Alpha Leisure (Scotland) Ltd v Customs and Excise [2003] UKVAT V18199 (16 June 2003)

18199

Bad Debt Relief; entitlement to bad debt relief where debt discharged; Value Added Tax Act 1994 section 36.

EDINBURGH TRIBUNAL CENTRE

ALPHA LEISURE (SCOTLAND) LTD	Appellants

- and -

THE COMMISSIONERS OF CUSTOMS AND EXCISE	       Respondents

Tribunal:	 (Chairman)   J Gordon Reid, QC., F.C.I.Arb

Sitting in Edinburgh on Friday 6 June 2003

for the Appellants		Colin Tyre, QC

for the Respondents	Mr R MacLeod

© CROWN COPYRIGHT 2003.

DECISION

Introduction
This is an appeal against an Assessment seeking recovery of the VAT on debts written off by the Appellants.  The Appellants had supplied services, accounted to Customs for the VAT thereon, but were unable to obtain payment from their customer.  They invoked section 36 of the Value Added Tax Act 1994 wrote off the debt and deducted the irrecoverable VAT from their returns.  The issue is whether they are entitled to do so.

Colin Tyre Q.C. appeared on behalf of the Appellants and led the evidence of the Appellants’ finance director, James Henderson.  Roddy MacLeod, Solicitor, Shepherd & Wedderburn WS, Edinburgh, appeared on behalf of the Respondents (“Customs”).  He led the evidence of Ron Carstairs, one of Customs’ senior assessment officers.  The parties produced a joint bundle of documents.  The authenticity and, where appropriate, the transmission and receipt, of these documents were not in dispute.

Legal Framework
Section 36, so far as relevant provides as follows:-

36 Bad debts

(1)	Subsection (2) below applies where –
(a)	a person has supplied goods or services [….] and has accounted for and paid VAT on the supply,
(b)	the whole or any part of the consideration for the supply has been written off in his accounts as a bad debt, and
(c)	a period of 6 months (beginning with the date of the supply) has elapsed.
(2)	Subject to the following provisions of this section and to regulations under it the person shall be entitled, on making a claim to the Commissioners, to a refund of the amount of VAT chargeable by reference to the outstanding amount.
[(3)	In subsection (2) above “the outstanding amount” means-
(a)	if at the time of the claim no part of the consideration written off in the claimant’s accounts as a bad debt has been received, an amount equal to the amount of the consideration so written off;
(b)	if at that time any part of the consideration so written off has been received, an amount by which that part is exceeded by the amount of the consideration written off;
	and in this subsection “received” means received either by the claimant or by a person to whom has been assigned a right to receive the whole or any part of the consideration written off].

	[(3A)	For the purposes of this section, where the whole or any part of the consideration for the supply does not consist of money, the amount in money that shall be taken to represent any non-monetary part of the consideration shall be so much of the amount made up of –

(a)	the vale of the supply, and
(b)	the VAT charged on the supply.

Part XIX of the Value Added Tax Regulations 1995 SI No 2518 make procedural provisions in relation to a section 36 claim including various record keeping requirements.  Although not referred to by either party, it may be noted that regulation 172 (1A) provides that the whole or any part of the consideration for a relevant supply is to be taken to have been written off as a bad debt when certain record keeping requirements are met.

Article 11C.1 of the EC Sixth Council Directive 99/388/EEC provides that In the case of cancellation, refusal or total or partial non-payment, or where the price is reduced after the supply takes place, the taxable amount shall be reduced accordingly under conditions which shall be determined by the Member States.  However, in the case of total or partial non-payment, Member States may derogate from this rule.

Facts
The Appellants carry on the business in Scotland of supplying a wide range of sports and leisure equipment from health suites to sports racquets.  They have been in business since 1982.  George Gordon Keith, his wife Elizabeth Bremner Keith and Mr Henderson are the directors and shareholders.  In about 1996 they joined forces with one of their customers (to whom they had supplied poolside equipment), SB Pools Ltd, (“Pools”) a construction company which installed swimming pools.  Its shareholders and directors were Stephen Booth and his wife.  Pools became dormant and the whole business of both companies was carried on by the Appellants.  A few years later the Appellants and the Booths decided to separate their combined business activities.  The Keiths, and Mr Henderson acquired shares in Pools and Mr Booth became a director and shareholder of the Appellants.  Pools then traded as a separate entity but under the name Alpha Leisure Services.  Thereafter, Pools incurred debts to the Appellants mainly through management charges but also in respect of the supply of some goods.  Pools became financially embarrassed and the Appellants did not enforce payment of the debts.  The Appellants did not incur any liability to Pools.  Eventually, because of Pools’ financial circumstances, the Appellants, the Keiths and Mr Henderson decided to sever all connection with Pools.  Two agreements were entered into on 15/12/00.  In the first, (“the Agreement”), between the Keiths, Mr Henderson and Mr Booth, Mr Booth agreed to purchase the 79 shares in Pools held by the others at the price of £1 per share.  The Agreement made provision for listing the assets and liabilities of Pools together with other accounting information.  Provision was also made in relation to staff, the consent of Pools’ bankers, the resignation by the Keiths and Mr Henderson as directors of Pools and renunciation of rights they previously held as shareholders; confidential information and a restrictive covenant, work in progress and connected undertakings, warranties and indemnities.  Clause 7 provided inter alia as follows:-

“The Agreement is subject to [the Appellants]…… being prepared to write off any debt or other amount due or to become due by [Pools] to [the Appellants] as at the transfer date.  On the transfer date, Mr Keith, Mrs Keith and Mr Henderson shall deliver to Mr Booth a formal Renunciation and Discharge executed by [the Appellants] …. by which [the Appellants] renounces and discharges in all time coming any claim which [the Appellants] might have against [Pools] as at the transfer date and in all coming in respect of any debt, liability or other amount due or that may become due in the future by [Pools] to [the Appellants].  On the date of transfer, Mr Booth will deliver to Mr Keith, Mrs Keith and Mr Henderson a formal undertaking executed by [Pools] to free and relieve [the Appellants] of any liability for payment of debts or sums due in respect of materials or goods supplied to [Pools] but for which payment has not been made by [Pools] on or before the transfer date.”

In the second Agreement (the “Minute of Agreement”), between the Appellants and Pools, the undertaking specified in clause 7 above was given; various other undertakings were given in relation to soliciting customers, on-going projects and the use of the name Alpha.  The transfer date was agreed to be 5/3/01.  Clause 2 provided as follows:-

“[The Appellants] renounces, discharges and disclaims in all time coming and with immediate effect any claim which [the Appellants] might have against [Pools] as at the transfer date and in all time coming in respect of any debt, liability or other amount due or that may become due in the future by [Pools] to [the Appellants].”

These agreements were carried into effect on 5/3/01.  The Keiths and Mr Henderson resigned as directors of Pools and Mr Booth resigned as a director of the Appellants.  The purchase price for the shares was paid to the Keiths and Mr Henderson.  The question of bad debt relief was not raised.  A letter dated 18/9/02 to Customs from Pools’ accountants to the contrary is incorrect in that respect.  The Appellants discharged their claims against Pools because they had no prospect of ever being paid anything due to the financial circumstances of Pools.  The Appellants reclaimed the sum of £15,995 as bad debt relief in their VAT return for the period to 30/3/01 and subsequently, in their accounts for the year to 30/9/01 wrote off the whole of the consideration, namely £91,403 less tax, for the supply of goods and services by them to Pools.  The claim for refund of VAT occurred more than six months after the supply of the goods and services in question.  The record keeping and procedural requirements of Part XIX of the Value Added Tax Regulations 1995 were met.  No payment was ever received by the Appellants for these goods and services.  As at the transfer date, the Appellants did not owe Pools any sums and apart from the terms of the two agreements were not indebted to Pools in any way.  The Appellants’ shareholders received a nominal one pound for their sale to Mr Booth of their shareholding in Pools.

In May 2002, Mr Carstairs made two visits to the Appellants’ premises.  The first was a routine inspection.  He raised the question of bad debt relief as he had noted from his records that the Appellants had made an inquiry about bad debt relief in November 2000.  On his second visit, he obtained copies of the agreements, a copy of a letter to Pools relating to bad debt relief and copies of invoices showing the amounts due by Pools.  He subsequently checked Pools’ VAT records.  They had taken credit for input tax in respect of the VAT on the sums owed by them to the Appellants, but which they had not paid.  Pools did not subsequently repay that tax to Customs.  Correspondence ensued between Customs and the Appellants.  While he was satisfied that the necessary paperwork to obtain bad debt relief was in order, Mr Carstairs was of the view that the Appellants wrote off the debt as an additional consideration to allowing Mr Booth to purchase the shares in Pools held by the Keiths and Mr Henderson.  Mr Carstairs’ views were supported by Customs’ Headquarters.  A Notice of Assessment in the sum of £15,995 was issued on 8/10/02.  The Appellants sought reconsideration.  On review, another senior Customs officer, Russell Harrison, by letter dated 22/1/03, expressed the view that although there might have been a case for bad debt relief prior to the two agreements, the agreements were to be seen as full and final settlement of financial differences between the Appellants and Pools; these agreements removed in full any claim either side would have against the other and accordingly there was no debt upon which relief could be claimed.

Submissions
Mr MacLeod, for Customs, submitted that the Appellants had to prove that there was a debt in respect of which relief could be claimed.  The effect of the agreements was to extinguish Pools’ indebtedness so that by the time relief was claimed there was no debt.  This was different from and went beyond merely writing off a debt.  There was a distinction between a debt which becomes due, is called for and remains unpaid and a debt which, for whatever reason, is not pursued and is formally discharged in exchange for a benefit to the creditor.  For this argument he relied solely on Clause 2 of the Minute of Agreement.  He also submitted that there was consideration for writing off the debt.  There was an association between the Appellants and Pools which the Appellants wished to sever.  That association created a potential liability for the Appellants from which they wished to distance themselves.  He accepted that this consideration could not be valued or at least there was no evidence before the Tribunal to do so.

Mr Tyre submitted that there were four questions to be resolved in this appeal, namely (i) Have the Appellants supplied goods or services and accounted for or paid VAT on the supply.  There was, he submitted, no dispute about this; (ii) Has the whole or part of the consideration for the supply been written off?  The accounts showed that the whole consideration has been written off; (iii) Has a period of six months elapsed from the date of the supply?  Again there was no dispute about this; and (iv) At the time of the claim has any part of the consideration written off been received?  The answer to this question he submitted was No.  Once the statutory conditions had been fulfilled entitlement to the claim arose.  It did not matter whether the claim was formally discharged, or unpaid and written off as long as it had been genuinely written off in the accounts.  Neither section 36 nor the related regulations (the Value Added Tax Regulations 1995 SI No 2518 Part XIX) drew such a distinction.  As for the issue of consideration, there was simply no evidence that any consideration was given for the debt.  There was no evidence from which actual value could be given to the so called potential liability.

Neither party relied on the Sixth Directive or the 1995 Regulations.  There was said to be no authority on the points raised in this appeal.

Decision
The issue in this appeal raises principally a short point of statutory construction.  By formally discharging a valueless claim against Pools have the Appellants excluded themselves from the Bad Debt Relief provisions?  The Tribunal considers that they have not and agrees with the approach to the issue advanced by Mr Tyre.  The Appellants have accounted for the VAT on the supply.  The whole of the consideration has been written off in their accounts.  The accounts have not been challenged as not being genuine or in accordance with sound commercial accounting practice.  There is no issue about the timing of or record keeping relating to the claim.  On the facts, no part of the consideration or its equivalent has been received.  The statutory conditions, which have been laid down in response to Article 11C.1 of the Sixth Directive, have therefore been met.  It does not seem to the Tribunal to matter that the Appellants recognised the inevitable by formally discharging their claim against Pools.  There was no prospect of that claim being met in whole or in part.  This was not a case of non-payment being temporary.  The claim has been written off both as a matter of business accounting and as a matter of law.  Section 36 does not draw a distinction between the two.  The Tribunal considers that Parliament did not intend to defeat a bona fide claim by a trader who has recognised the inevitable and formally discharged a claim for payment which had no value.  Such 36 should be construed in a practical way.  Its purpose is to enable a trader to obtain a refund of VAT accounted for in respect of a supply the consideration for which is genuinely irrecoverable in whole or in part and in respect of which no substitute consideration has been given.  While the two agreements referred to above are linked, the Agreement is not one to which the Appellants were a party.  No consideration can therefore be identified in that agreement.  The Minute of Agreement contains the discharge of the claims.  However, none of the other clauses can be identified as being consideration in whole or in part for the supply of the goods and services.  Rather, the underlying theme of the arrangements appears to be that the connection and association between the Appellants and Pools and their respective directors are severed by mutual agreement in exchange for which various obligations are undertaken by both sides.  The liability of Pools to the Appellants had no commercial value to the Appellants.  The agreements gave them nothing in return for the supply of the goods and services in question.  The distancing of the so called potential liability founded upon by Mr MacLeod, whatever it may have been worth, was not part of any consideration for the supply of the goods and services in question.

In these circumstances, the Tribunal considers that the Appellants fall within the statutory requirements of section 36 of the 1994 Act.  No consideration has been received in respect of the supply.  As this appeal was brought under section 83(h) of the 1994 Act, the appeal will be allowed and the Notice of Assessment appealed against quashed.  Parties were agreed that if the Appellants were successful they should be found entitled to expenses.  The Tribunal therefore finds the Appellants entitled to expenses and directs, in terms of Rule 29 of the Tribunal Rules, that the expenses of the Appellants of, incidental and consequent upon the appeal shall, failing agreement, be taxed by the Auditor of the Court of Session on a party and party basis.

J GORDON REID, QC., F.C.I.Arb.,

CHAIRMAN

RELEASE:  16 JUNE 2003 

EDN/03/14