Tax

Value added tax - Bad debt relief - Taxpayer solicitors acting for insurance companies

Simpson & Marwick v Revenue and Customs Commissioners: Upper Tribunal (Tax and Chancery Chamber) (Lord Drummond Young): 20 December 2011

The taxpayer was a firm of Edinburgh solicitors, which had been registered for VAT since 1973. The greater part of its practice related to the provision of legal services in respect of insurance claims.

In such matters, it was instructed by insurance companies, but it also had a professional responsibility towards the insured person. Before 1 January 1985, it sent its fee notes to the insurers who instructed it with the expectation that the insurers would pay VAT on all its fees and outlays as well as the fees and outlays themselves. Immediately prior to February 1985, the Revenue and Customs Commissioners, (the Revenue) reached an agreement with the British Insurance Association and other bodies connected with insurance in respect of such fees and outlays.

A direction was published in the Journal of the Law Society of Scotland in February 1985. Subsequently, from 1985, the taxpayer issued its fee notes in duplicate in cases where the policyholder was registered for VAT. The principal fee note claiming payment only of fees and outlays was sent to the insurer. A duplicate was sent to the policyholder, who was asked to pay only the VAT on fees and outlays. In the covering letter it was made clear that the insured person would not be out of pocket because they should be able to recover as input tax VAT that which they were being asked to pay.

It was the practice of the taxpayer to follow up any unpaid VAT periodically and, if payment could not be achieved, by sending reminders to claim VAT bad debt relief. On every quarterly VAT return there had been a separate sheet which identified the VAT bad debt relief claim. Such claims were all accepted. At no time between 1985 and 2007 had the Revenue challenged the procedure that was followed for claiming VAT bad debt relief. It was never suggested that, when the firm made a claim for relief because a policyholder who was registered for VAT had failed to pay or had become insolvent, the firm should call upon the insurer to satisfy the VAT that was due.

In 2007, the Revenue raised queries about the firm’s method of claiming bad debt relief. In particular, it suggested that the taxpayer had been incorrectly calculating relief in that it had claimed the full relief on the invoices which showed a ‘VAT only’ amount. The taxpayer had claimed bad debt relief on sums totalling £379,346.70 over the VAT periods from April-July 2004 to April-July 2007.

The Revenue contended that the bad debt relief should be limited to 7/47 of the amount claimed. That proportion was calculated (assuming a VAT rate of 17.5%) as the VAT component of the total amount unpaid, on the assumption that the total unpaid amount represented both a net price and a VAT component (calculated as 17.5 divided by 117.5, which equalled 7/47). Thus the Revenue contended that the unpaid VAT component should have been treated in exactly the same way as any other unpaid debt, with both an element of net price and an element of VAT, and bad debt relief should have been limited to the VAT component. Thus the non-payment of the taxpayer’s invoices was treated as if the sum unpaid were a normal professional debt, including both a component of net price and a component comprising the VAT on that price. In February 2008, the Revenue issued an assessment to the taxpayer for the difference rounded down to £322,843 plus interest. That sum was subsequently reduced to £216,862.36. The taxpayer challenged that assessment.

The First-tier Tribunal (Tax Chamber) (the tribunal) held that the position taken by the Revenue had been correct, and dismissed the appeal. The tribunal considered the terms of section 36 of the Value Added Tax Act 1994, read in the context of section 19, which indicated the meaning of ‘consideration’. The latter section indicated that, because there was a single ‘supply’ of services, the ‘consideration’ was the aggregate of fees and the VAT thereon. Section 36, however, only provided for bad debt relief on ‘the outstanding amount’ of the consideration written off.

On that basis, the taxpayer had been limited to claiming the VAT portion of the amount written off, which was 7/47 of the total consideration. The taxpayer appealed.

The taxpayer submitted, inter alia, that the relevant provisions of the 1994 act, in particular section 36, ought to be construed in accordance with the general principles of the law of the EU. It was accepted that the approach taken by the Revenue had been consistent with previous tribunal decisions, however, none of those decisions was binding on the Upper Tribunal. The taxpayer’s contention that it had not been required to bear VAT that was not paid by the final consumer of its services was inconsistent with the basic principles of the VAT regime, in particular article 11(c)(1) of Council Directive (EC) 77/388 (on the harmonisation of the laws of the member states relating to turnover taxes - common system of value-added tax: uniform basis of assessment)(the directive). The appeal would be allowed.

Tax statutes generally had to be construed strictly, and a strict construction would frequently, perhaps normally, be a literal construction. Nevertheless, a strict construction was not the same as a literal construction, and if a literal construction was at odds with the clear and obvious purpose of the legislation, the literal construction had, if possible, to give way to a purposive construction. If, for example, the literal construction produced a result that was perverse, or contrary to elementary standards of fairness, or which ignored the basic structure of the tax regime in question, it might be appropriate to try to achieve the underlying purposes of the legislation rather than accepting the manifestly unsatisfactory result produced by a literal approach. The construction adopted in such a case could still be regarded as strict, but it would be a construction informed by the objectives of the legislation.

To do anything else could not be regarded as intellectually acceptable. The purpose of section 36 of the 1994 act was to permit the refunding of VAT in respect of bad debts, to ensure that the taxpayer who collected the VAT on behalf of the Revenue was not left out of pocket by a failure to obtain payment from his customer. That purpose required that the whole of the VAT that had not been recovered from the customer should be refunded; otherwise the taxpayer was out of pocket. Section 36, reading the first three subsections together, permitted a refund of the amount of VAT chargeable by reference to an amount equal to the amount of the consideration so written off.

The amount written off was, demonstrably, all VAT. The compound preposition ‘by reference to’ indicated that, in determining the amount of the refund, reference had to be to the consideration that was written off. If that amount was only VAT, that fact had to be taken into account in determining how reference was to be made to the consideration written off. If that was done, it was clear that the consideration written off was all VAT, and the refund would be calculated accordingly. When regard was had to the purpose of section 36, that was a more probable construction than the alternative, that only a percentage should be refundable. That conclusion was supported by reference to article 11C(1) of the directive (see [26], [28], [33] of the judgment).In the instant case, the taxpayer issued VAT-only invoices, on the instructions of the Revenue, and when one of those was unpaid it was obvious that the amount that was not recovered all represented VAT. Consequently, elementary fairness demanded that it would be refunded as though it were all VAT (See [28], [33] of the judgment).

W J Wolffe QC for the taxpayer; K Campbell (advocate) for the Revenue.