20051
BAD DEBT RELIEF — debt written off on management buyout — was there consideration for the write off — yes — is appellant entitled to bad debt relief — no — Value Added Tax Act 1994 section 36 — appeal dismissed
MANCHESTER TRIBUNAL CENTRE
BERCK LIMITED Appellant
- and -
THE COMMISSIONERS FOR
HER MAJESTY'S REVENUE AND CUSTOMS Respondents
Tribunal: Lady Mitting
Sitting in public in Birmingham on 1 February 2007
Mr Andrew Jackson, Managing Director, for the Appellant
Mr Jonathan Cannan, counsel, instructed by the Acting Solicitor for HM Revenue and Customs for the Respondents
© CROWN COPYRIGHT 2007
DECISION
- The Appellant appeals against an assessment to Value Added Tax in the sum of £24,008 representing VAT arrears for the period 03/04 and arising out of the Commissioners' decision to reject a claim for bad debt relief, such decision being notified on 7 November 2005.
- The Appellant was represented at the hearing by its managing director, Mr Andrew Jackson, who also gave oral evidence on behalf of the company. The Commissioners called no oral evidence but submitted a witness statement from the assessing officer, Mr Christopher Green, which had not been challenged by the Appellant. Mr Cannan offered to call Mr Green if Mr Jackson had wished to question him but he did not.
The Law
- The relevant law is set out in Section 36 Value Added Tax Act 1994 which 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".
The Evidence
- The Appellant company carries on business as the manufacturer of parts and accessories for motor vehicles. On 25 August 2005, Mr Green visited the business premises to carry out a pre-arranged VAT audit. He met there Mr Jackson, who was then the finance director for the company. During the course of the audit, Mr Green checked the validity of a claim for bad debt relief in the VAT quarter ending 31 March 2004 for £24,008.81. He was told by Mr Jackson that the claim was in respect of supplies made to a company called Flex Connectors Limited ("Flex") from 1999 onwards. Mr Jackson went on to explain to Mr Green that although some payments had been received from Flex they had been allocated to the more recent supplies, leaving the older ones unpaid. When he checked the sales ledger, Mr Green could see that no allocation had in fact been made. Based upon what Mr Jackson had told him, namely that the bad debt claim was for the earlier periods, Mr Green disallowed it in total because part of it was out of time, i.e. more than three years and six months old, and the remainder because no notice had been served on Flex that the claim was to be made. This decision was notified to the Appellant by letter dated 25 August 2005.
- Mr Green then received a letter from Mr Jackson dated 19 September 2005 in which he stated that he had now had time to look at the bad debt claim in more detail. He wrote that it was in fact the company's practice to allocate payments to the earlier invoices first. He had been able to relate the claim to two invoices numbered 31041 and 31042 both dated 31 March 2003. A claim for bad debt relief would therefore be in time and as the invoices post dated 1 January 2003 no letter of notice to Flex would have been required. Mr Jackson therefore requested that the refusal of the claim should be reconsidered. Mr Green replied by letter dated 21 September that he was unable to change his mind in view of what he had been told by Mr Jackson on 25 August and also in view of the fact that he believed that the Appellant was still supplying Flex.
- After taking advice from VAT consultants, Mr Jackson responded by letter dated 19 October 2005. He began his letter by saying that at the time of the VAT visit he did not have all the relevant information immediately to hand and was therefore unable to adequately present the facts of the matter. He went on to say that the Appellant had owned a 41.5 per cent stake in Flex until 31 July 2003 when Flex performed a management buyout as an alternative to liquidating. To finance the buyout, the Appellant had to write off part of the trading debt to reduce the overall debt to £480,000. To that end, the Appellant wrote off the two invoices numbered 31041 and 31042 which were in the total value of £161,201.75. He said in his letter that this arrangement was commercially important for the Appellant to preserve its continuing trade with Flex, with whom they were still trading. On receipt of this letter, Mr Green asked for copies of the invoices and for a copy of the management buyout agreement. Mr Jackson provided a document dated 31 July 2003 between Flex and the Appellant and headed "Memorandum of Understanding". The document recited that it was intended to set out each party's intentions and was not intended as a legal agreement. It did little more than set out the future trading relationship between the two companies, including such matters as level of production, level of stock, pricing, etc. Mr Jackson also prepared a short note of the details of the buyout which he sent to Mr Green and was in the following terms:
"Details of the Management Buy-out of Flex Connectors Ltd
31 July 2003. Directors of Flex Connectors purchased 34,000 (41.5%) Ordinary shares from Berck Limited at the cost of £1 in total.
At that date Berck Limited write off all but £480,000 of the inter company trading debt.
Of the £480,000, £100,000 is Cummulative Redeemable Preference Shares and £40,000 Convertible Shares (both issues non-voting)."
- There followed an exchange of emails between Mr Green and Mr Jackson. Mr Green emailed Mr Jackson as follows: "Can you confirm that the write off was part of the agreement, that is the agreement was the sale of the shares plus the debt write off for a consideration of £1". Mr Jackson's response within the hour was as follows: "The shares were sold for £1, the debt was reduced to enable Flex to continue trading, Berck received an agreement to exclusively supply Flex for a minimum period of four years on ten days net monthly terms. All of these are elements of the agreement". On receipt of this email, Mr Green wrote to Mr Jackson as follows:
"Thank you for your email of 31st October.
As I now understand your dealings with Flex Connectors Ltd, you agreed to sell shares to the directors of Flex. You also agreed to reduce the amount of the debt owed by Flex to Berck Ltd for the consideration of an exclusive supply agreement. You stated in your email that all the above were 'elements of the agreement'.
I am of the opinion that there is no bad debt in this situation for you to claim the relief against and I will not be withdrawing my decision. If you wish to discuss the matter or have any more relevant facts please do not hesitate to contact me."
There matters lay. Nothing further was heard from the Appellant company until the Notice of Appeal to the tribunal was put in. There was no relevant communication between either of the parties until the Tribunal hearing.
- Mr Jackson told the tribunal that Flex had been set up in 1997 to pioneer and process the design of a new style lighting connection. They needed funding to make a start and the Appellant agreed to take a 41.5 per cent shareholding in the company. There was never any formal or legal agreement between the two companies and over the next few years, the Appellant continued to fund Flex whenever needed. This could be for anything including wages and overheads, Flex would merely state how much they needed and the Appellant would make the payment to them. After some years of trading like this, it began to appear that Flex's sales projections had been over ambitious and they never reached the targets which they had projected. By 2003, Flex owed the Appellant somewhere in the region of £700,000. The options open to the companies were either for Flex to liquidate in which case the Appellant would lose the entire £700,000 or for the buyout under which some part of the debt would have to be written off but some part of it could be saved and most importantly the Appellant would retain its customer. Flex had been told that sufficient capital for the buyout would only be provided if their indebtedness to the Appellant was reduced to £480,000. This would mean the Appellant writing off £220,000 which to save its customer it agreed to do and it is this £220,000 which is at the core of the claim for bad debt relief. Mr Jackson told the Tribunal that the Appellant did not in fact have an exclusive supply agreement with Flex. He had assumed at the time he emailed Mr Green that there was such an agreement but that this had been wrong. In fact, he said, that as soon as Flex started to trade on their own, they found a cheaper supply for some components and also began to do some of the assembly work, which the Appellant had been used to doing, themselves. There was no legal agreement in Mr Jackson's view and never any intention that there should have been.
- In cross examination, Mr Jackson accepted that the Memorandum of Understanding did not deal with the transfer of the shares but that the transfer had taken place exactly as set out on Mr Jackson's note. He said that there had been no discussion and no negotiation between the two companies. The terms upon which Flex would be funded had been laid down by their capital finance company and they were non negotiable. The Appellant either had to agree or not agree in which case it would lose its entire indebtedness of £700,000. The ultimate decision on behalf of the Appellant was taken by Mr Yates who owned the company following discussions between Mr Jackson, Mr Yates and the Appellant's auditors. Apparently the auditors had been in favour of allowing Flex to liquidate thinking that the buyout would never succeed but Mr Yates and Mr Jackson had been rather more optimistic and indeed, as it turned out, their optimism paid off. Mr Jackson was pressed by Mr Cannan on the question of the exclusive supply agreement and why he had told Mr Green by email that there was such agreement but was stating in evidence today that there was not. All Mr Jackson could say was that he had made a mistake and had made an incorrect assumption. That there was no such agreement was evidenced by the fact that Flex immediately started trading elsewhere and he admitted that the Appellant was disappointed and somewhat put out when this began to happen.
Submissions
- It was Mr Cannan's submission that on the facts there was an exclusive supply agreement between Flex and the Appellant and that that agreement constituted consideration for the write off thus preventing it from being a write off in the section 36 sense. Mr Cannan drew a distinction between two contexts in which a debt is written off. First, there is the situation where a decision to write off is a unilateral act by the supplier. The contractual liability of the purchaser to pay is unaffected and this is reflected in Regulation 171 VAT Regulations 1995 which makes provision for repayment of the relief where payment of the debt is subsequently received or attributed. The second context is where the debt is written off pursuant to a binding agreement between the supplier and the purchaser under which consideration is given for the writing off of the debt. In such a case the purchaser is no longer under a liability to pay and bad debt relief would not be available. The present case, submitted Mr Cannan, fell into this second category. Mr Cannan referred to two tribunal cases namely Alpha Leisure (Scotland) Limited 18199 and AEG (UK) Limited 11428. In AEG, the Appellant's appeal was dismissed when the tribunal held that shares allotted to the supplier by way of voluntary arrangement in the purchaser's liquidation constituted consideration for the prior debt owed by the purchaser to the supplier. The supplier received the shares in return for the debt and these operated to replace the debt. There was therefore no longer any amount outstanding which could be the subject of bad debt relief. In Alpha Leisure, the Appellant succeeded but, contended Mr Cannan, the principle remained the same. However, in Alpha Leisure, the tribunal expressly found that on the facts, no part of the consideration or its equivalent had been received. The tribunal decision contains the following passage:
"The tribunal considers that parliament did not intend to defeat a bone fide claim by a trader who has recognised the inevitable and formally discharged a claim for payment which had no value. Section 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."
- Mr Jackson, in submission, said that he had inadvertently misled Mr Green on the initial audit because he had not looked sufficiently into the details of the write off. Equally, he was mistaken when he told Mr Green in email that there was an exclusive supply agreement. There was no such agreement. Mr Jackson contended that there was no formal contract between the Appellant and Flex. He explained that Mr Yates did not like lawyers or contracts and everything would be done by word of mouth and a handshake. There was no written contract in any form. The shares were transferred merely to get the deal going, not pursuant to contract. There was, in terms, no consideration for the writing off of the debt and bad debt relief was therefore due.
Conclusions
- It should be stated at the outset that on the documents provided, it was impossible to reconcile the amount of the bad debt relief claimed to the two invoices to which the tribunal was told it related. The VAT on the invoices totalled just short of £37,000. Mr Jackson could not explain the difference between that figure and the claim of £24,008 but believed that it was due to a credit note being given. Mr Cannan, on behalf of the Commissioners, accepted this and accepted that the claim did arise out of the two invoices in question and that the figure of £24,008 was a proper amount to claim. No point was taken on the record requirements.
- The first matter before the tribunal is to determine, as a matter of fact, the nature of the agreement between Flex and the Appellant and specifically whether or not it included a term that the Appellant would have the benefit of an exclusive supply agreement. The only evidence on this point comes from Mr Jackson, there being no documentary evidence either way. His evidence consists of two statements at complete odds with each other. By email he told Mr Green that there was such an agreement. In his oral evidence to the tribunal he said this had only been an assumption; it had been wrong and there was not. I find Mr Jackson's evidence unconvincing because of this very contradiction. It is not the only contradiction in this case. Mr Jackson initially told Mr Green that payments from Flex were allocated to later invoices. When bad debt relief was refused, he said that they were in fact allocated to the earlier invoices. There are further reasons why I am uneasy with Mr Jackson's oral evidence. First, his email statement is totally clear and unequivocal. Not only does he write that there was an exclusive supply agreement but goes on to say that this was an element of the agreement. Secondly, this statement was made quite unprovoked. The possibility of an exclusive supply agreement had never been mentioned by Mr Green. Mr Green had asked for confirmation that the write off was part of the agreement. Mr Jackson volunteered the exclusive supply agreement. Thirdly, Mr Jackson was party to the discussions back in 2003. He referred to himself, Mr Yates and the auditors discussing the matter. As such, and in his capacity of finance director, he must have known whether there was such an agreement and his email statement leads me to believe that there was.
- Mr Jackson backs up his contention that there was no such agreement by pointing to the fact that Flex began trading immediately with other suppliers. This is not evidence that there was no such agreement. It is equally consistent with Flex acting in breach of just such an agreement. For all these reasons, I believe that the agreement between Flex and the Appellant did contain an exclusive supply agreement.
- The issue thus now becomes whether in law the presence of such an agreement amounts to a satisfaction of the debt such that there can be no claim for bad debt relief. There was a clear agreement between Flex and the Appellant and in my view a clear intention to create legal relations. The Appellant agreed to and effected the transfer of the shares. The Appellant agreed to and effected the writing off of the debt. The mere fact that the Appellant could gain some benefit from the writing off of the debt would not, however, without more, be sufficient to constitute satisfaction for the debt. The Appellant clearly gained benefit from the management buyout because it retained its customer and retained a chance of repayment of a major part of the indebtedness. This benefit to the Appellant on its own, can not amount to a satisfaction of the debt or a consideration for the writing off such that bad debt relief could be denied. But once one adds in the additional element of the agreement, namely that in return for the writing off of the debt, Flex entered into an exclusive supply agreement, the situation changes and immediately there is consideration for the writing off. In return for writing off the debt, the Appellant has received the benefit of an exclusive supply agreement. In this way, the debt has been satisfied and as such cannot give rise to a claim for bad debt relief.
- Accordingly, the tribunal finds that the Appellant is not entitled to claim bad debt relief and the appeal fails. No application for costs was made and no order is made.
LADY MITTING
CHAIRMAN
Release Date: 23 February 2007
MAN/06/0386
