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Steve Allen of VAT Advisers Ltd reports on a further selection of recent VAT cases.

Tribunal says Bad Debt Relief due on Unpaid Loan Balances

This case concerns bad debt relief, and is interesting because of HMRC’s approach to the meaning of ‘outstanding amount’ under VATA 1994 s 36.

The Appellant had a bad debt upon which it felt it was entitled to relief. A customer owed it over £1.25m on two agreements called the ‘Logistics Support Agreement’ (LSA) and the ‘Investment Amortisation Agreement’ (IAA). The customer went into administration, with about £575K being owed to the Appellant as trading arrears under the LSA. The Appellant said the termination of the LSA meant it was also owed about £680k under the IAA. Under a compromise agreement, the Appellant was paid £600K in cash, and £400K in kind (a conveyor belt), but said the rest was a bad debt of which 46% was unpaid consideration for taxable supplies under the LSA.

HMRC said the only debt was the amount of trading arrears due under the LSA. No obligation to pay the unamortised balance of £680K under the IAA had arisen at the relevant time, because the LSA had not yet been terminated in writing (this being the condition that triggered payment of the unamortised balance becoming due). The Appellant had not exercised the right to terminate arising when the customer went into administration, as it wished to retain its right under the LSA to exercise a lien over the customer’s stock. The amount due under the LSA was more than covered by the £600K cash receipt, and as such, HMRC said there was no entitlement to relief. HMRC also argued that the amounts paid under the compromise agreement amounted to substitute consideration for the supplies, so there was no ‘outstanding amount’.

The Tribunal decided that the Compromise Agreement settled all the issues between the parties, including any liabilities that had not yet arisen, but which would subsequently arise. The Compromise Agreement did not say that it only covered amounts due under the LSA. The sums paid under it did not replace the original consideration, and the bad debt rules in VATA 1994 s 36 could not be interpreted that way. Section 36 implemented the EC Directive rules in cases where supplies were not paid for in full – it did not derogate from the Directive in the way HMRC were arguing. The appeal was thus allowed.

The Tribunal said it was clear that the Appellant did not receive all the monies due to it under the two agreements, and the nature of the Compromise Agreement meant that there was a shortfall. Some of that shortfall was in respect of supplies on which VAT had been declared, so it was only right that bad debt relief should apply in respect of that element.

CPG Logistics Ltd (TC00627)

Tribunal says Flat Built in Loftspace was New Dwelling

This case concerns the construction of a new residential flat and its eligibility for a refund under the DIY Builders Scheme.

The Appellant constructed a new flat in the roof space of a building which already contained two flats. The description of the works in the planning permission was for the “construction of a new gable end roof to replace the existing roof, including erection of two dormer windows and two front roof lights to create an additional self-contained flat in the roof space”. The Appellant was not VAT registered for the relevant period, but made a DIY Scheme claim under VATA 1994 s 35 for the VAT incurred on the works undertaken. HMRC rejected the claim on the basis that a conversion of the loft space had occurred, and so was not within the DIY Scheme because it was not a residential conversion within the meaning of VATA 1994 s 35(1A)(c) (i.e., the loft was not a non-residential part of a building because it was part of the top flat, even if no one actually lived in that space). However, it is possible to claim the VAT in two other ways as follows:

• s35(1A)(a): construction of a building designed as a dwelling/number of dwellings
• s35(1A)(b): construction of a building for use solely for a relevant residential purpose or relevant charitable purpose.

Here, the definition of ‘construction of a building’ is in VATA 1994 Sch 8 Group 5 Note (16)(a).

The Court went on to show that the Appellant could claim the VAT on the basis of s35(1A)(a). For this to apply, it had to be shown that:

1. The new flat has its own separate entrance
2. The new flat is not a conversion, alteration reconstruction, enlargement or extension of the existing building unless the enlargement or extension itself creates an extra dwelling

On the first condition, the Tribunal noted that the flat concerned was a new flat built on the new second floor. There were also flats on the first floor and on the ground floor. The ground floor flat had its own separate entrance. The first and second floor flats shared a communal front door but then each had its own separate entrance. It was held that this was sufficient.

For the second condition, whilst the council had described the works in its completion statement as a ‘loft conversion’, the Court accepted the Appellant’s evidence that this was an error. The ‘regularisation certificate’ dated the same day as the completion certificate had described the works as a ‘conversion of existing house into two self-contained flats’, and this document agreed with both his chartered surveyor’s letter and the planning permission. It was decided that the works did consist of an enlargement, but HMRC argued that the new dwelling was not “wholly within the enlargement or extension” as it was partly built in the old roof space, so the enlargement had not created a new dwelling. The Court held that if this were the case, then only people with completely flat roofs could ever reclaim VAT for building a new flat on top of an existing building, which is not a sensible interpretation. It was also noted that Note (16)(b) itself did not contain the word ‘wholly’, but in any case, it was held that the new flat was wholly within the enlargement and amounted to an ‘additional’ dwelling rather than an enlargement of an existing dwelling.

Ali Kia Jahansouz (TC00637)

Court of Appeal says Interest Claims Were In Time, and so Allows the Case to Continue

This case concerns the payment of statutory interest by HMRC, and whether it should be paid on a simple or compound basis. 

The Appellant said taxpayers are entitled to view VATA 1994 s 78 as giving a directly effective Community law right to compound interest. In the previous Upper Tribunal case, it was held that the Appellant’s appeal against the refusal to pay compound interest was out of time, so it appealed in relation to this time limit issue. HMRC cross-appealed on the basis of the Upper Tier Judges’ decision that there was an entitlement to compound interest where VAT has been paid in breach of Community law, although they also concluded s 78 was not the appropriate route for such a claim - an action at common law was needed.

The CoA decided to hear arguments on the time limits issues as a preliminary matter. The Court decided that ‘secondary’ claims made after an initial claim for tax and interest had been made and settled were acceptable, provided that they were brought within the interest time limits prescribed in s 78. In view of this, the Appellant’s appeals were in time.

The decision gives the Appellant a chance to continue its case in relation to the underlying right to compound interest. Although only a procedural battle, this decision has important wider ramifications on the application of time limits and secondary claims. Having allowed the Appellant’s appeal on time limits, the CoA will now have to hear the arguments on the substantive issue, which could involve a possible reference to the ECJ. Alternatively, the Court may decide to await the outcome of the ECJ reference in the Littlewoods case.

John Wilkins (Motor Engineers) & Others, Court of Appeal, 30 July 2010