Who reclaims VAT on legal costs paid by the other side

Q: How does this look in numbers?

Illustration only. A fully taxable VAT registered company wins a contract claim. Its solicitors bill it £50,000 plus £10,000 VAT, and it reclaims the £10,000 on its VAT return. The court orders the defendant to pay the claimant's costs, assessed at £40,000. The defendant pays £40,000 with nothing for VAT, and records the payment with no input tax. Had the claimant been an unregistered individual, the defendant would have paid £40,000 plus the corresponding VAT, and still could not reclaim it.

When a court orders the losing party to pay the winner’s legal costs, the lawyers’ services were supplied to the winner, not the loser. A VAT registered winner that can reclaim the VAT on its own lawyers’ bills recovers it as input tax and receives only the net costs from the loser; the loser pays the VAT element only where the winner cannot recover it, and the loser can never reclaim that VAT itself.

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Why can the losing party not reclaim the VAT it pays?

Input tax is defined in section 24(1) of the VAT Act 1994 as VAT on the supply to the taxable person of goods or services used for the purpose of their business. The words “supply to him” are the key. HMRC’s VAT Supply and Consideration Manual at VATSC11531 explains that in most disputes each party employs its own lawyers, and those lawyers supply their services to their own client. A payment of the other side’s costs under a court order is a contribution to costs, and the paying party cannot recover input tax on the winner’s lawyers’ fees.

This was confirmed in Turner (Queen’s Bench, 29 April 1992), summarised at VATSC11532. Mr Turner lost an action against a liquidator and a firm of solicitors, was ordered to pay their costs including VAT, and reclaimed that VAT through his agricultural business. The tribunal and the High Court upheld HMRC’s assessment: the solicitors’ services were supplied to their clients, the defendants, not to him, so the tax could not be his input tax.

The VAT Input Tax Manual at VIT13600 states the same rule from the other direction. The sum a court orders the loser to pay is not consideration for any kind of supply, so there is no output tax for the winner and no input tax for the loser.

Why does a VAT registered winner only get the net costs?

A costs order is an indemnity: it compensates the winner for what the litigation actually cost it. If the winner is VAT registered, fully taxable and used the legal services for its business, it recovers the VAT on its own lawyers’ invoices through its VAT return, so the VAT is not a cost to it. VIT13600 says that where the action was for the purpose of the winner’s taxable business and it is entitled to recover input tax, the court will order no contribution in respect of VAT.

The Law Society guidance reproduced by HMRC at VATSC11533 and VATSC11534 sets out the working rules:

the winner’s lawyer bills its own client and issues the tax invoice to that client
if the client is a registered, fully taxable person using the services for its business, it reclaims the VAT and the paying party pays costs exclusive of VAT
if the client is not a registered, fully taxable person and cannot recover the VAT, the paying party pays the costs and the VAT, but still cannot recover that VAT
if the client is partly exempt, the paying party pays the VAT only to the extent the client cannot recover it

So the loser ends up paying VAT only where it is a genuine cost to the winner. For a partly exempt winner such as an insurer, a bank or a business with exempt property income, the recovery rate under its partial exemption method decides how much VAT the loser bears.

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What should the paying party receive instead of an invoice?

VATSC11534 says that in no circumstances may the winner’s solicitor issue a tax invoice to the paying party, because the services were not rendered to it. The paying party should receive a note of the other side’s costs that cannot be mistaken for a tax invoice. The 1983 guidance at VATSC11533 suggests marking the copy bill “This is not a tax invoice”, or sending a summary without a VAT registration number or VAT shown separately, and warns that issuing a tax invoice to the wrong person is likely to be a criminal offence for which the solicitors, and possibly their clients, could be prosecuted.

The paying party’s finance team should therefore post the payment as a non VAT expense. If a document that looks like a tax invoice arrives, it should not be used to support a claim; see our guide to VAT invoice requirements.

What if the winner used an in house lawyer?

Services of an employee do not attract VAT. VATSC11533 explains that where the winner was represented by an employed solicitor, the employer has suffered no VAT on those legal costs, so there is no VAT to be reimbursed and the costs statement should make no mention of VAT. The paying party pays the assessed costs as though VAT did not exist, apart from any VAT on other disbursements, which follows the normal rules above.

When is paying the other side’s costs part of a taxable supply?

Not every payment of another party’s costs is an indemnity outside the scope of VAT. VATSC11534 lists costs ordered after litigation or arbitration, and abortive costs where a transaction does not complete, as outside the scope. But where a transaction obliges one party to bear the other’s costs and the transaction completes, the payment is part of the consideration for the supply.

The common example is a tenant paying the landlord’s legal costs on the grant of a lease, which HMRC treats as part of the consideration for the landlord’s supply. If the landlord has opted to tax, it recovers the VAT on its own costs and adds VAT to the net amount it recharges, and the tenant receives a tax invoice. If the landlord has not opted, the tenant pays the gross costs but receives no tax invoice and cannot reclaim. HMRC also treats a tenant’s payment of the landlord’s costs for exercising an existing right under the lease as consideration, a change of practice effective from 1 December 1992. For more on options, see the option to tax.

Can the winner always reclaim VAT on its own legal fees?

Only if the legal services were for the purpose of its business. VIT13600 says there must normally be a direct connection between the substance of the legal action and the activities of the business. Defending an individual against criminal charges is unlikely to qualify even if a conviction would damage the business. Where the costs fail the business purpose test, the winner cannot recover the VAT, and in principle the costs it seeks from the loser should then include it. Direct tax relief for the same fees is covered in our guide to legal and professional fees.

Where litigation is backed by insurance, Notice 701/36, paragraph 5.2, says legal services in subrogated claims are supplied to the insured party, not the insurer, even though the insurer runs the case. The same logic applies to repairs funded by insurers; see VAT on insurance claim repairs.

How does this look in numbers?

Illustration only. A fully taxable VAT registered company wins a contract claim. Its solicitors bill it £50,000 plus £10,000 VAT, and it reclaims the £10,000 on its VAT return. The court orders the defendant to pay the claimant’s costs, assessed at £40,000. The defendant pays £40,000 with nothing for VAT, and records the payment with no input tax. Had the claimant been an unregistered individual, the defendant would have paid £40,000 plus the corresponding VAT, and still could not reclaim it.

What mistakes do businesses make with costs and VAT?

The paying party reclaiming VAT shown on the other side’s bill of costs.
A winner claiming VAT from the loser when it has already recovered that VAT as input tax.
Solicitors addressing a tax invoice to the paying party.
Treating a landlord’s costs recharge on a new lease as an outside the scope indemnity.
Ignoring partial exemption when working out how much VAT the loser should bear.

Costs in tax appeals follow separate tribunal rules; see tribunal costs in tax appeals.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 24 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.