A group of law firms is mulling a tribunal challenge to HMRC in a complex and potentially costly tax dispute.

The issue has arisen over the significant sums in interest on client money which firms have benefited from since rates began to rise in 2022. 

Law firms are usually able to fully recover so-called ‘input VAT’, which is the tax paid on goods and services bought for business use. However, client interest income is not subject to VAT and, depending on the sums involved, can restrict a firm’s ability to recover the input tax.

HMRC letterhead surrounded by cash

Before 2008, HMRC commonly granted partial exemptions enabling firms to mitigate restriction to input VAT recovery

Source: Alamy

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Another tax blow for law firms

Before 2008, when law firms last booked significant amounts in client interest income, HMRC commonly granted partial exemptions enabling law firms to mitigate the restriction to input VAT recovery. This time around, however, HMRC is denying all applications by law firms for such exemptions.

In an article for Gazette Online published today, Andrew Allen, partner and head of legal sector at the accountants PKF-Francis Clark, says: ‘For many law firms, the amounts of potential input VAT at risk are significant – at the 2025 financial year-end the latent liability commonly ranged from £50,000 to £750,000.

‘We are in contact with a group of law firms who have reached an impasse with HMRC on this issue and the next step on their journey would be a tribunal hearing. We are keen to coordinate this on behalf of the legal sector if there is sufficient appetite.’