19180
TAX POINT – Continuous supplies of gas and electricity – Netting agreement taking effect on Appellant going into administration – All outstanding transaction thereupon terminated – Subsequent calculation of outstanding balance – Payment of outstanding balance on agreed date – Tax point arising on date of payment or issue of invoice, whichever earlier – Calculated balance paid in period 9/02 – Further sums outstanding subject of litigation not paid or invoiced in period 9/02 – Whether outstanding sums fell to be declared in period 9/02, or tax point arose in that period – No – VAT Regs 1995, reg 86(1)

LONDON TRIBUNAL CENTRE

	ENRON EUROPE LIMITED (IN ADMINISTRATION)	Appellant

-	and –

	HER MAJESTY’S  REVENUE AND CUSTOMS 	Respondents

				Tribunal:	ANGUS NICOL (Chairman)
						RACHEL ADAMS FCA 
					 	M M HOSSAIN FCA FCIB

Sitting in public in London on 11 February 2005

Andrew Hitchmough, counsel, instructed by PricewaterhouseCoopers, chartered accountants, for the Appellant 

Amanda Tipples, counsel, instructed by the Solicitor for the Customs and Excise, for the Respondents

© CROWN COPYRIGHT 2005

DECISION

1.	This appeal is concerned with the question whether an assessment to value added tax, in the sum of £6,608,250, dated 8 September 2003, for the period to 30 September 2002, in respect of certain supplies of natural gas and electricity by the Appellant to Morgan Stanley Capital Group (“MSCG”), was raised for the correct period.  It was the Appellant’s case that it was not, and that therefore the assessment was not valid. The Commissioners’ case was that the Appellant made a taxable supply of power to MSCG in that period, and should have accounted for VAT for that period since payment was received in that period, which was, under regulation 86 of the Value Added Tax Regulations 1995, the tax point for that supply.

The facts

2.	The facts were not in dispute, and we find them to be as appears in the following paragraphs.  We take them from the statement of case and from a statement of agreed facts supplied by the Appellant.  These do not appear to have been wholly agreed, since there was a reference, in paragraph 8, to which we were particularly referred, to contentions by ECTRL, suggesting that the truth of those contentions might not have been accepted by the Commissioners.  We set out below those parts of that statement to which we were particularly referred.  

3.	The Appellant carried on the business of the wholesale supply of gas and electricity.  On 29 November 2001 an administration order was made in the High Court in respect of the Enron corporate group, and insolvency practitioners from PricewaterhouseCoopers (“PWC”) were appointed joint administrators.  Correspondence followed between PWC and the Commissioners thereafter concerning the Appellant’s VAT affairs, and a visit was made to PWC on 3 October 2002.  The visiting officers discovered that a payment of £655,858 was made by MSCG to Enron Capital & Trade Resources Ltd (“ECTRL”) in July 2002 which had been received by PWC.  ECTRL was a subsidiary of the Appellant and a member of the Enron VAT group. It was found that MSCG and ECTRL had made supplies of gas and electricity to each other., and had entered into what was described as a “netting agreement” on 25 October 2001. Under that agreement, in certain circumstances outstanding debts between the two parties were to be settled by netting off sums due from one to the other and the payment, if such payment were necessary, of the balance due.  In or about February 2002 MSCG had calculated that it owed the sum of £655,858 to ECTRL under the netting agreement. It notified PWC of that on 21 February 2002.  On 19 July 2002 PWC requested payment by MSCG of that sum, and that sum was paid.

4.	Correspondence followed between PWC and the Commissioners, and in a letter dated 8 November 2002, following a meeting on 3 October, PWC referred to that payment:

“I mentioned [at the meeting] that we had received £655,858.00 from [MSCG] in respect of what they believe to be settlement of the net position with ECTRL.  The administrators are vigorously disputing this as we believe [MSCG] owe sums far in excess of this to ECTRL.

Whilst we will not be returning this money to [MSCG] we do not believe it represents consideration for any specific supplies and we will not be issuing tax invoices to [MSCG] until such time as the dispute is resolved.  However, we appreciate that cash has changed hands and we propose to treat this for VAT accounting purposes only as a down payment.  In the absence of any adequate methodology for pro-rating the amount between standard-rated and zero-rated supplies we propose to account for VAT on the full amount on an inclusive basis i.e. 7/47 x 655,858 = £97,680.98 output tax to be declared on the 09/02 return....”

The Commissioners did not agree with that.  In April 2003 PWC submitted the return for the period 9/02.  That shewed total output tax of £5,746,018.83, which included, so the Commissioners understood, that sum of £97,680.98.  The return also shewed input tax of £7,608,738.66, and a net repayment of £1,862,719.83.  (The statement of case erroneously states that that was a net liability to the Commissioners.)  An assessment was raised, which was subsequently withdrawn.  The assessment the subject of this appeal was raised and notified on 8 September 2003.  It was in the amount of £6,608,250, being the difference between the sum claimed as input tax by MSCG, of £6,705,931, in respect of the same transactions, on the total value of the supplies calculated by MSCG under the netting agreement as having been received from the Appellant, and the amount declared by the Appellant.

5.	In further and better particulars of the grounds of appeal, submitted by PWC in April  2004, they said:

“1.	... The assessment related to VAT allegedly due on supplies made by the Appellant to [MSCG].  In accordance with Regulation 86 Value Added Tax Regulations [1995], a supply is treated as taking place each time that a payment in respect of the supply is received by the supplier, or a VAT invoice relating to the supply is issued by the supplier, whichever is the earlier.

2.	It is the Appellant’s case that the only payment received by [MSCG] in prescribed accounting period 09/02 was in the sum of £655,858. The Appellant accordingly declared output tax of £97,680, in respect of this payment, in its VAT return for period 09/02.  The Appellant therefore submits that the purported assessment issued by the Respondents is wrong in law, in that it seeks to impose an output tax charge in respect of supplies that did not take place in the prescribed accounting period concerned.”

In a third paragraph, it was pleaded further and in the alternative that the assessment had not been made to the best of the Commissioners’ judgment. This hearing was not concerned with that issue.

The netting agreement

6.	The netting agreement, made on 26 October 2001 between MSCG and ECTRL, began by reciting:

“Whereas MSCG and [ECTRL] have entered into and intend entering into (i) cash settled derivative transactions, (ii) spot and forward transactions to purchase and sell gas and electricity in the United Kingdom and Europe, and (iii) transactions, whether spot or forward transactions, with a right to purchase or sell gas and electricity in the United Kingdom and Europe (each a “Transaction”);

Whereas MSCG and [ECTRL] wish to provide for close out netting in respect of the Transactions in certain circumstances,

Now therefore in consideration of the mutual undertakings herein the parties agree as follows:”

So far as is relevant to this appeal, the netting agreement provided as follows:

“1.	Close-out Netting

	(a)	If a party or any entity providing credit support (a “Credit Support Provider”) for a party in respect of any Transactions:
	. . .
		(vi)	seeks or becomes subject to the appointment of an administrator, provisional liquidator, conservator, receiver, trustee, custodian or other similar official for it or for all or substantially all its assets;

	each an “Event of Default”, the party which has suffered, or whose Credit Support Provider has suffered an Event of Default, shall be the “Defaulting Party” and the other party shall be the “Non-Defaulting Party”,  Upon the occurrence of an event of Default the Non-Defaulting Party may by not more than 20 days’ notice in writing to the Defaulting Party specifying the relevant Event of Default and designating a day, not earlier than the day of such notice, as the date of termination (the “Early Termination Date”), terminate all, not some only, of the Transactions then outstanding.

	(b)	Upon the service of a notice in accordance with clause 1(a), no further payments or deliveries in respect of the terminated Transactions shall be made.

	(c)	On termination of all Transactions in accordance with clause 1(a) the amount due from one party to the other shall be an amount equal to the net Market Value (as defined below) of all Transactions on the Early Termination Date.  If such amount is a positive number, the Defaulting Party will pay it to the Non-Defaulting Party, if it is a negative amount, the Non-Defaulting Party shall pay the absolute value of such amount to the Defaulting Party.  For the purpose of this clause 1(c), the “Market Value” of  Transaction on the Early Termination Date means the sum in pounds sterling of: (i) the amount determined reasonably and in good faith (such determination to be based as far as possible on published indices generally relied on by participants in the relevant market) by the Non-Defaulting Party as the likely cost (expressed as a positive number) or gain (expressed as a negative number) to the Non-Defaulting party if it were required to replace the Transaction on the Early Termination date with a Transaction to be entered into with an independent counterparty in the market which would have the effect of preserving for the Non-Defaulting Party the economic equivalent of any payment or delivery which would have accrued to the Non-Defaulting Party under the original Transaction had it not been terminated; and (ii) the aggregate amounts due and remaining unpaid to the Non-Defaulting Party (expressed as a positive number) or by the Non-Defaulting party (expressed as a negative number) in respect of each Transaction.

	(d)	On or as soon as reasonably practicable following the service of a notice in accordance with clause 1(a), the Non-Defaulting Party shall make the calculations referred to in clause 1(c) and shall provide to the Defaulting Party a statement showing, in reasonable detail, such calculations (including all published indices relied on) and specifying any amount payable.

	(e)	The party due to receive the amount calculated in accordance with clause 1(d) shall invoice the other party for the same.  The amount set out in such invoice shall be due and payable on the day that is (5) five working days after the day of receipt of the invoice by the paying party (the “Due Date”).  Interest shall be payable on such amount (before as well as after judgment) in pounds sterling from (and including) the Due Date to (but excluding) the date such amount is paid at the rate set out in clause 3.

	(f)	The parties agree that the amount recoverable under clause 1(c) is a reasonable pre-estimate of loss and not a penalty.  Such amount is payable for the loss of bargain and the loss of protection against future risks and, except as otherwise specifically provided under the terms of any Transaction, neither party will be entitled to recover any additional damages as a consequence of such losses.

	(g)	If the Event of Default is also an event of default that leads to the termination of transactions in accordance with terms of any netting agreement in respect of transactions similar to the Transactions entered into by MSCG and [ECTRL] ... then the amount calculated as payable under clause 1(c) above shall be set off against any amount calculated in accordance with such netting agreement as payable as a result of termination of the transactions subject to such netting agreement.”

The notice of an event of default

7.	In a letter dated  29 November 2001, MSCG gave notice in accordance with clause 1(a)(vi) in the following terms:

“We refer to the Netting Agreement dated as of October 26, 2001 between [MSCG] and [ECTRL] (“the Agreement”).  Unless separately defined herein, capitalized terms have the meaning set forth in the Agreement.

We hereby give notice that, as a result of [ECTRL] seeking or becoming subject to the appointment of an administrator, an Event of Default as specified in clause 1(a)(vi) has occurred and is continuing.

Accordingly, we hereby give you notice that we are exercising our rights under clause 1 and designate Saturday, December 1, 2001, as an Early Termination Date in respect of all outstanding Transactions.

MSCG reserves all rights and remedies it has under the Agreement or otherwise.”

A further letter, to ECTRL, dated 21 February 2002, which referred to the letter of 29 November 2001, enclosed a statement of the net amount payable under clauses 1(c) and 1(g) of the netting agreement, “and the terms of the individual Transactions (including, without limitation, the relevant master agreements). Further details supporting the calculation of this net amount are set forth in the exhibits hereto.”  The letter concluded:

“MSCG notes that the amount of £655,858 is payable to ECTRL, which amount shall become due, pursuant to Clause 1(e) of the Agreement, five working days after the day of receipt of an invoice for such amount by MSCG.  The invoice should be addressed to Scott Wichard, with copies to Beth Ng in New York, and to James Pointon, c/o Morgan Stanley, 20 Cabot Square, Canary Wharf, London E14 4QW.

MSCG reserves all rights and remedies it has under the Agreement and the Transactions whether at law or equity, by way of contract, or otherwise.”

To that was attached a summary of calculations pursuant to the netting agreement and the Transactions, including the relevant master agreements.  The calculations are in accordance with the first and second parts of clause 1(c), and are made as at 29 November 2001, the aggregate unpaid VAT being calculated as at 30 November 2001.  The calculation shews a net amount payable by MSCG to the Appellant of £655,858.  That calculations is accompanied by some 90 pages of exhibits setting out the amounts due under each Transaction.  The invoice of 19 July 2002, from ECTRL to MSCG, refers to the calculation dated 21 February 2002.  Under “quantity supplied, the entry is “N/A”.  The net total is shewn as £655,858, and VAT of nil.

8.	The statement of agreed facts states that 

“8.	The calculations statement correctly identified the net position between the parties arising from November 2001 trading to be £10,231,392 (section 2 of the calculation statement).  This statement also contained details of approximately applied credits against that amount of £3,943,164 and £1,347.  However ECTRL took issue with a number of further aspects contained within this statement, namely sections 5, 6 and the amount payable to MSCG by ECTRIC (see below). IN particular, ECTRL contends that MSCG wrongly purported to apply the following three further credits:

i.	An amount of £2,239,924 said to be owed by ECTRL to a Spanish registered company, Endesa SA.

ii.	An amount of £1,659,419 said to be owed by ECTRL to another Spanish registered company, Endesa Trading SA.

iii.	An amount of £3,533,962 said to be owed to MSCG by a corporation registered in the state of Delaware, Enron Capital & Trade Resources International Corporation (“ECTRIC”)

This dispute as to whether MSCG was wrong to apply the above three credits is the subject matter of litigation between MSCG and ECTRL in the High Court of Justice, Chancery Division.”

9.	The exclusion of the three credits set out in paragraph 8 of the statement of agreed facts would have the result that MSCG was indebted to the Appellant in the larger amount of £6,287,381.  In July 2002 the Appellant issued an invoice to MSCG for £655,858 including VAT of £97,680, which Vat was declared in the Appellant’s return for the period 9/02.  MSCG claimed input tax of £6,705,951 in its VAT return for the period 8/02 in respect of supplies made by ECTRL totalling £38,319,606 together with that amount of VAT.  That was shewn in exhibits 2A and 2C accompanying the calculation statement and was comprised of the following:

i. 	ECTRL made supplies of £1,511,856 plus VAT of £264,574.  That was the total of the “buys” shewn in exhibit 2A
ii.	ECTRL made supplies of £36,807,750 plus VAT of £6,441,556.  That was the total of the “buys” shewn in exhibit 2C.	

10.	On 7 February 2002 ECTRL assigned all its rights and claims against MSCG to Enron Capital Trade & Resources (Recoveries) Limited which, on 21 July 2003 began proceedings in the High Court (Claim No HC03C02621) against MSCG, claiming the difference between £6,278,381 and the £655,858 already paid.

The VAT Regulations 1995

11.	The regulations, so far as bear upon this appeal, provide as follows:

“86–(1)	Except in relation to a supply to which subsection (7) and (8) of section 6 of the Act apply and subject to paragraphs (2) and (3) below, a supply of—

	(a)	. . .
	(b)	coal gas, water gas, producer gases or similar gases, or
            (c) 	petroleum gases,  or other gaseous hydrocarbons, in a gaseous state, or
	(d) 	any form of power, heat, refrigeration or ventilation,

shall be treated as taking place each time that a payment in respect of the supply is received by the supplier, or a VAT invoice relating to the supply is issued by the supplier, whichever is the earlier.”

The Appellant’s contentions

12.	Referring to the fact that no invoices had been issued in respect of supplies, Mr Andrew Hitchmough contended that as at the date of the administration no supply had been made because there had been no payment, and therefore regulation 86 had not been triggered. Referring to Exhibit 2C accompanying the calculation statement, Mr Hitchmough said that although every entry in that document, which was described as a “Buy/sell indicator from MS viewpoint” shewed an invoice date of 1 December 2001, no invoices had in fact been issued. (We understood that that was not in dispute.)  That document, which contained 301 entries, shewed sales by the Appellant of £43,249,119, including VAT if £6,441,358, and purchases from MSCG of £31,283,639 including VAT of £4,659,265.  That shewed that a sum of £11,965,480 was owed by MSCG to the Appellant.  Of that amount of £43m owed to the Appellant, £31m had been paid by way of set-off.  Applying the time of supply rule in regulation 86, the supply occurred on that date to that amount.  The same was true in respect of invoices exhibits 2A, 2B and 2C.  At the time when the Appellant was placed in administration no “supply” within the meaning of regulation 86 had been made, since no payment had been made nor had any invoice been issued.  

13.	The total amount of the supplies for which payment to the Appellant from MSCG was outstanding, as at the date of the administration, was £46,034,554 (inclusive of VAT).  Those “supplies” were made, so the Appellant contended, as follows.  As to £37,945,391, the supply was made at the latest by 21 February 2002, on which date MSCG served the calculation statement on ECTRL which set out the net trading position between them.  That date was outwith the period 9/02.  The calculation statement shewed that that sum of £37m of the £46m had been paid by way of set-off.  A further £655,858 was paid on 9 August 2002 when MSCG made a cash payment to ECTRL.  The Appellant accounted for tax in respect of that amount in the return for the period 9/02.  This is outwith the assessment.  The balance owed by MSCG to ECTRL remains unpaid and, Mr Hitchmough said, was the subject of ongoing litigation.  No VAT invoice had been issued in respect of those sums, and therefore no “supply”, under regulation 86, had been made.  Whatever the outcome of the litigation, payment of the disputed sum cannot have been received by ECTRL, or Recoveries, in the period 9/02, and therefore no “supply” for which the disputed sum was the consideration can have been made in that period.  

14.	In order to recover payment under clause 1(e) of the netting agreement it was necessary that an invoice should be served.  The invoice was served, dated 2 August 2004, for £7,433,304.  It was issued by Recoveries as assignee of the balance of funds due. If Recoveries is successful in the litigation against MSCG, Mr Hitchmough contended, no further payment in the amount of the disputed sum will have been made by MSCG or received by ECTRL via Recoveries.  That sum remains outstanding.  If no payment has been received, and since no VAT invoice has been issued by ECTRL, no “supply” has been made for the purposes of regulation 86.  The invoice referred to, of 19 July 2002,  was in accordance with the netting agreement, but it was common ground that it was not a VAT invoice, being defective in terms of regulation 14.  MSCG paid £655,858 on 6 August 2002 by electronic transfer, and that created a tax point under regulation 86.  Therefore ECTRL accounted for output tax in the return for 9/02.  That too was common ground (see paragraph 10 of the statement of agreed facts).

15.	The dispute arises because the Commissioners contend that because a payment of £655,858 was made, that meant that a supply of more than £45m was made in the same period.  It was the Appellant’s case that £36m had been set off in the earlier period 3/02, which extinguished the liability to make the payment.  If the disputed sums, as between MSCG and ECTRL were right, then that £36m was less than the actual sum.  The Commissioners were trying to fix a single tax payment in period 9/02 because a physical payment of £655,858 was made in that period, which was in fact less than 1½ per cent of the whole amount. The Appellant contended that that was clearly wrong.

16.	There were, Mr Hitchmough contended, several flaws in the Commissioners’ approach.  First, it presupposed that there must be a single supply and a single tax payment. That did not fit in with regulation 86, which referred to multiple supplies when it provided that a supply took place “each time that a payment in respect of the supply is received by the supplier, or a VAT invoice relating to the supply is issued to the supplier....”  Secondly, if ECTRL had waived its right to the £655,858, then there would have been no payment in the period 9/02, and therefore no tax point.  The Commissioners would then say that there was no tax liability. Again, if ECTRL should succeed in its High Court proceedings, but not for some considerable time, if the Commissioners are right ECTRL would have to account for VAT on a very large sum which it had not received, in spite of regulation 86.  Therefore, it followed that the only supply which took place in period 9/02 was for a consideration of £655,858, which had been physically received, and VAT paid, and which was not included in the assessment.  It follows that the assessment was raised for the wrong period. 

The Commissioners’ contentions

17.	Miss Amanda Tipples, for the Commissioners, began by analysing the nature of netting.  She said that it was a two-stage process: first, calculation, and then payment, and only on the latter event did the tax point arise.  She referred to Goode on The Principles of Corporate Insolvency Law.  At page 172, under the heading “The nature and Purpose of Set-Off and Netting”, Professor Goode said,

“Set-off is the right of a debtor who is owed money by his creditor on another account or dealing to secure payment for what is owed to him, by setting this off in reduction of his own liability.”

Under the subheading “Netting”, Professor Goode said,

“The terms ‘netting’ and ‘set-off’ are often treated as interchangeable but in financial circles netting is used in a rather wider sense to denote the totality of contractual arrangements designed to produce or facilitate contractual set-off.  These include such matters as bilateral contractual consolidation4, settlement netting5, the conversion of non-monetary into monetary claims through the exercise of a right to cancel or close out transactions, and the adoption of institutional rules giving bilateral and multilateral clearing and settlement or providing for novation of all relevant contracts to a clearing house6.

4 Otherwise known as netting by novation.
5 Also termed payment netting.
6 See pages 179 et seq. [Part cited in paragraph 20 below].”

Miss Tipples referred next to Goode on Legal Problems of Credit and Security, third edition, 2003.  In that work, at page 245, under the heading “Types of netting arrangement”, Professor Goode said,

“We have previously seen that netting includes a bilateral or multilateral arrangement for conversion of mutual claims into a single net claim.  For this purpose a number of techniques are available which in normal circumstances can be expected to be effective.  These include the following:”

Professor Goode lists “Novation netting (contractual consolidation)”, “Settlement (or payment) netting” and “Close-outs”.  Miss Tipples referred to passages from the text under the first two of those subheadings. 

18.	The first of those passages includes the following:

“The characteristic of this form of netting, which distinguishes it from settlement netting, is that the fusion of the claims on both sides into a new claim for a single balance or a single delivery obligation occurs immediately upon the occurrence of the event stipulated by the contract, whereas in settlement netting the contracts remain separate until they have been netted out at maturity and the net balance paid or delivery obligation has been discharged.”

Miss Tipples relied upon the following passage explaining settlement (or payment) netting:

... Whereas contractual consolidation involves amalgamation of unmatured claims, settlement netting is the process by which matured claims are netted out and paid.  It is only the act of payment of the net balance which extinguishes the claims on both sides.  Again, settlement netting may be effected either by bilateral arrangements or by multilateral arrangements through a clearing house.  In the former case the parties simply agree that when claims on both sides mature those on one side shall be set off against those on the other and the balance paid.”

Paragraphs 1(c) and (d) of the netting agreement had the result, Miss Tipples contended, of providing the first stage of the process, the calculation. The product was the calculation statement which specified the amount to be paid.  The second stage, provision for payment, was to be found in clause 1(e).  Only on payment of the amount in the invoice were the mutual obligations discharged.  There was in fact no invoice, but a payment was made, and the effect was to discharge the parties’ obligations.

19.	Miss Tipples contended that the litigation between MSCG and ECTRL had no bearing on the matter.  Referring to the calculation statement, Miss Tipples said that the issues in dispute were those shewn in sections 5 and 6 and the net amount.  The figures relating to supplies were not affected by the question whether sections 5 and 6 and the figure of £3.5m were correct.  What was crucial was that the netting agreement took place on 6 August 2002; the figures in section 2, of unpaid amounts and other amounts (primarily resulting from settlement of outstanding Transactions as of November 30 2001), were not affected by the dispute over sections 5 (debts owed by ECTRL to Endesa SA acquired by MSCG) and 6 (debts owed by ECTRL to Endesa Trading SA acquired by MSCG).  Miss Tipples relied upon a passage in Derham on The Law of Set-off, third edition, at paragraph 2.17, in which the author said:

“If the defendant’s cross-claim in its nature is liquidated, a set-off will not be denied simply because the cross-claim is disputed by the claimant as to all or part on grounds that require determination by litigation or arbitration.  The defendant in such a case may plead the cross-claim as a defence to an action brought against him for payment of a debt, and in an application by the claimant for summary judgment the defendant may be granted leave to defend.  As Hirst LJ remarked in Aectra Refining and Manufacturing Inc v Exmar BV [1994] 1 WLR 1634, 1647], when Cockburn CJ in Stooke v Taylor [(1880) 5 QBD 569] spoke of ‘money demands which can be readily and without difficulty ascertained’, he was referring to ascertainment of the quantum of the demand, and not to the amount which might ultimately be held recoverable after all the defences put forward had been considered.”

The payment of 6 August 2002 gave rise to the tax point, which is not affected by the dispute.  Therefore the litigation is irrelevant.   It does not affect the fact that a netting agreement was made and a netting exercise carried out resulting in the calculation statement, which identified the net a mount payable and the fact that the net amount payable had in fact been paid:  it was on that payment that the tax point arose.  That payment was made on 6 August 2002.

The Appellant’s reply

20.	Referring to Professor Goode’s Principles of Corporate Insolvency at page 179, under the heading “Contractual consolidation (novation netting)”, Mr Hitchmough drew attention to the following:

“Contractual consolidation, or novation netting, involves the amalgamation of two or more executory contracts into a single new contract to be performed at a future time.  The characteristic of this form of netting, which distinguishes it from settlement netting, is that the fusion of the claims on both sides into a new claim for a single balance or a single delivery obligation occurs immediately upon the occurrence of the event stipulated by the contract, whereas in settlement netting the contracts remain separate until they have been netted out at maturity and the net balance paid of delivery obligation discharged.”

The netting agreement, Mr Hitchmough continued, provided that being placed in administration was an event of default, which terminated all the executory contracts.  By clause 1(b), “Upon the service of a notice in accordance with clause 1(a), no further payments or deliveries in respect of the terminated Transactions shall be made.”  The Transactions were therefore replaced by a new set of obligations.  A sum became payable under the netting agreement, calculated by reference to the Transactions which had been terminated, and which were cancelled, not closed out.  The “event stipulated by the contract” was the service of the notice of default.  The numerous buy and sell contracts fused into a single new contract.  Then the calculation was made and the invoice served, and the contract was fulfilled by the payment being made.  The contracts did not remain separate.  Payment might be calculated by reference to what might have happened if the separate contracts had run their course, but that does not amount to the running of those contracts to maturity.  It does not amount to payment being made under those contracts.  The only source of payment is the netting agreement itself, all else has gone as a result of it.

21.	Referring to Professor Goode’s Commercial Law, third edition, at page 473, where the author said, under the heading “Settlement”,

“In a net settlement system the mutual obligations of the parties involved are set off against each other and only the net balance paid.  This form of netting is known as settlement (or payment) netting.  In contrast to contract netting, settlement netting is purely an accounting process and does not in itself bring about a contractual consolidation of the separate accounts which have given rise to it.  It takes place only at the point when payment falls due, and it is not until the completion of payment that the obligations under those contracts are discharged.  Net settlement takes place in two phases.  There is the netting itself, that is the computation of balances due, and this is followed by the payment of balances so ascertained.”

What the netting agreement did, Mr Hitchmough contended, was that it did bring about a contractual consolidation, a real change in the relationship between MSCG and ECTRL as a result of the service of the notice of default, which brought into play the terms of the netting agreement.  It is not a pure accountancy process.  It was the Commissioners’ case that this was settlement netting, but it was not, it was contractual or novation netting.  The former obligations to buy and sell were replaced with brand new obligations to pay the sum calculated under clause 1(c).  That, Mr Hitchmough contended, was enough to dispose of the appeal.

21.	The Commissioners were in effect saying that although the Appellant may not receive all the money due, it must nonetheless pay tax as if it had all been received.  That was not consonant with regulation 86, which provided that the tax point occurred when payment was made.  The disputed sums will not be ascertained until either settlement or judgment.

Written submissions

22.	The Tribunal received a letter from Miss Tipples, of the same date as that of the hearing, in effect a rejoinder to Mr Hitchmough’s reply as to the netting agreement.  Miss Tipples referred us again to the passage from Professor Goode’s Principles of Corporate Insolvency, at page 179 (see paragraph 17 above), and to footnote 21 to that passage which refers to Professor Goode’s Commercial Law, third edition, at page 514, under the heading “7.  Contract netting (netting by  novation)”.  The passage to which she particularly referred was as follows:

“Where parties are continuously engaged in mutual dealings it is both administratively convenient and legally prudent for them to offset or ‘net out’ their reciprocal obligations, reducing them to a single amount.  The term ‘netting’ is used in two distinct senses.  In the first, it denotes the amalgamation of two or more executory contracts into a single new contract to be performed at an agreed future date.  This is known as netting by novation, to which we now turn.  In its second sense it signifies the netting out of matured obligations for the purpose of computing a payment immediately due.  This form of netting is commonly termed payment, or settlement, netting and will be examined in the discussion of settlement.”

The Commissioners maintained, Miss Tipples said, that the netting agreement provided for netting in the second sense, the netting out of the matured unpaid obligations identified in exhibits 2A and 2C to the calculation statement, and that it was not a case of netting of contracts to be performed in the future.

23.	Mr Hitchmough, in a reply dated 15 February 2005, took issue with that contention. Referring to the same passage, he said that the netting agreement provided for a novation of the parties rights and obligations.  Those rights and obligations, to buy and sell gas and electricity at some future date, referred to as the Transactions, were executory at the time when ECTRL was placed in administration.  The effect of the service by MSCG of the notice under clause 1(a) of the netting agreement was that the Transactions were terminated before the parties obligations had matured, clause 1(b) providing that no further payments or deliveries would be made in respect of the terminated Transactions.  Therefore the terms of the netting agreement fell within Professor Goode’s description of netting by novation.  Mr Hitchmough referred to a passage in the paragraph following that set out above:

“This form of netting [contract netting] has two distinct characteristics.  It has immediate contractual force and it gives rise to a single new indebtedness which does not fall due for payment until a later date agreed between the parties.”

Mr Hitchmough observed that the netting agreement provided for the payment of the amount described in clause 1(c) following the preparation and service of the calculation statement described in clause 1(d) within five days of receipt of an invoice under clause 1(e).  Professor Goode also described netting by novation as “the fusion of the claims on both sides into a new claim for a single balance”, which, he contended, was precisely the situation in the present case.  The passage relied upon by the Commissioners in fact supported the Appellant’s case, rather than that of the Commissioners. 

Conclusions

24.	The sole issue concerns the period during which the sums paid pursuant to the netting agreement were paid by MSCG to ECTRL or to Reserves for ECTRL.  In particular, we have to consider what effect, if any, the netting agreement may have had as to the date when the tax point arose, and the interaction, if they do interact, between the netting agreement, and in particular clause 1, and regulation 86(1) of the 1995 Regulations.

25.	The terms of regulation 86 are clear.  The supply of gas or power is made, for VAT purposes, at the earlier of one of two points of time: either when, and each time that, a payment in respect of the supply is received by the supplier, or when a VAT invoice in respect of the supply is issued by the supplier.  The wording of the regulation (see paragraph 11 above) does not suggest that if, for example, supplies worth £1m are delivered, and a payment of £1,000 is made, that the tax point has occurred in respect of the entire £1m worth.  Or, again, if a VAT invoice is issued which covers only £1,000 of the various supplies making up that £1m worth, that the liability to VAT in respect of the period in which the invoice is issued extends to the entire £1m.  That is in normal circumstances, ignoring the netting agreement.  It does not appear from that wording that the detailed provisions of the contract under which gas or electricity may be delivered have anything to do with the matter. In the normal course of such a contract (the contract for the supply of gas and electricity was not produced at the hearing), the supplies would be made more or less constantly, and there would be provision for payment periodically.  But whether payment were made precisely in accordance with the contractual provisions, or whether invoices were issued regularly or irregularly and prior to each payment or not, in accordance with regulation 86 the tax point would occur either on the issue of the invoice or upon payment, whichever were the earlier.  The question then arises, whether for the purposes of regulation 86 the netting agreement, which alters the contractual relationship between the parties thereto, affects what happens under regulation 86?

26.	At the date when notice of an event of default was served, it appears that there were agreements for supplies of gas or electricity which remained uncompleted.  Those are referred to in the calculation statement (which, for convenience, we attach as an appendix to this decision).  The effect of the notice was that those outstanding agreements, “the Transactions”, were terminated forthwith, and, specifically, no further payments or deliveries were to be made in respect of those Transactions.  Until that moment, it follows, those Transactions had been current, and further deliveries and payments were to have been made. Those Transactions were, therefore, uncompleted, or executory.  So far as payment under those Transactions was concerned, none was yet due, and if it had been an invoice would normally have been issued.  That would have been the tax point.  Otherwise, presumably, it was contemplated that payment might be made without or before the issue of the invoice.  If that occurred, that would have been the tax point for the purposes of regulation 86.  With the service of the notice under clause 1(a), that situation ceased to exist, whether or not there were further deliveries or further payments due under any of the Transactions.  The netting agreement remained the only agreement under which any of those Transactions could be furthered, and that under the time-table set up by clauses 1(c) to (e).  Thereafter, there would be a single invoice in respect of the whole remaining net balance.  That invoice would, at a future date, trigger the tax point under regulation 86, unless, for some reason, payment were made before the issue of the invoice, contrary to the provisions of the netting agreement.

27.	The calculation was duly made, in accordance with clause 1(c) and (d), and served under cover of a letter of 21 February 2002.  The balance under that calculation was the sum of £655,858, as the calculation statement shews.  That total takes into account certain transactions which are mentioned, in sections 5 and 6 of the calculation statement, as being in dispute between ECTRL and MSCG, and are deducted.  Had they been included, the final balance would have been considerably greater than the £655,858.  In the events which occurred, the invoice was issued for £655,858, and that is the sum which was paid, in August 2002, and therefore within the accounting period covered by the assessment.  No other sum was either invoiced or paid during that period.  That sum was declared in the Appellant’s VAT return for that period, and output tax accounted for in respect of it.  Those were the events which actually occurred.  

28.	The difference between novation netting and payment netting are clearly described by Professor Goode. The former “involves the amalgamation of two or more executory contracts into a single new contract to be performed at a future time.”  The latter, by contrast, “is purely an accounting process and does not in itself bring about a contractual consolidation of the several accounts which have given rise to it.  It takes place only at the point when payment falls due.... Net settlement takes place in two phases.  There is the netting itself, that is the computation of balances due, and this is followed by the payment of balances so ascertained.”  What happened under the netting agreement appears to us to bear some characteristics of each type.  There was a calculation of the balances due (whether or not this is in dispute), and there was a payment of balances so ascertained.  There had also been the amalgamation of all the outstanding Transactions, and provision for the resolution of that situation at the dates in the future contained in the time-table set out in clause 1.  However, that prior termination of the uncompleted Transactions, as it appears to us, amounted to the replacement of the obligations to buy and sell with a new obligation to calculate the resultant sums under those erstwhile Transactions and to pay the sum calculated under clause 1(c).  It was clearly not purely an accounting process, because of the effect which it had upon the outstanding Transactions. Novation netting is, in our judgment, what was intended by the netting agreement, and what took place under it.

29.	In either case, the fact remains that no other invoice was issued and no other payment made save that of the sum of £655,858.  Under the netting agreement as it actually took effect, no other invoice could or should have been issued, nor payment made, until the dates laid down in clause 1.  It would only have been the issue of the invoice, or the payment, whichever came earlier, that would have activated regulation 86 and provided the tax point for any other sums receipts.  It appears to us that even if it were a case of payment netting rather than novation netting the result would be the same, given the terms of regulation 86.  There appears to us to be nothing in the netting agreement, nor in the way that it took effect, nor in regulation 86 which would have the effect of importing into the invoice which was issued the remaining sums to which the assessment was related.  The unresolved litigation is not wholly irrelevant to the position between MSCG and ECTRL, in that it might be determined that those other large sums are properly payable by the former to the latter, or it might not.  It does not appear to be suggested that that litigation is a kind of subterfuge for the purpose of escaping a very large liability to VAT.

30.	For the above reasons we have come to the conclusion that no tax point arose in respect of any sum other than the £655,858 in the period 9/02, and further that no tax point occurred in respect of any other sum in that period.  So far as the netting agreement is concerned, in our view, for the reasons we have given, we consider that it was a novation netting, and not simply payment netting.  For those reasons, this appeal succeeds.

31.	Each party made an application for its costs of the appeal in the case of success.  We therefore direct that the Commissioners pay to the Administrator the Appellant’s costs of and incidental to and consequent upon the appeal.  In case of any failure to agree as to costs, either party shall be at liberty to apply to the Tribunal in the matter of costs.  Any such application should be made not later than 42 days after the date of release of this decision.

ANGUS NICOL
CHAIRMAN

RELEASED: 25 July 2005

LON/03/944