VAT CASH ACCOUNTING– factoring debts – were the debts assigned or sold – yes – output tax required to be accounted in the period in which the debt was assigned or sold  - assessment to best judgement – yes – Appeal Dismissed – VAT Notice 731 applied. 

LONDON TRIBUNAL CENTRE

	RTI SERVICES LTD	Appellant

-	and –

	THE COMMISSIONERS OF CUSTOMS AND EXCISE	Respondents

				Tribunal:	MICHAEL TILDESLEY   (Chairman)
						 ELIZABETH MACLEOD JP, CIPM

Sitting in public in London on 17 December 2003

Mr L A Woon-Sam, Accountant, for the Appellant 

Mr Robert Kellar, Counsel, for the Respondents

© CROWN COPYRIGHT 2004

DECISION

The Appeal

1.	The Appellant is appealing against an assessment for VAT in the sum of £23097.62 (£22575 plus interest of £522.62) dated 12 April 2002. 

2.        The Notice of Appeal dated 4 September 2002 sets out the following ground of appeal:

“The assessment is flawed on a point of law. Chapter 4.5 of VAT Notice 731 refers to a debt which is sold or formally assigned as an absolute assignment. Under the factoring agreement all invoices are re-assignable and therefore none of the factored invoices was sold or formally assigned as an absolute assignment”.

The Legislation

3.	VAT Notice 731 deals with cash accounting. Paragraph 4.5 sets out the accounting arrangements for VAT in respect of factored debts where the trader is operating under the cash accounting regime. Paragraph 4.5 states that 

“If you sell or assign debts due to you in respect of supplies you have made to your customers, you must account for output tax in the tax period in which the debt is sold or formally assigned as an absolute assignment. VAT must be accounted for on the full value of the supply or supplies to which the debt relates, not on the amount for which the debt is assigned.

If subsequently, all or part of the debt is assigned back to you under a recourse clause and the debt qualifies for bad debt relief under the normal rules, you will be able to make an adjustment.

If only part of the debt is assigned back, you can only make an adjustment of VAT relating to the amount that is still unpaid. This means that for invoices which cover supplies at different rates of tax, you must attribute payments in accordance with the bad debt relief rules to work out how much of the unpaid amount relates to sales at each rate of VAT. Further details are given in Notice 700/18 Relief from VAT on bad debts”.

4.	Under the cash accounting scheme the trader calculates output tax at the end of each VAT return period on a cash received basis. However, this arrangement does not apply to a debt  sold or assigned to a factor when the trader must account for VAT on the full value of the supplies to which the debt relates at the date of sale or assignment 

The Issue

5.	The Appellant  operated the cash accounting scheme and factored most of its sales invoices through First National Invoice Finance. The issue was whether the factoring arrangement with First National Invoice Finance involved the sale or formal assignment of the debt, in which case the Appellant was required to account for the VAT on the full value of the debt in the tax period  when the debt was sold or assigned. If, on the other hand, there was no sale nor formal assignment of the debt, the Appellant was entitled to account for VAT in the tax period in which the factor received payment from the debtor. 	

The Evidence

6.	We heard evidence from Mr  LA Woon-Sam for the Appellant. Mrs Christine Gale and Mrs Lorraine McLoughlin, Customs and Excise Officers, gave evidence on behalf of the Respondents. We were also provided with a bundle of documents.

The Facts Found 

7.	The Appellant carried on business in  conveyor belts sales and repairs from premises at 147 Altwood Road, Maidenhead. The Appellant company was established in 1999 and traded throughout England and Wales. The Appellant’s turnover was about £600,000, employing ten members of staff. The Appellant was registered for VAT under registration number 756 2118 34.

8.	The Appellant operated the cash accounting scheme and factored most of its invoices to The First National  Invoice Finance Ltd. The Appellant accounted for output tax when the amount of the invoice was settled by the customer rather than accounting for the tax when the invoice was transferred to First National Invoice Finance Ltd. These arrangements enabled the Appellant to raise finance and maintain its cash flow.

9.	The Appellant sent its sales invoices to First National Invoice Finance Ltd. About 95% of those invoices were accepted by First National and classified as “approved debts”.  The remaining 5% were termed  “disapproved debts” which would arise, for example, if the customer of the Appellant exceeded his credit limit  set by First National. When an invoice for an “approved debt” was transferred, First National advanced 75% of the value of the debt to the Appellant. When the customer paid the full purchase price of an “approved debt” by the due date, the Appellant could draw upon the outstanding 25% of the debt. First National, however,  would not provide an advance in respect of “disapproved” debts.  If the customer did not pay an “approved debt” within 60 days, it was reclassified as a “disapproved debt” which required the Appellant  to return the 75% advance with interest to First National. About 50% of “approved debts” became “disapproved debts” following non-settlement of the invoice within 60 days.

10.	The Appellant’s sales invoices carried the following instruction:

       “This account has been assigned to and is to be paid to First National Invoice Finance Ltd at PO Box 697 Harrow HA1 1JQ by whom it has been purchased. Payment to or for the accounts of First National Invoice Finance Ltd will discharge the debt represented by this invoice and they must be advised of any claim or dispute in respect thereof within 10 days of receipt”.

11.	First National Invoice Finance Ltd managed on behalf of the Appellant the collection of both “approved and disapproved debts”, which included, for example, the writing and sending of solicitors’ letters to debtors.

12.	The Appellant produced a copy of its agreement with First National Invoice Ltd, which contained the following clauses:

1.1	You (the Appellant) will at our request and at your expense (including any applicable stamp duty) complete, execute and deliver to us a formal written assignment of any debt purchased by us (First National Invoice Finance Ltd).

1.2	You (the Appellant)  will hold in trust for us (First National Invoice Finance Ltd)  and separately from your own property any debt  purchased by us of which the ownership shall fail to be transferred effectively to us.

5.1 We (First National Invoice Finance Ltd) shall set up an account in your name (the Appellant) to be known as the Client account. To this account we shall:
(a)	credit the purchase price of each debt purchased by us.

	 7.1 Until the termination of the Agreement and the discharge of all your obligations you (the Appellant)  warrant and undertake:		
(g)	to keep proper books and records of account and to make appropriate entries in them to show that all debts purchased by us (First National Invoice Finance Ltd) have been sold to us.

8.8	After the ownership of any debt has been transferred back to you (the Appellant) as a result of our exercise of recourse……	

9.1	We (First National Invoice Finance Ltd) shall have the sole right to enforce payment of and collect any debt so long as we remain the owner of it…..

17	“Recourse”: our (First National Invoice Finance Ltd) right to require that you should repurchase any outstanding debt at a repurchase price equivalent to the amount of that debt as notified.

13.	Mrs Christine Gale, an Officer of Customs and Excise visited the Appellant on 29 January 2002 as part of a routine VAT inspection. She noticed that most of the sales invoices were factored through First National Invoice Finance Ltd.  Mrs Gale informed the Appellant that VAT would be due on all factored debts. The Appellant agreed to provide Mrs Gale with a list of debtors outstanding at the end of October 2001 upon which an assessment for VAT was carried out. The assessment for outstanding VAT of £23097.62 was issued to the Appellant on 12 April 2002.

Submissions

14.	Mr Woon-Sam for the Appellant relied upon  guidance issued by the Respondents dealing with factoring.  The guidance drew a distinction between non-recourse and recourse factoring. In the former the factor buys the debt, whereas in the latter the factor takes sole responsibility for debtor account management with the debt reverting back to the trader if certain conditions were met. Mr Woon-Sam contended that the Appellant’s agreement with First National Invoice Finance Ltd was a recourse agreement because the debts reverted back to the Appellant if they remained unpaid after 60 days. He was of the opinion that the agreement with First National Invoice Finance Ltd did not meet the requirement for an absolute assignment under VAT Notice 731 because of the clause  permitting  First National Invoice Finance Ltd to return unpaid debts to the Appellant.

15.	Mr Kellar, Counsel for the Respondents, submitted that the question for determination by the  Tribunal was whether the Appellant had sold or assigned the debts to First National Invoice Finance Ltd. In his view the evidence was absolutely clear that the debts had been sold or assigned by the Appellant. The agreement with First National Invoice Finance Ltd  required the debt to be sold and formally assigned by the Appellant. The words “purchase” and “purchase price” appeared in the agreement on a regular basis. The instruction on the Appellant’s invoice explicitly stated that the debt had been assigned to and purchased by First National Invoice Finance Ltd. The guidance relied upon by Mr Woon-Sam was not legally binding, whereas the wording in Notice 731 had the force of law.

Our Decision

16.	Our starting point is the wording of  Paragraph 4.5 of Notice 731 which states that if debts are sold or assigned output tax must be accounted for in the tax period in which the debt is sold or formally assigned as an absolute assignment. Paragraph 4.5 recognises the possibility that the debt could be re-assigned under a recourse agreement in which case the debt qualifies for bad debt relief. Thus the fact that the debt might revert back to the trader under a recourse agreement does not under Paragraph 4.5 alter the trader’s obligation to account for output tax in the period in which the debt is sold or assigned to the factor. This construction of Paragraph 4.5 undermines Mr Woon-Sam’s argument that the phrase “absolute assignment” excludes factoring agreements which contain recourse clauses.

17.	The agreement between the Appellant and First National Invoice Finance Ltd explicitly states that First National Invoice Finance Ltd purchases the Appellant’s debts. Under clause 1.1 First National can require the Appellant to execute a formal assignment of the debt purchased. Further the instruction on the Appellant’s invoices informs the Appellant’s customers that the debt has been assigned and purchased by First National Invoice Limited.  The fact that some of the debts are returned to the Appellant under the recourse clause in the agreement does not undermine the original purchase of the debt by First National, particularly as the recourse clause envisages that the debt in question is repurchased by the Appellant.  The evidence given by Mr Woon-Sam showed that the factoring arrangements in practice did not depart from the terms of the agreement between the Appellant and First National. 

18.	We are satisfied on the facts found  that the Appellant sold its debts to First National  Invoice Finance Ltd except  the estimated 5% of invoices which National  Invoice Finance Ltd rejects when initially offered for sale.  We, therefore, find that the Appellant should have accounted for the output tax in the tax period in which the debts were sold to First National Invoice Finance Ltd in accordance with  paragraph 4.5 of Notice 731. 

19.	The assessment for outstanding VAT was based upon the list of creditors up to 31 October 2001. Thus there is a firm basis for the assessment from which we conclude that the assessment of outstanding VAT for £23097.62 is to best judgement. We, therefore, dismiss the appeal and  make no order for costs.

MICHAEL TILDESLEY
CHAIRMAN

RELEASED:

LON/02/776