England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
The Hon Mr Justice Etherton
HC 03 C04456

		Royal Courts of Justice Strand, London, WC2A 2LL
		20 July 2005

Jacob LJ (giving the first judgment at the request of Lord Justice Judge):
 



 


1. This appeal is about the amount of rent payable for Debenhams' department store in Swindon. It is made up of 2 elements, a fixed annual amount and an 'additional rent'. That rent is a proportion of turnover. But does the turnover for the purposes of the lease include VAT or not? Etherton J found that it did not. From that decision the landlords appeal.
2. The lease was granted for a term of 99 years less 10 days from 1 October 1965. For many years Debenhams paid a rent on the basis that the turnover did include VAT, though once or twice they queried whether they should be doing so. In 2003 they decided to ask the Court for:

"A declaration that for the purposes of calculating the additional rent payable under the terms of the lease the turnover to be calculated in accordance with paragraph 3(a) of the third schedule of the lease should not include Value Added Tax".

3. Originally they also sought return of the sum said to be overpaid. But that claim has been abandoned. Since the lease has 60 years to run there is still a lot of money involved.

The Relevant Terms of the Lease

4. The terms about the rent are set out in the Third Schedule of the lease, which, so far as relevant, is as follows:

"1 The rents hereinbefore reserved shall be:

(i) the yearly sum of FIFTY-FIVE THOUSAND POUNDS

(£55,000) (hereinafter referred to as "the basic rent") and

(ii) such sum (if any) in each year (hereinafter referred to as

"the additional rent") as shall be equal to a proportion of turnover (as in Clause 3 hereof defined) calculated by taking the aggregate of:-

(a) Four per centum (4%) of the excess of turnover above the sum of ONE MILLION THREE HUNDRED AND SEVENTY-FIVE THOUSAND POUNDS (£1,375,000) and up to the sum of ONE MILLION FIVE HUNDRED THOUSAND POUNDS (£1,500,000) and

(b) Two per centum (2%) of the excess of turnover above the sum of ONE MILLION FIVE HUNDRED THOUSAND POUNDS (£1,500,000) and up to the sum of THREE MILLION POUNDS (£3,000,000) and

(c) Three per centum (3%) of the excess of turnover above the sum of THREE MILLION POUNDS (£3,000,000) without limit

…

2. (a) The basic rent shall be payable by equal quarterly payments in advance on the usual quarter days in every year the first of such payments or a proportionate part thereof being in respect of the period from the date of this Underlease to the quarter day next following to be made on the signing hereof

(b) the additional rent (if any) shall be payable in each year within Twenty-one days after it shall have been calculated and determined in manner hereinafter appearing

…

3. (a) In this Schedule the expression "turnover" shall mean the gross amount of the total sales including services from trade in the Demised Premises or any part or parts thereof by the Tenant (meaning in this context the turnover of the Tenant and of any licensee of the Tenant trading in any part of the Demised Premises) during any trading period of the Tenant commencing on or about the First Day of February in each year (hereinafter called "the Trading Period" or "trading Periods") where the context so requires and in calculating turnover account shall be taken of goods and merchandise returned by customers and accepted by the Tenant and of cash and other discounts given in the normal and ordinary course of trade and in all cases in relation to periods of less than the Trading Period (if any) turnover shall be deemed to accrue from day to day and in relation to any licensee of the Tenant turnover shall be included only for any lesser period

(b) The Tenant shall procure a certificate (hereinafter referred to as "the turnover certificate") to be issued by its Auditors within the period of two months following the last day of the Trading Period in each year specifying the amount of turnover and in the event of default involving delay in issuing the turnover certificate the Tenant shall pay to the Landlord interest on such additional rent (if any) as shall become payable by virtue of the issue of such Turnover Certificate at the rate of seven per centum (7%) per annum less income tax for the period commencing the First day next following the said period of two months

(c) The Tenant shall keep and cause each of its licensees to keep full proper and accurate records of turnover and shall afford all necessary facilities to the Landlords and their duly authorised Accountants to inspect the same at all reasonable times

(d) If the Landlords shall not agree the turnover certificate they shall give notice in writing to that effect to the Tenant as soon as may be practicable and the parties shall thereupon use their best endeavours to agree the amount of turnover provided that in default of agreement the dispute shall be referred at the instance of either party to an Arbitrator appointed by the President for the time being of the Institute of Chartered Accountants in England and Wales and if by agreement between the parties or on the decision of such Arbitrator it shall be decided that the turnover certificate shall have been incorrect then the Tenant shall forthwith pay to the Landlords the amount (if any) so agreed or found by such decision to be due together with interest thereon at the rate and for the period mentioned in sub-clause (b) hereof unless on arbitration the said Arbitrator shall desire that no such interest should be paid."

The date point

5. The lease itself is dated 19^th April 1971. But it was granted pursuant to an agreement for a lease made in 1965 – the formality of the actual lease was delayed as a result of delays to the associated head lease and possibly other transactions concerning the overall development in Swindon of which the Debenhams' new store formed part. It was not disputed that the terms which we are to construe should be considered as negotiated in 1965. And it is common ground that the lease is to be construed as of 1965.

The Factual Matrix

6. There is very little to this. In 1965 VAT did not exist. It was, at best, no more than a gleam in the eyes of some economists and the Treasury. It can have formed no part of the thinking of either party. What did exist, however, was purchase tax. This was a tax imposed only on wholesalers of goods. As far as retailers were concerned the tax was simply part of the price of the goods they bought. So also for the ultimate consumers. When a retailer bought goods he was quoted a price. It was technically necessary for the invoice to set out the price ex tax together with the tax, but as far as the retailer was concerned the only thing that mattered was the overall figure – his cost. The purchase tax to be paid by his supplier was of no direct concern to him, any more than any other cost or tax borne by his supplier.
7. That is not to say that retailers or indeed consumers were ignorant of or unconcerned by purchase tax. Far from it. I am afraid that I am old enough to remember well budget announcements of the raising or lowering of purchase tax on different items. Retailers would have to respond by raising or lowering their prices – but those responses were their own commercial decisions.
8. At the time of the lease, therefore, the trading accounts of Debenhams or any other retailer would have simply shown the cost of goods purchased and the value of goods sold. As a matter of business, the cost of goods purchased would have had factored within them the relevant purchase tax at the rate for the kind of goods concerned. But the tax itself would have formed no part of the retailer's accounts. That is as one would expect, and is confirmed by a memorandum ("the Tucker memorandum") of 1975: "in those days we added our profit to the cost price plus Purchase Tax".
9. The next piece of background is the nature of the premises. They formed an important part of a 60's town centre development. So the success or failure of the tenant and the size of its turnover depended also on the success or failure of the overall development – a matter largely out of the hands of either side.
10. Next there is the question of the extent to which price inflation would have been in the minds of the parties. I think it would have been part of the background of the negotiations. By 1965 we were told that commercial leases had begun to incorporate rent review clauses (not a few of which gave rise to disputes in the 1970's when the first review points were reached or passed without a review being activated). Moreover the lease itself contained contingent provision for a "substituted rent" upon assignment or the premises not being wholly open for trading. Such a rent would run for 21 years – but with an upward only review provision. This indicates some concern about the possibility of inflation – albeit not overarching.
11. There are, in my judgment, no other relevant background matters by which this lease is to be construed. I do not regard it as helpful to go to the detailed accounting requirements of the Companies Act 1985 or an explanatory note SSAP5 issued in April 1974 shortly after the introduction of VAT. Both of these require that a trader's accounts should not include the VAT element in figures of income or expenditure of the trader himself. It by no means follows that this lease should be construed in the light of these matters – they were simply not part of the factual matrix at the time of negotiations. Of some, but to my mind not of great significance, is that purchase tax would not have formed an explicit part of a retailer's accounts.

VAT

12. VAT works differently from purchase tax. The whole point of VAT is to bring the burden of this down to the ultimate consumer. It operates with a system of inputs and outputs to achieve this – it is well described in more detail by Miss Hazel Williamson QC in Hostgilt v Megahart [1999] STC 141 at pp.142-3. VAT is a tax on a retailer's turnover, which purchase tax was not.
13. So what happens is that a shopper at Debenhams is charged an overall price – one which includes the VAT. The invoice may show the VAT as a separate item. The money handed over belongs to Debenhams, but the VAT becomes due at the time of supply (see s.1(2) of the VAT Act 1994). Under statutory accounting arrangements Debenhams do not have to hand the money over to Customs immediately – there is an accounting period. And when the account is taken Debenhams can of course deduct the VAT they have paid their suppliers (called input tax).
14. Moreover at no point does the VAT enter into Debenhams' accounts – it is not included as part of the trading receipts, nor as part of the trading expenses.

The Judge's Construction

15. Etherton J found in favour of Debenhams. His reasons (supported by Mr Brock QC) were, in summary, as follows:

i) The expression gross amount of total sales can mean different things according to context. It is not, as Mr Furber QC had submitted, plain and unambiguous;

ii) The position was that the expression had to be construed in context, just as the expression gross receipts obtained in the theatre had to be so construed in the Nova Scotia Court of Appeal case, Lynn v Nathanson [1931] 2 DLR 457. In that case a government theatre tax had to be paid by patrons – who bought two tickets, one for the theatre and one for the tax. The tax was held to be outside the phrase in the lease.

iii) The words must be construed in a commercial context.

iv) The "purpose or at least an important purpose" of the turnover rent was sharing of the risk of trading success.

v) To include the VAT is not consistent with that purpose because it does not "swell the tenant's assets over the full duration of the annual trading or accounting period in respect of the rental accounting period" (Debenhams will have had to pay Customs meanwhile).

vi) Changes in VAT rates would directly affect the rent if VAT counts as part of turnover – that is inimical to the "important purpose".

vii) There is no difficulty in calculating sales net of VAT. This is what would have been done for the purposes of drawing up the company accounts (as now required by company law). And even if the process of auditing for rental purposes and for company accounts were not simultaneous, the same process (ex VAT) would be involved for both. VAT is excluded from a "true and fair view" of a company's profit and loss and that is what the parties had in mind.

viii) Thus, just as in the lease, trade discounts and returns are allowed for in company accounts, but VAT is not.

ix) It is irrelevant that purchase tax operated at the time when the lease is to be construed. Purchase tax was not a tax on Debenhams or its customers. Although it formed part of Debenhams' costs, whether it was passed on to its customers was purely a matter for its commercial judgment. VAT by contrast, is a non-discretionary element of the price to be charged to the customer.

16. Mr Brock supported this further by analogy. He submitted that no businessman or trader would reasonably or honestly include VAT when asked "what is your turnover". To include it would positively mislead in many circumstances – for instance if a barrister seeking judicial office included it on the form as his income he ought to be refused on that ground alone.

My opinion

17. I would reject Mr Furber QC's first submission, that the words have a single plain and unambiguous meaning. The Judge was right on this point. Context is everything – indeed, as Lord Hoffmann said in Kirin Amgen v Hoechst Marion Rousel [2004] UKHL 46, [2005] RPC 9 at [64]:

"No one has ever made an acontextual statement. There is always some context to any utterance, however meagre."

18. I also agree with the Judge that the words are to be construed in their commercial context. Indeed it is because I place even greater emphasis on commercial context, that I disagree with him.
19. What would have mattered to the businessmen negotiating this lease or agreement for a lease is money. Form would be a secondary consideration. Putting on one side formalities, purchase tax would have had a significant effect on what was actually paid by way of rent. For it was an inbuilt cost to Debenhams. True it is that it could set its own prices, but in reality (apart from sales or loss-leaders) it had to put a mark up on the price it paid. In the real world purchase tax affected ultimate prices, just like VAT.
20. So I cannot see why the parties would have regarded a substitute for purchase tax which also affected ultimate prices as excluded by the words gross amount of the total sales including services from trade. As a commercial matter, tax was included originally and is included now. It is just that the tax is levied further down the chain of supply now than it was in 1965.
21. I also think the Judge placed too much emphasis on the notion of risk sharing. Whilst no doubt turnover (with or without tax) bears some relationship with success or failure, the link is nowhere as direct as a link to profits from trading at the premises –that would be a direct link to success or failure. Other factors are clearly involved with a link to turnover only – particularly inflation. Doubtless too the success or failure of the town shopping centre itself would have affected turnover and profits – but in the end there is little to favour one construction or the other by taking this into account as a background to the negotiation.
22. Nor do I consider the fact that purchase tax would not appear in the company accounts explicitly as relevant. What does or does not appear in accounts is essentially machinery and convention. It is a secondary consideration to the actual money involved. And as I have said, in substance purchase tax did appear, masked as part of the price of goods, in the turnover figures.
23. Nor am I impressed with Mr Brock's analogy. He is of course right in that when a man is asked about his turnover he ought generally to give the ex-VAT figure. But all depends on context and, for the reasons I have expressed, I think the context in this lease is different.
24. Finally I should mention the two cases cited on wording said to be comparable. The Nova Scotia case is clearly different. The money as collected by the theatre was Crown money when collected, and as such impressed with a trust. The Judge was right to say not much assistance is gained from it (para.72). Actually none is. Nor is any assistance to be gained from Yates v Yates [1913] 33 NZLR 281 a case holding that the expression "gross income" in a will did not mean "gross receipts". The context was wildly different from that of the Debenhams lease.
25. Accordingly I would allow this appeal.

Lord Justice Mance:
 


26. I agree with Jacob LJ's reasons and conclusion, but add a few words because (for the reason given by Jacob LJ in paragraph 5) the case requires an interesting exercise of contractual interpretation in changed factual circumstances.
27. To speak even of objective intention in such circumstances involves some artificiality. Even if we were judicial archaeologists, we would find in the wording of the lease negotiated in 1965 no actual or buried intention regarding VAT, since it was introduced in April 1973, and the regime in force in 1965 was the different purchase tax regime. But no-one suggests that the lease cannot or should not apply in the changed circumstances. We have to promote the purposes and values which are expressed or implicit in its wording, and to reach an interpretation which applies the lease wording to the changed circumstances in the manner most consistent with them.
28. In that exercise, I find compelling the submission that, although the method of collection is different - purchase tax being collected at the single (wholesale) stage in the production and distribution chain, and VAT being collected in instalments - both represent in effect "a tax on final consumer expenditure in the domestic economy" (cf paragraph 2.1 of Value-Added Tax (Cmnd. 4621 dated March 1971). In 1965, purchase tax was charged by wholesalers to Debenhams, appearing as a separate item on every invoice to Debenhams. It was, inevitably, one of the elements of cost taken into account by Debenhams when arriving at an overall price which they charged to their customers for any item. The judge's observation that it was a matter for Debenhams' "discretion and commercial judgment" whether to "pass on" purchase tax to their own customers does not to my mind reflect the commercial reality.
29. It is clear from the Tucker memorandum of April 1975 that, prior to the introduction of VAT, "turnover" - defined as "the gross amount of the total sales" under clause 3(a) of the Third Schedule of the lease - was treated by both Debenhams and their then landlords as referring to the total sales amount including any element which could have been attributed to the incidence of purchase tax at the wholesale stage. It is not, and could not in my view have been, seriously argued that this involved a mistaken interpretation of the lease.
30. The argument now is that VAT is a completely different animal from purchase tax. So it is no doubt, viewed from some angles. But in the present context, where the issue is what should count as "the gross amount of the total sales" for the purposes of determining rental, I think it clear that VAT should be regarded as a substitute for purchase tax and as part of the gross amount. The Tucker memorandum (written after the then landlords had queried the effect of "the replacement of purchase tax by V.A.T.") explains that rates of VAT were (not surprisingly) set at a level which meant that the impact of VAT, as a tax on final consumer expenditure, was, at least in the case of stores like Debenhams', virtually identical in effect to the impact of purchase tax. The memorandum said thus that

"the sales figures in the days of Purchase Tax and the sales figures which we quote now [i.e. under the VAT regime] are quite reasonably comparable".

It continued, referring to the possibility of an increase of rates:

"and in fact the introduction of multi-rate V.A.T. with a 25% rate will certainly not be to the disadvantage of [the landlords] and would be comparable to the old days when Purchase Tax was raised from say 11¼[%] to 25%"

31. In these circumstances, it would be wrong to treat the differences between the incidence and operation of purchase tax and of VAT as relevant under clause 3(a) of the Third Schedule of the lease. One system replaced the other, with almost identical impact on final consumer expenditure and on the total received by Debenhams. On Debenhams' current case, the introduction of VAT would potentially have given them an uncovenanted bonus; instead of the rent being calculated by reference to a turnover amount including (in effect) purchase tax, it should, as from the moment when VAT replaced purchase tax, have been calculated by reference to a lesser net amount, even though the total paid by consumers to and received by Debenhams was effectively the same under both systems.
32. I therefore agree that this appeal succeeds, and that we should substitute for the judge's declaration a declaration that VAT is to be included in turnover for the purpose of calculating the Turnover Rent under the lease dated 19 April 1971.

Lord Justice Judge:

33. I agree with both judgments.