[2010] UKFTT 380 (TC)

TC00662

Appeal number:  EDN/08/0045

VAT – Bad Debt Relief - Solicitors acting on instructions of insurance companies - insured party registered for VAT - invoice for VAT element of fees rendered on insured party - Bad Debt Relief claimed in respect of unpaid VAT - Appeal dismissed.

FIRST-TIER TRIBUNAL

VAT 

	SIMPSON & MARWICK	Appellants

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS (VAT)	Respondents

TRIBUNAL JUDGE: 	JOHN M BARTON, WS 
(Members): 			SCOTT RAE, LLB., WS
DR H POON, CA., CTA

Sitting in public in Edinburgh on Tuesday 4 May and Wednesday 22 June 2010

D Johnston QC, for the Appellants

K Campbell, Advocate, for the Respondents

© CROWN COPYRIGHT 2010

DECISION

1.	This is an appeal by Simpson & Marwick, Solicitors, against a decision of the Commissioners for Her Majesty's Revenue and Customs (“HMRC”) to assess Simpson & Marwick in the sum of £322,843 of Value Added Tax ("VAT") in accordance with Section 73 of the Value Added Tax Act 1994.  The assessments related to amounts reclaimed by Simpson & Marwick as bad debt relief and covered the VAT periods from 1 May to 31 July 2004 (“07/04”) to 1 February to 30 April 2007 (“04/07”).  The amount at issue was latterly agreed at £216,862.36.
2.	The appeal was heard at 126 George Street, Edinburgh on Tuesday 4 May and Wednesday 22 June 2010.  Simpson & Marwick were represented by D Johnston QC, and K Campbell, Advocate, represented HMRC.
3.	The following documents were before the Tribunal –
A.	Notification for VAT registration dated 31 October 1972.
B.	Excerpt from Journal of Law Society of Scotland February 1985.
C.	Excerpt from Journal of Law Society of Scotland March 1985.
D.	Specimen VAT invoice.
E.	Specimen (non-VAT) invoice addresses to insurers.
F.	Visit Report dated 13 June 2007.
G.	Record of telephone call 14 June 2007.
H.	Record of telephone call 27 June 2007.
I.	Notice of Appeal dated 28 February 2008.
J.	VAT Notice 700/18 December 2002.
K.	VAT Notice 701/36 May 2002.
also correspondence between Simpson & Marwick and HMRC over the relevant period.
4.	The Tribunal heard the evidence of Peter Anderson, senior partner of Simpson & Marwick and accepted an agreed statement of Neil Fleming, their partnership secretary.  Karen Ross gave evidence for HMRC (which expression also includes the former HM Customs and Excise).

Material Facts
5.	The material facts were not in dispute and are as follows –
6.	Simpson & Marwick are a firm of solicitors with their principal place of business at 58 Albany Street, Edinburgh.  They have been registered for VAT since 1 April 1973.   
7.	The greater part of their practice relates to the provision of legal services relating to insurance claims.  In these matters, they are instructed by insurance companies, but they also have a professional responsibility towards the insured person.  
8.	Prior to 1 January 1985, Simpson & Marwick sent their notes of fee to the insurers with the expectation that the insurers paid the VAT on all their fees and outlays as well as the fees and outlays themselves.
9.	The following direction was published in the Journal of the Law Society of Scotland of February 1985 –
Legal services in insurance claims

The Commissioners of HM Customs and Excise have agreed with the British Insurance Association and other insurance bodies that policy-holders who are registered for VAT can count as input tax VAT incurred on legal services supplied to them in connection with an insurance claim relating to their business.
From 1st January this applies whether the solicitor is instructed by the policy-holder or by the insurer on his behalf and whether or not in practice the proceedings are controlled by the insurer.  It has also been agreed that, normally, such legal services are supplied to the policy-holder not the insurer even where the insurer exercises his right of subrogation to pursue or defend a claim in the name of the policy-holder.
10.	 This direction was supplemented by the following which appeared in the March 1985 issue of the Journal of the Law Society of Scotland – 
VAT on legal fees--insurance claims
11.	The Society has received the following letter from the Secretary-General of the British Insurance Association.
‘HM Customs and Excise have reviewed the application of VAT to legal services in relation to insurance claims.  Following discussions with the BIA, Customs have extended their view that such services are normally supplied to the policyholder to encompass claims in which the insurance company exercises its right of subrogation.  Furthermore, and for lawyers' invoices issued on or after 1st January 1985, Customs have agreed that if the claim relates to the policyholder's business then legal services supplied to the policyholder are for the purposes of that business and, if registered, the policyholder can recover the VAT incurred - subject of course to the normal rules for input tax deduction.
The insurance company will therefore indemnify the policyholder in respect of an amount net of VAT.  Where such a policyholder is partially exempt, for example a bank, the policyholder will not be able to recover all the VAT as input tax.  The insurance company will therefore have to indemnify the policyholder in respect of an amount which will include some VAT.  This VAT will not be recoverable from Customs by the insurance company.  If, however, the insurance does not relate to the policyholder’s business and/or the policyholder is not registered for VAT, the insurance company will indemnify the policyholder in respect of an amount which will include VAT.  This VAT will not be recoverable from Customs by the insurance company.
The procedure for UK solicitors' services will depend on whether or not the policyholder is registered for VAT and whether the claim appears to relate to his business or private activities.  If the policyholder is registered and can recover VAT from Customs, the solicitor is obliged under the VAT regulations to address a tax invoice to him.  This will request payment of an amount equal to the VAT and it will state that the balance of the account will be settled by the insurance company.  A copy of the invoice will be sent to the insurance company endorsed to indicate that the policyholder has been asked to pay the VAT amount and that the insurance company should settle the balance.  If the policyholder is not registered for VAT and/or cannot recover the VAT from Customs, for example because the claim does not relate to his business, then the Solicitor will address his invoice to the policyholder and send it to the insurance company for settlement.  Copy invoices sent to insurance companies for settlement will be endorsed to the effect that they are not tax invoices and care should be taken that VAT on supplies to policyholders is not counted as input tax by the insurance company’.
12.	From 1 January 1985 Simpson & Marwick prepared their fee notes in duplicate in those cases where policyholders were registered for VAT.  The principal version claiming payment only of the fees and any outlays was sent to the insurer.  A duplicate was sent to the insured person.  They were asked to pay only the VAT on fees and any relevant outlays.  In their 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 the VAT they were being asked to pay.  Simpson & Marwick have continued to follow this procedure to the present.
13.	It was the practice of Simpson & Marwick to follow up any unpaid VAT periodically and if payment could not be achieved by reminders, to claim VAT bad debt relief.  On every quarterly return there would have been a separate sheet which identified the VAT bad debt relief claim.  The bad debt relief claims were all accepted.
14.	Between 1985 and 2007, HM Customs & Excise and latterly HMRC, had visited Simpson & Marwick about every three years to carry out an inspection of their VAT records and procedures.  The sheet identifying the VAT bad debt relief claim with each quarterly return would have been available for inspection.  At no time over this period, did anyone from HMRC ever challenge their procedure for claiming VAT bad debt relief.  It was never suggested that where the firm was making claims for relief because an insured VAT registered person had failed to pay or had become insolvent, the firm should be calling upon the insurer to satisfy the VAT that was due.  Karen Ross was the officer of HMRC who carried out such an inspection in or about 2003.
15.	On 13th June 2007, Karen Ross made a further visit to Simpson & Marwick’s premises and in the course of her inspection, she raised queries into the firm’s method in claiming bad debt relief.  In particular, it was suggested to the firm that they had been incorrectly calculating the relief in that they had claimed the full relief on those invoices which showed a "VAT only" amount on the invoice.
16.	On 14 June 2007, the firm’s finance manager, John Haugh, telephoned HMRC’s National Advice Service and asked in regard to “VAT only invoices” relating to insurance claims, whether they could reclaim bad debt relief if these invoices remained unpaid.  The answer given by the Advice Service was that provided the firm had followed the conditions of VAT Notice 700/18 then the full amount of the “VAT only invoices” could be reclaimed under the bad debt relief procedure.
17.	On 19 June 2007, HMRC wrote to Mr Fleming of Simpson & Marwick in relation to the matter of bad debt relief referred to during the recent visit.  There was enclosed with that letter a copy of VAT Notice 700/18 with particular reference to paragraph 3.13.
18.	Paragraph 3.13 of Notice 700/18 provides as follows – 
What if my customer pays everything but the VAT?
If your customer refuses to pay the VAT charged, or you did not charge VAT when the supplies were made but issued supplementary invoices to recover the VAT from your customer, the claim to relief is limited to the VAT element of the total debt.  For example if you originally charged £100 which your customer paid, and you unsuccessfully attempt to recover the £17.50 VAT charge originally omitted, you are only entitled to claim the VAT fraction of £17.50 as bad debt relief.
19.	On 27 June 2007, Mr Haugh, again telephoned HMRC’s National Advice Service and in response to a question whether a VAT registered business making an insurance claim is able to reclaim the VAT they are charged when the insurance company only pays them the net value, he was advised that “they can claim this as normal”.
20.	 Simpson & Marwick had claimed bad debt relief on sums totalling £379,346.70 over the VAT periods from 07/04 to 04/07.  In the opinion of HMRC, Simpson & Marwick’s entitlement to bad debt relief was limited to 7/47 of that figure.  On 1 February 2008, HMRC issued an assessment to Simpson & Marwick for the difference rounded down to £322.843.00 plus interest.
21.	Simpson & Marwick have since recovered substantial sums from various insured persons and insurance companies, which sums they have forwarded to HMRC, leaving a present balance of £216,862.36 in dispute.
Statutory Provisions
22.	The Tribunal was directed to the following statutory provisions
Value Added Tax Act 1994 ("the VAT Act") s36, 83 and 84.
Value Added Tax Regulations 1995 [SI 1995/2518], regulations 168 – 172B.
Human Rights Act 1998, s3, 6 and Article 1 of the First Protocol of the European Convention of Human Rights.
Tribunals, Courts and Enforcement Act 2007 (“the TCE Act”) s20 and 21.
Authorities
23.	The following cases were listed or otherwise referred to
Palmer t/a R & K Engineering v Customs & Excise Commissioners (1993) VAT Decision 11739 [MAN/92/724].
National & Provincial Building Society & ors v UK [1997] STC 1466, (1998) 25 EHRR 127

Broniowski v. Poland (2005) 40 EHRR 21 
Dangeville SA v. France [2003] STC 771, (2004) 38 EHRR 32
"Bulves" AD v. Bulgaria [2009] STC 1193
Gasus Dosier- und Fordertechnik GmbH v. Netherlands (1995) 20 EHRR 403
WHA Ltd v Customs & Excise Commissioners [2004] STC 1081, [2004] EWCA Civ 559 
Goldsmiths (Jewelers) Ltd v. Customs & Excise Commissioners [1997] STC 1073, [1997] ECR 1-3801
Pine Valley Developments v. Ireland (1992) 14 EHRR 319
Stretch v. UK (2004) 38 EHRR 12
Rowland v. Environment Agency [2005] Ch 1 (CA), [2003] EWCA Civ 1885
A W Mawer & Co v Customs & Excise Commissioners [1986] VATTR 87 (VTD 2100)
CGI (Europe) Ltd v Revenue & Customs Commissioners [2010] UKFTT 224 (TC) [LON/2007/9374]
Customs & Excise Commissioners v Nat West Bank plc [2003] STC 1072
Oxfam v Revenue & Customs Commissioners [2009] EWHC 3078 (Ch)
Space 2 Build Ltd v Revenue & Customs Commissioners [2010] UKFTT 66 (TC) 7 
Aspin v Estill [1987] STC 723
R v Commissioners of Inland Revenue ex parte MFK Underwriting Agencies Ltd [1990] 1 WLR 1545
Corkteck Ltd v Revenue & Customs Commissioners [2009] EWHC 785 (Admin)
Abbey National plc v Customs & Excise Commissioners [2006] STC 1
Enderby Transport v Customs & Excise Commissioners (1984) VAT Decision 1607 [MAN/83/304]
Caernarfonshire Fatstock Group Ltd v Customs & Excise Commissioners (1990). VAT Decision 5033 [MAN/89/748]
Engineering Services (Bridgend) Ltd v Customs & Excise Commissioners (2002) VAT Decision (2001) VAT Decision 17556 [LON/01/161]
Grounds of Appeal
24.	In the statement which accompanied the Notice of Appeal dated 28 February 2008, Simpson & Marwick summarised their case to the effect that they were only claiming bad debt relief on VAT which they had paid and had then been unable to recover from an insured person.  In doing this, they claimed that they were complying with a long standing practice to which HMRC had never taken any objection.  The VAT was not owed to them by clients.  Their clients were the insurers, and it was their insured person who had the VAT obligation.
25.	On 22 April 2010, the Tribunal granted leave for Simpson & Marwick to amend their grounds of appeal by adding the following – 
In these circumstances we contend that the restriction of BDR (bad debt relief) to a fraction of the VAT which we have remitted but have been unable to recover from the insured person would constitute a disproportionate interference with our right under Article 1 of the First Protocol to the European Convention of Human Rights to the peaceful enjoyment of our possessions.  The Tribunal should adopt an interpretation of section 36 of the Value Added Tax Act 1994 which is compatible with our Convention rights.  In terms of section 6 of the Human Rights Act 1998 it will act unlawfully if it fails to do so.  A disproportionate interference arises for the following reasons:
(i) Firstly, restriction of recovery to the VAT fraction of the amount of the unrecovered VAT would operate as a windfall gain to the respondents (HMRC).  Where the insured person pays the VAT to us he is entitled to recover it as input tax (subject to the usual rules of recovery of input tax): see the publications referred to in paragraph 7 above and also VAT Notice 701/36/02 at paragraphs 5.1 and 5.2.  The transaction is therefore neutral so far as the respondents are concerned, in accordance with the underlying Community law principle of neutrality.  In contrast, where the insured person fails to pay the VAT to us, the respondents would, if their interpretation of section 36 were upheld, be better off because they would be obliged to repay only 7/47 of the VAT which would otherwise have been credited in full to the insured person.  The obtaining of such an advantage constitutes a disproportionate interference with our Article 1 right.
(ii) Secondly, in any event, in the circumstances of this case, the past actings of the respondents described above created a legitimate expectation that they would continue to allow BDR in respect of the full amount of VAT not recovered from the insured person.  Such a legitimate expectation is a possession for the purposes of Article 1.  The assessments which have been made constitute a disproportionate interference with that possession in respect that they seek to disallow relief for periods of account prior to that in which the respondents' interpretation of the BDR provisions was first intimated to us.
In order to comply with our Convention rights, we therefore contend that section 36 of the 1994 Act falls to be construed as entitling us to a refund of the amount of VAT for which we invoiced insured persons but which we were unable to recover from them due to their insolvency or other reasons beyond our control.
26.	The publications referred to are the directions which appeared in the Journal of the Law Society of Scotland in February and March 1985.  Paragraphs 5.1 and 5.2 of VAT Notice 701/36 are as follows –
5.1 Claims related VAT
It is important to establish who is receiving supplies made in connection with or in settlement of insurance claims because this will determine who could have the right to recover any VAT charged on those supplies as input tax.  Guidance on determining who is receiving particular supplies made in connection with insurance claims is given further on in this section in paragraphs 5.2 to 5.5.
5.1.1 Supplies made to the insured party
Where supplies of claims-related goods or services are made to the insured party and the claim relates to their VAT registered business, any VAT incurred on those supplies may be deducted as input tax subject to normal rules.
Where the insured party is able to recover the VAT charged in respect of such supplies from us, the insurer will normally be responsible for paying only the net amount due (less any excess payable by the insured party) under the insurance claim.
5.1.2 Supplies made to the insurer
Where supplies of claims related goods and services are made to the insurer, the deductibility of any VAT incurred on those supplies will be subject to the partial exemption rules and the recoverable amount calculated under the insurer's partial exemption method.
Where costs are incurred in respect of an individual claim (for example, legal costs incurred where the insurer is in dispute with the policyholder over the legitimacy of the claim) any VAT on those costs will be directly attributable to the associated supply of insurance and the recoverability of any VAT charged will depend upon whether or not the relevant supply of insurance gives a right to input tax deduction.
5.2 Legal costs
Where an insurer obtains legal services in connection with, for example, policy interpretation or in relation to a dispute with a policyholder, the supply of the legal services is to the insurer.  In the case of subrogated claims however (that is, claims where the insurer exercises their right to pursue or defend a claim against a third party in the name of the insured party) supplies of legal services in connection with those claims are made to the insured party and not to the insurer.
Submissions
27.	On behalf of HMRC, Mr Campbell submitted that the Tribunal did not have jurisdiction in relation to the subject matter of the amendment.  He advanced five propositions in support of this:
(1)	The jurisdiction of the First-tier Tribunal in relation to VAT is determined entirely by statute, namely the VAT Act 1994; and s83 (1) contains an exhaustive list of matters which may be the subject of an appeal.
(2)	None of the provisions of s83 confers a general supervisory jurisdiction akin to judicial review.  Section 20 of the TCE Act transferred judicial review functions to the Upper Tribunal, and s21 sets out the functions and powers of the Upper Tribunal.  No supervisory jurisdiction is conferred on the First-tier Tribunal.
(3)	Decisions of HMRC which do not fall within s83, for example misdirection by act or omission, or an act in abuse of statutory powers, would be susceptible to judicial review applying ordinary principles of public law rights and remedies.  Mr Campbell reviewed a series of conflicting authorities.  In Customs & Excise Commissioners v Nat West Bank plc Jacob J held that s83 excludes a general supervisory jurisdiction, but the contrary view was taken by Sales J in Oxfam v Revenue & Customs Commissioners.  This conflict was identified by Judge Avery Jones in Space 2 Build Ltd v Revenue & Customs Commissioners, and until the matter might be clarified, he was not prepared to accept jurisdiction.  It was also noted that a wider view had been taken by Judge Hellier in CGI (Europe) Ltd v Revenue & Customs Commissioners.  Mr Campbell invited the Tribunal to prefer the view taken in Customs & Excise Commissioners v Nat West Bank plc in that it was founded on an established line of authorities; and he added that neither Sales J nor Judge Hellier had considered the framework of the First-tier Tribunal in relation to the Upper Tribunal.
(4)	The amendment did not refer to a misapplication of the law in the circumstances of a particular supply, but that a particular understanding and expectation has been created by conduct attributed to HMRC.
(5)	The First-tier Tribunal has no supervisory jurisdiction in relation to the general conduct of HMRC. 
28.	In reply, Mr Johnston pointed out 
(1)	The subject matter of the appeal is a claim for refund of VAT under the provisions of s36 of the VAT Act.  Simpson & Marwick are entitled to relief and therefore the matter is within the jurisdiction of this Tribunal.  
(2)	The amendment is not an appeal to some supervisory jurisdiction but seeks an interpretation which is consistent with s6 of the Human Rights Act 1998.
(3)	Mr Johnston submitted that the case of Customs & Excise Commissioners v Nat West Bank plc did not apply in the present circumstances.  The present case is looking to a proper construction of s36 of the VAT Act.  He found support in Oxfam v Revenue & Customs Commissioners and in particular to the following observation of Sales J at para 70.
Moreover, there is a clear public benefit in construing section 83 (of the VAT Act) by reference to its ordinary and natural meaning which strongly supports that construction.  It is desirable for the Tribunal to hear all matters relevant to determination of a question under section 83.
Mr Johnston also found support in the case of CGI (Europe) Ltd v Revenue & Customs Commissioners and in particular, the statement -
in the context of the Convention, the rights of the taxpayer are rights under the law.  The taxpayer is seeking to enforce those rights in accordance with the law; not seeking to prevent his being taxed in accordance with the law. 
29.	At the adjourned hearing on 22 June 2010, Counsel made their submissions in relation to the substantive case.
30.	Mr Johnston advanced two distinct lines of argument, based respectively on domestic law and the European Convention on Human Rights.
31.	In relation to UK law, his key points were as follows:
By virtue of s36(1) of the VAT Act, relief is available where the whole or part of the consideration for a supply of goods or services has been written off in a trader's accounts as a bad debt.
Relief` under s36 (2) consists of a refund of “the amount of VAT chargeable by reference to the outstanding amount”.
“Outstanding amount” is defined by s36(3), for the case where at the time of the claim no part of the consideration written off as a bad debt has been received, as “an amount equal to the amount of the consideration so written off”.
The issue between the parties can be expressed in this way: suppose the net amount of a supply is £100 and the VAT charged is £17.50; and that the trader receives £100 and writes off £17.50 as a bad debt, does section 36(2) entitle the trader to claim bad debt relief in relation to the whole unpaid amount or only the VAT fraction of the outstanding amount?
32.	Mr Johnston accepted that a line of cases identified by HMRC, beginning with A W Mawer & Co v Customs & Excise Commissioners arrives at the conclusion that bad debt relief may be claimed only in relation to the VAT fraction of the outstanding amount.  However, he found support in the case of Palmer t/a R & K Engineering v Customs & Excise Commissioners where the bad debt relief provisions were identified as being to “give relief to a trader for the amount of value added tax for which he has accounted to the Commissioners, but which he is unable to recover from his customer”.  In that case, the Tribunal had found that by reason of HMRC mistakes, the appellant had in effect been prevented from recovering VAT from his customer at the appropriate time.  Mr Johnston contended that by reason of the requirement imposed by HMRC to recover VAT direct from policyholders from 1985, and their subsequent approbation of Simpson & Marwick’s practice of' claiming bad debt relief on the full amount of VAT unpaid, Simpson & Marwick had similarly been prevented from making alternative arrangements with the instructing client, the insurer, to recover VAT at the appropriate time.
33.	Mr Johnston acknowledged that his principal case was founded on the Human Rights Act 1998, and he referred in particular to the following provisions.
Section 6 - Acts of public authorities
(1) It is unlawful for a public authority to act in a way which is incompatible with a Convention right.
(3) In this section “public authority” includes—
(a) a court or tribunal,

Section 3 - Interpretation of legislation
(1) So far as it is possible to do so, primary legislation and subordinate legislation must be read and given effect in a way which is compatible with the Convention rights.
Article 1 of the First Protocol - Protection of property
Every natural or legal person is entitled to the peaceful enjoyment of his possessions.  No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and by the general principles of international law.
The preceding provisions shall not, however, in any way impair the right of a State to enforce such laws as it deems necessary to control the use of property in accordance with the general interest or to secure the payment of taxes or other contributions or penalties.
34.	Mr Johnston submitted that the 1998 Act requires the words “VAT chargeable by reference to the outstanding amount” in s36 of the VAT Act to be read as referring to the whole VAT paid by the policyholder (rather than as a reference to only the VAT fraction of the outstanding amount).  On the basis of case law, he identified the following key points on Article 1 -
For Article 1 to be engaged, it is necessary to show that the person relying on it has a “possession”.
Article 1 contains three rules: it must be shown that one of these applies: an interference with the peaceful enjoyment of possessions; deprivation of possessions; or a control on the use of possessions.
The interference, deprivation or control on use must affect the person in question disproportionately, so that he is subjected to an individual and excessive burden.
35.	Mr Johnston principally founded on the case of National & Provincial Building Society & ors v UK to demonstrate that a legitimate expectation may be a `possession' for the purposes of Article l; and he referred to the case of Dangeville SA v France as illustrating where the interference to a party’s right to the peaceful enjoyment of its possessions was disproportionate.
36.	 Mr Johnston made the following factual submissions -
(1)	HMRC require the supply in the present circumstances to be treated as made by the solicitor to the insured person (rather than the insurer).  This practice is a change with respect to previous practice and is one that was imposed by HMRC.
(2)	HMRC therefore necessarily accept that VAT paid by the insured person is deductible as input tax; there will be a restricted right to deduct only where the legal services relate wholly or partly to non-business activities or where the insured person's business is wholly or partially exempt from VAT.
(3)	VAT is paid by a VAT-registered insured person to the solicitor, who accounts for it as output VAT to HMRC; it is then deducted by the insured person (ie:  the policyholder) as input tax in his own return.  The transaction is therefore tax neutral from the HMRC’s point of view, given that the output VAT paid by the solicitor is offset by the input VAT claimed by the VAT-registered policyholder.
(4)	If the insured person fails to pay the VAT to the solicitor, the consequence is that HMRC are better off.  The transaction is no longer tax-neutral.
37.	However, in answer to a question from a member of the Tribunal, Mr Johnston acknowledged that HMRC would not have been financially advantaged if the insured person had deducted the amount of the VAT in making his return but had failed to account to the solicitor.
38.	Mr Johnston made the following submissions in relation to Article l.
(1)	The effect of the restricted bad debt recovery under section 36 is to deprive Simpson & Marwick of their possessions, in that they made a payment to HMRC which they have been unable to recover in full from the insured person; and a deprivation of possessions arises to the extent of the unrecovered difference. 
(2)	The conduct of HMRC in accepting past claims to deduct the whole VAT on bad debts created a legitimate expectation for Simpson & Marwick that HMRC would continue to act in the same way; and the change of position constituted a disproportionate interference with their possessions.

39.	In regard to the foregoing, Mr Johnston particularly observed that:-
(1)	Until 2007, HMRC accepted Simpson & Marwick’s VAT returns, in which they had consistently applied the same treatment in relation to bad debts.  During this period, HMRC were provided with wholly unrestricted access to the Appellants' books and records and took no exception to the firm’s practice.
(2)	Prior to 2007, there was no communication from HMRC about the treatment of bad debt relief on the particular invoices; and subsequent communications appeared to support the approach which had been taken by the firm.
(3)	If the contrary interpretation of section 36 had been known to Simpson & Marwick prior to 2007, they would have made arrangements with insurers in order to remove the risk of loss to them.   The substantial delay by HMRC in raising the present issue had given rise to very significant costs.
40.	In reply, Mr Campbell submitted that in each case, there was a “single supply” and he highlighted the practice as appearing from the invoices which had been produced.  He founded on the reasoning set out in the case of A W Mawer & Co v Customs & Excise Commissioners; and he distinguished the case of Palmer t/a R & K Engineering v Customs & Excise Commissioners where there had been reliance on express advice which had turned out to be erroneous.  The purpose of bad debt relief is to give relief to traders who may not be paid or who may not be paid in full, ie mitigating a loss that might not otherwise be recovered.  Mr Campbell further submitted that confining the relief to the VAT fraction was proportionate; and in relation to what might be “legitimate expectation” he referred to R v Commissioners of Inland Revenue ex parte MFK Underwriting Agencies Ltd wherein…. it was observed that where an assurance is given by HMRC which might involve the Revenue foregoing tax, such assurance could only be relied upon if it had been given in response to a full disclosure.  He acknowledged that the directions set out in the Journals of the Law Society had not covered the question of bad debt relief, but explained that in such circumstances, the general rules of bad debt relief should apply.
Reasons 
41.	It is significant that in any case where an insurance company is involved in a claim, the proceedings run in the name of the insured person, irrespective of whether the de facto instructions are given by the insurance company or the insured person.
42.	Prior to 1985, it seems to have been the practice for solicitors, including Simpson & Marwick to address any invoice to the insurers where they were under an obligation to pay the solicitors.  The directions which appeared in the Journal of the Law Society of February 1985 and March 1985 have been set out in paragraphs 9 and 10 above.  The directions have no statutory authority, and neither the Law Society of Scotland nor Simpson & Marwick was a party to the agreement whereby the directions were issued.  In the ordinary case, the solicitor and the insured person are both in a neutral position in that the solicitor can still recover the VAT on his fees and the insured person is able to claim input tax on the amount of the solicitor’s fees.  The potential beneficiary of the directions would appear to have been the insurance companies in that they would no longer have to bear VAT on the solicitor’s charges where the insured party was registered for VAT and the claim related to the insured’s business. 
43.	The new procedure is illustrated by the sample invoices produced by Simpson & Marwick.  The VAT invoice is rendered to the insured person, but in view of the indemnity which will have been written into the insurance policy, it is the insurance company which is asked for an amount equivalent to the net fees and outlays.  There is only a single supply – which is to the insured person; but there are two payments – the net fees and outlays being paid by the insurance company, and the balance (namely the VAT element), being paid by the insured person.  This situation is recognised in the published directions (in the February 1985 Journal) where it is stated that “this applies whether the solicitor is instructed by the policy-holder or by the insurer on his behalf and whether or not in practice the proceedings are controlled by the insurer.  It has also been agreed that, normally, such legal services are supplied to the policy-holder not the insurer even where the insurer exercises his right of subrogation to pursue or defend a claim in the name of the policy-holder.”  The arrangement as set out in the above-mentioned directions is not unique.  The case of A W Mawer & Co v Customs & Excise Commissioners illustrates that since 1973 there has been a corresponding practice direction in the High Court in England in relation to solicitors’ fees.
44.	The subject matter of the present appeal is a succession of claims to bad debt relief made under the provisions of s 36 of the VAT Act.  That section provides: 
(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;
(4)	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.
45.	The word “consideration” is not defined above, but some indication of its meaning can be found in s 19 which declares:-
(1)	 For the purposes of this Act the value of any supply of goods or services shall, except as otherwise provided by or under this Act, be determined in accordance with this section and Schedule 6, and for those purposes subsections (2) to (4) below have effect subject to that Schedule.
(2)	If the supply is for a consideration in money its value shall be taken to be such amount as, with the addition of the VAT chargeable, is equal to the consideration.
46.	As there was only a single “supply” in the present case, it follows that the “consideration” was the aggregate of Simpson & Marwick’s fees and the VAT thereon.  However, s36 only provides for bad debt relief on “the outstanding amount” of the consideration which has been written off.  Using the figures set out in paragraph 30 above, the consideration was £117.50, but only £17.50 was written off – a fraction of 7/47 of the whole consideration.  It follows that Simpson & Marwick were limited to claiming that proportion as a bad debt on which relief was available under s 36.  The same approach was taken by the VAT Tribunal in the case of A W Mawer & Co v Customs & Excise Commissioners. 
47.	Mr Johnston put forward the case of Palmer t/a R & K Engineering v Customs & Excise Commissioners.  In that case, there had been a mistake on the part of the Customs & Excise Commissioners which had resulted in a critical delay in the initial VAT registration; and the VAT Tribunal observed –
The purpose of the provisions is to give relief to a trader for the amount of value added tax for which he has accounted to the Commissioners, but which he is unable to recover from his customer.  It was pointed out in the Caernarfonshire Fatstock case (Caernarfonshire Fatstock Group Ltd v Customs & Excise Commissioners), to which we have already referred, that a trader cannot simply treat payments first received as being for his own benefit, so as to enhance the apparent amount of the outstanding VAT, and thus to enhance also the amount which he is able to recover by way of bad debt relief if there is any part of the invoice which is unpaid.  Payments must be apportioned fairly between those entitled to them.
That, however, is not the position here.  By reason of the Commissioners' mistakes, the Appellant was in effect prevented from recovering VAT from his customer at the appropriate time, and was forced to attempt to do so at a later date.  By that stage, he was not recovering or attempting to recover any sum due to himself, but a sum the entirety of which was value added tax which the Appellant was attempting to recover for the Commissioners' benefit.  The position might be different in the case of a trader who, culpably registering late, was attempting, belatedly, to recover from his customer sums which he should have charged at an earlier date but which, because of his own default, he has failed to charge.  That is not this Appellant's position; the blame for his late registration lies not with him but with the Commissioners themselves.  In our judgment, the amount of tax chargeable by reference to the outstanding amount is the whole of the VAT-only invoice and the Appellant is entitled to bad debt relief for the entirety of that sum.
48.	In the present case, there was no “mistake” on the part of HMRC, and this Tribunal does not otherwise find that the reasoning in Palmer t/a R & K Engineering v Customs & Excise Commissioners extends to other cases where the bad debt is only of an amount equivalent to the VAT element of the consideration.
49.	The amendment to Simpson & Marwick’s grounds of appeal gave rise to extended submissions on the matter of jurisdiction.  It is accepted that in relation to Convention matters, this Tribunal has a limited jurisdiction.
50.	At the initial hearing on 4 May 2010, Mr Johnston countered Mr Campbell’s objections by submitting that the amendment was not an appeal to some supervisory jurisdiction but that he was seeking an interpretation which was consistent with s 6 of the Human Rights Act 1998.
51.	However, the principal content of the amendment and Mr Johnston’s submissions on 22 June 2010 indicate that this Tribunal should take a broader approach to the application of bad debt relief.  As a preliminary consideration to this, it is appropriate to review the conclusions which may be drawn from the material facts and the effect of these conclusions on the Convention issues.
52.	Mr Johnston pointed out that until 2007, Simpson & Marwick had consistently applied the same treatment in relation to bad debts and that HMRC accepted their returns; also that during this period, HMRC had been provided with wholly unrestricted access to Simpson & Marwick’s books and records and had taken no exception to their practice in relation to claiming bad debt relief.  However, the foregoing fails to take into account the substance of Karen Ross’ evidence.  It was not patent from Simpson & Marwick’s quarterly returns that they were in effect claiming relief against the whole consideration; and when visiting the premises of a registered trader, HMRC ordinarily did not carry out a full audit, but selected certain matters for checking.  At the inspection in 2007, Ms Ross was only alerted to investigate the bad debt claims when she observed that there had been a considerable increase in the number of these claims.  It is therefore inappropriate to draw any conclusion from the apparent inactivity on the part of HMRC in relation to Simpson & Marwick’s prior claims to bad debt relief. 
53.	The material circumstances were that at some time in or after 1985, a bad debt arose when Simpson & Marwick were working the new procedure and a decision was taken within the firm to claim the whole VAT as a bad debt; and in doing so, the firm failed to appreciate that the greater proportion of the consideration had indeed been paid by the insurance company.  Simpson & Marwick thereby adopted a flawed procedure which continued until the inspection in 2007
54.	Reference was made to 2 telephone calls which followed on 14 and 27 June 2007, which conveyed the impression to Simpson & Marwick that their approach had been correct.  The Tribunal did not hear any primary evidence from the parties to these calls, but it is apparent from the written record of each call that the respective enquiries were in fairly general terms.  Furthermore, the Tribunal has noted that HMRC’s letter dated 19 June 2007 to Simpson & Marwick (following the phone call enquiries) made particular reference to paragraph 3.13 of the Notice 700/18.  Para 3.13 clearly states that only the ‘VAT fraction of £17.50’ can be claimed as bad debt relief.
55.	Mr Johnston submitted that in normal circumstances the transaction is tax-neutral for HMRC in that VAT is paid by the insured person to the solicitor, who accounts for it as output VAT to HMRC; and the VAT is then deducted by the insured person as input tax in his own return.  This is indeed so.  However, where the insured person fails to pay the VAT to the solicitor, it is possible that the VAT might still have been deducted by the insured person as input tax in his own return – to the betterment of the insured person and a corresponding loss to HMRC.  There was no evidence that such did not happen. 
56.	It is with this background that the Tribunal looks to Simpson & Marwick’s case under the European Convention.  In the first numbered paragraph of their amendment, it was submitted that where the insured person fails to pay the VAT, HMRC would, on the basis of their interpretation of section 36, be better off because they would be obliged to repay only 7/47 of the VAT which would otherwise have been credited in full to the insured person; and that the obtaining of such an advantage would constitute a disproportionate interference with their Article 1 right.  However, this proposition is based on the premise that Simpson & Marwick acted properly in claiming relief on the whole VAT element and had thereby a right of possession in the whole amount, whereas the true position was that there had been a single supply and that the insurance company had already paid 40/47 of the consideration.  The bad debt therefore only pertained to 7/47 of the consideration.  It is also significant, as has been pointed out in the preceding paragraph, that the VAT might still have been deducted by the insured person as input tax in his own return – with a consequent loss to HMRC if the solicitor had obtained bad debt relief on the whole amount of the VAT. 
57.	The second paragraph of the amendment was that the past actings of HMRC created a legitimate expectation that they would continue to allow bad debt relief in respect of the full amount of VAT not recovered from the insured person; that such a legitimate expectation is a possession for the purposes of Article 1, and that the assessments which had been made constituted a disproportionate interference with that possession.  For the reasons set out above, the Tribunal does not find there were any “actings” on the part of HMRC that could be founded upon.  Indeed, until the inspection in 2007, HMRC were unaware of the procedure being followed by Simpson & Marwick, and there were no circumstances which might previously have put an onus on HMRC to investigate the matter.
58.	Having expressed these opinions, it is not necessary for the Tribunal to consider further the matters of jurisdiction of a First-tier Tribunal in relation to such issues. 
59.	The Tribunal therefore finds in favour of HMRC; and that Simpson & Marwick are properly assessed in the amended figure of £216,862.36.
Expenses
60.	 The Tribunal does not find any circumstances to make an order of its own initiative for an award of expenses.
61.	This document contains full findings of fact and reasons for the decision.  Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.  The application must be received by this Tribunal not later than 56 days after this decision is sent to that party.  The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.

MR JOHN M BARTON, WS
TRIBUNAL JUDGE

RELEASE DATE:  16 AUGUST 2010