for travel or accommodation costs incurred by your staff

When you act as principal, the payment is a recharged expense for VAT purposes. You must add VAT at 20% when recharging it to your client, even if the original third-party invoice did not include VAT.

Worked Example: Conveyancing Search Fees

Consider a typical conveyancing transaction. Your firm orders a local authority search through a third-party search provider. The search provider charges £100 plus £20 VAT, total £120. The search provider's invoice is addressed to your firm.

You are acting as principal because the search provider contracted with your firm, not your client. When you recharge the £120 to your client on the completion statement, you must add your own VAT at 20% on the full £120. Your client sees a charge of £144 including VAT.

If instead the search provider's invoice is addressed to your client and your client is legally liable to pay, you act as agent. You pay the £120 from client money held on the client account, and you recharge exactly £120 to your client with no VAT added. Your client reclaims the £20 input VAT directly from HMRC if they are VAT-registered.

VAT Treatment of Disbursements: The Rules in Practice

The VAT treatment follows from the principal/agent distinction. HMRC's policy is clear: a true disbursement (agent) is outside the scope of VAT for the solicitor. A recharged expense (principal) is part of the solicitor's taxable supply and must include VAT.

Common mistakes solicitors make:

• Adding VAT to court fees (incorrect: court fees are exempt from VAT, and the solicitor acts as agent)
• Not adding VAT to search fees paid through a firm subscription (incorrect: the firm is principal)
• Adding VAT to SDLT payments (incorrect: SDLT is a tax, not a supply, and the solicitor acts as agent)

If HMRC finds that you have incorrectly treated a recharged expense as a disbursement and failed to charge VAT, you face a VAT assessment for the underpaid VAT plus interest and penalties. The firm bears the cost, not the client.

SRA Accounts Rules: Client Account Treatment

Under the SRA Accounts Rules, client money held for disbursements must be paid into the client account. Rule 4.1 requires that you only withdraw client money when you have the client's authority and the payment is for a proper purpose.

When you act as agent, you pay the third party directly from the client account. The client account record shows the payment to the third party. No VAT adjustment is needed on the client account side.

When you act as principal, you typically pay the third party from the office account (because the firm is liable). You then transfer funds from the client account to the office account to recharge the client. This transfer must be properly recorded and supported by a VAT invoice from your firm to the client.

Rule 8.3 requires that you reconcile the client account at least every five weeks. Disbursement entries must be clearly identifiable on the client ledger. A COFA should review the firm's disbursement procedures as part of the annual compliance review.

Practical Steps for Solicitors and COFAs

To stay compliant, implement these procedures in your firm:

• Train all fee-earners on the principal/agent distinction. Provide written guidance with examples specific to your practice areas.
• Review third-party invoices before payment. Check who the invoice is addressed to. If it is addressed to your firm, you are likely principal.
• Use separate nominal codes in your accounting system for disbursements (agent) and recharged expenses (principal). This makes VAT returns and SRA reconciliations cleaner.
• Document your firm's policy in your COFA compliance manual. Include a decision tree for fee-earners to follow.
• Conduct a periodic audit of disbursement entries on client ledgers. Look for patterns where VAT may have been incorrectly omitted.

For a deeper dive into the SRA Accounts Rules, see our SRA Accounts Rules essentials guide. If you need support with your COFA responsibilities, our COFA compliance support service can help.

Disbursements and the Accountant's Report

Your firm's accountant reviews disbursement treatment as part of the annual accountant's report under Rule 12. The accountant checks that client money was properly held and that transfers between client and office accounts were correctly recorded.

If the accountant finds systematic errors in disbursement VAT treatment, they may qualify the report. A qualified report triggers SRA scrutiny and can affect your firm's practising certificate renewal.

Firms that hold more than £10,000 client money at any point during the accounting period must submit an accountant's report. The SRA Accounts Rules service page explains the reporting requirements in more detail.

Example: Mixed Disbursement and Recharged Expense on One Matter

Consider a commercial litigation matter. Your firm pays the following on behalf of a client:

• Court fee: £10,000 (agent, no VAT added)
• Expert witness fee: £5,000 plus £1,000 VAT, invoice addressed to client (agent, recharge £6,000 with no VAT)
• Travel costs for your solicitor: £500 (principal, recharge with VAT at 20% = £600)
• Company search via firm subscription: £50 (principal, recharge with VAT at 20% = £60)

Total recharged to client: £10,000 + £6,000 + £600 + £60 = £16,660. Your firm accounts for output VAT on £600 + £60 = £660 at 20%, so £110 VAT. The court fee and expert fee are outside the scope of VAT for your firm.

Your client can reclaim the £110 input VAT if they are VAT-registered and the supply relates to their taxable business activities.

Common Questions from Solicitors

Here are answers to the most frequent questions we hear from solicitors about client disbursements.

Do I need to add VAT to Land Registry search fees?

It depends. If you use a personal search agent and the invoice is addressed to your firm, you are principal and must add VAT. If the client orders the search directly and you pay on their behalf as agent, no VAT is added. Check the invoice address.

What about SDLT payments?

SDLT is a tax, not a supply. You act as agent when paying SDLT to HMRC on your client's behalf. No VAT is added to the SDLT amount. The same applies to LBTT in Scotland and LTT in Wales.

Can I pay disbursements from the office account?

You can, but only if you are acting as principal and the firm is liable for the payment. If you are acting as agent, the payment must come from the client account because the money belongs to the client until paid. Mixing these up creates a client account breach.

How do I record disbursements in my accounting software?

Use separate nominal codes for disbursements (agent) and recharged expenses (principal). Record the third-party invoice in the appropriate code. When recharging, ensure the VAT treatment matches the code. Most legal accounting packages have built-in controls for this.

Final Thoughts

Getting client disbursements right requires attention to two separate regulatory frameworks: the SRA Accounts Rules and HMRC's VAT rules. The principal/agent distinction is the key to both. When in doubt, ask: who is legally liable to pay the third party? The answer determines the client account treatment and the VAT treatment.

If you are a COFA or a partner responsible for compliance, review your firm's disbursement procedures now. A small error in VAT treatment on a single matter can compound across hundreds of matters and trigger a significant HMRC assessment.

For tailored advice on your firm's specific circumstances, speak to a legal-sector-specialist accountant. We work with solicitors across all practice areas and firm sizes. Contact us to discuss your firm's compliance needs.