England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		The Royal Courts of Justice The Strand London WC2A 2LL
		4th December 1998

1. JUDGE: This is an appeal from an order of Chief Master Dyson made on 9th July of this year on application under Order 14 made by the plaintiff, Hostgilt Limited, by summons dated 19th April 1998. It raises a point of construction described as whether the price in an option agreement was "VAT inclusive" or "VAT exclusive".
2. The facts are relatively simple. Megahart Ltd, a hotel operator, or intended hotel operator, purchased a freehold property from Hostgilt Ltd under a contract which took the form of an option dated 9th June 1998 and then a sale pursuant to the exercise of the option.
3. The property itself was actually held by a company called Marble Green Limited as nominee for Hostgilt. At the time of the contract, both parties appear independently to have believed that the transaction was exempt from Value Added Tax. I should say a little about Value Added Tax in what I hope is not an over-simplification of the position.
4. Value Added Tax is charged on the supply of goods and services. It is an obligation on the supplier making the supply to pay the Value Added Tax and not on the recipient. There is a policy described as "fiscal neutrally" along the line of supply. As long as a party is making taxable supplies it can set off the tax it pays on any input into its business against the tax which it charges on any output. It can either pay the difference to, or reclaim the difference from, Customs and Excise. The only person who eventually gets fixed without any potential set off is the end consumer who is not making taxable supplies. This can be a party not making supplies at all or a party making exempt supplies, or, complicatedly, partially exempt supplies, a situation which applies in the areas of financial services, banking and the insurance industries. To anyone making taxable supplies, the imposition of VAT is irrelevant; to anyone not doing so, it is an expense such that the taking of supplies under a VATable transaction creates additional cost and makes the supply consequently more expensive.
5. Because the obligation to pay VAT is on the supplier, the supplier is obliged to treat monies received as comprising the price for the goods, which is known as the "basic price", and the VAT element as well. This arises from Section 19(2) of the VAT Act 1994 which provides: "If the supply is for a consideration in money its value shall be taken to be such amount as, with the addition of VAT chargeable, is equal to the consideration". Depending on the rate of tax the VAT element will be a differing fraction of the total receipt. At present with Value Added Tax at 17.5% that fraction is 7/47ths. Thus, if a VAT registered supplier simply charges £100 to a customer he is obliged to treat 7/47ths of that sum as tax and account for it to Customs and Excise. In order to obtain £100 net of Value Added Tax he must charge £117.50 to the customer. Also, he is obliged to give the customer the Value Added Tax receipt providing the breakdown of the basic price and the VAT which customer has paid. This is a valuable document as it enables the customer to make his own reclaim of Value Added Tax if he is himself registered for VAT.
6. It might come as a surprise to the layman to find that Value Added Tax is charged on land transactions. This is because it does not apply to residential property. However, commercial property for the last few years has been subject to a regime under which, for VAT purposes, the grant or supply of a lease under 21 years is classed as the supply of a service and the grant or transfer of a long lease or freehold is classed as the supply of goods. However, land transactions are an exempt supply unless the supplier waives the exemption, ie does what is known as "exercising the option to tax". This is quite often done in commercial property because the supplier, who is the vendor or the grantor, especially if he is a developer, will have received taxable supplies and will himself wish to set off the tax paid on these against Value Added Tax so as to reduce expenses to himself.
7. It is common ground, therefore, between the parties here that one should approach this case on the assumption that the possibility of the transaction being subject to VAT will be a circumstance generally known in the relevant industry, the commercial property industry, and would not, therefore, be a possibility that would take either party unawares in general terms.
8. I turn now to the terms of the contract.
9. The option agreement itself contains the following material terms. By Clause 1, which contains definitions and interpretation, the "Price" is described as: the price referred to in Clause 3.3. The "Sale Conditions" means the terms of the sale and purchase of the property set out in the draft contract annexed hereto. Clause 2 describes the "Call Option" which states: "In consideration of £5,000 now paid by the buyer to the seller of which the seller acknowledges receipt the seller grants to the buyer the Call Option." The exercise of the option is dealt with in Clause 3 and by Clause 3.3: "On the exercise of the Call Option the seller and the buyer will become bound to one another to complete the sale and purchase of the property at the price of £400,000". By Clause 5: "Completion of the sale of the property is to take place in accordance with the sale conditions".
10. We then come to the important Clause: "7, Value Added Tax. Sums payable under this agreement for the supply of goods and services are exclusive of Value Added Tax on the payment".
11. The sale agreement itself, the draft of which is annexed to the option agreement, provides by Clause 1:

"In this agreement the Purchase Price means £400,000". By Clause 3 it is stated: "The seller shall transfer to the purchaser the Property on the Completion Date for the Purchase Price".

12. The £5,000 was paid pursuant to the option agreement. The option itself was subsequently exercised. It was in fact exercised orally but this was accepted in lieu of the obligation to exercise the option in writing. The purchaser paid, I think, a reduced deposit but nothing turns on that. Completion of the sale took place on 8th October. At that date the purchaser paid the balance of sums bringing in total payments of £395,000, making £400,000 when including the initial option payment of £5,000 that was non-returnable. There was a transfer of the property of 8th October which stated: "In consideration of £400,000, the receipt of which is hereby acknowledged, we, Marble Green Limited" (that is the nominee) "hereby transfer to Megahart Limited the relevant property." There the matter rested. However, subsequently the plaintiff's accountants told the plaintiff that the transaction was subject to VAT. This was because, previously, the option to tax had been exercised by the previous owner and it had not been appreciated that although the nominee had not exercised the option to tax, because it was only a nominee, that previous option would remain applicable. On this basis, therefore, the plaintiff would have to pay 7/47ths of the consideration over to the Customs and Excise and must receive a significantly reduced sum for themselves. As a result, the plaintiff demanded £70,000 from the defendant, sending them a VAT invoice in November. The defendant refused to pay on the grounds that the contract did not provide for it to pay VAT in addition to the £400,000 designated as "the Purchase Price".
13. The plaintiff started proceedings and an Order 14A application was made in front of Master Dyson. The Master held that the contract did impose an obligation on the defendant to pay further VAT and gave judgment for Hostgilt, the plaintiff. He did so on the basis of his view of the construction of Clause 7, but either additionally, or in aid of that construction, he stated that there was an implied term in the contract to the effect that the purchaser would pay the VAT. The defendant did not pay the VAT into court and judgment was entered against it. The defendant has appealed.
14. In the course of that appeal it is sought to introduce a further affidavit of a Mr Bagirades. This evidence is expressly disavowed as evidence of intention going to the construction of the contract, but Mr McKay who appeared for the defendant sought to introduce it as evidence going to the question of an implied term, negativing one possible basis for implying such a term, namely an alleged common intention by the parties.
15. This affidavit was served a month before the hearing. At that time the plaintiff took the view that the evidence was irrelevant, but in the course of the hearing Mr McDonnell on behalf of the plaintiff sought to introduce a draft affidavit contesting some of the factual assertions of Mr Bagirades, in particular whether VAT was ever in fact mentioned in the course of negotiations. Mr McKay objected because of the lateness of this evidence and the surprise of it, saying that he could not deal with it. It was agreed, however, that this point would only become relevant if the question of the implication of any term had to be dealt with in detail and that consequently I should continue to hear the matter; questions of the admissibility or otherwise of this evidence could be dealt with as and when they actually arose.
16. I turn, therefore, to the point of construction. As already indicated, the words which have to be construed are: "Sums payable under this agreement for the supply of goods and services are exclusive of Value Added Tax on the payment".
17. The first point is that Mr McKay does not rely on the reference to "goods" and "supplies" in any way. It is accepted that that was a red herring and does not render the term meaningless because everybody would realise that the supply of land is deemed to be a supply of goods or services under the legislation that I have already mentioned. Neither does he contend that the £400,000 was paid under the separate sale agreement and not under this agreement, namely the option agreement, being the agreement in which Clause 7 itself actually appears. Also, he accepts that the fact that the contract was completed by the transfer cannot be relied on either by him as there is a term in the sale agreement, namely Clause 10, which prevents the merger of contractual obligations into the transfer.
18. The argument which Mr McKay puts forward is the attractively simple one that Clause 7 is merely a statement of fact and it does not go so far as to impose any obligation on the purchaser to pay Value Added Tax. In order to impose such an obligation he says an express term would be needed. He compares the position with the Law Society's Conditions which say, at Clause 1.4.1, "An obligation to pay money includes an obligation to pay any Value Added Tax chargeable in respect of that payment", and at Clause 1.4.2, "All sums made payable by the contract are exclusive of Value Added Tax". He says that in the absence of such an obligation, as is shown to have been in the mind of the draftsman of the Law Society's Conditions in including Clause 1.4.1, the obligation to pay VAT rests squarely on the vendor and is nothing to do with the purchaser.
19. He does not go so far as to suggest that Clause 7 itself can be elevated into any warranty or stipulation that the sums made payable under the contract are VAT free.
20. For the plaintiff, Mr McDonnell says that it is a common concept that prices quoted are either "VAT exclusive" or "VAT inclusive". When the quote is "VAT exclusive" this is understood to mean that the purchaser will pay the VAT as well as the quoted price; he says that is the position here.
21. Interestingly, both parties say they rely on the literal meaning of the clause. The difference is what they say that literal meaning is. Mr McKay for Megahart says that it is that the price is all that is to be paid, ie it excludes any further payment of VAT because that is an obligation imposed on the vendor and nothing to do with the purchaser. Mr McDonnell objects that this cannot be right because it has the effect of making the sum payable under the contract in fact inclusive of VAT rather than exclusive as it says, because the plaintiff would then have to pay the VAT out of that sum. Mr McKay objects that the plaintiff's construction makes "exclusive of VAT" mean that the price is to be paid plus VAT.
22. I was initially attracted to the argument of the defendant that there is no express obligation on the purchaser to pay the VAT, as the framer of the Law Society's Conditions clearly thought was necessary. However, Clause 7 was plainly intended to have some meaning and effect, and the approach of the defendant in fact gives it no meaning at all. If, as the defendant contends, and in my mind rightly, it cannot be construed as a warranty that the price simply is not VATable, then it becomes merely a very interesting statement of fact. It is plain that the inclusion of such a term in the contract is intended to have more effect than that. If the clause is not to be emasculated in this way then it really can have only one effect, namely that contended for by the plaintiff, ie to make the point that the sums quoted are the sums net of VAT which will therefore be additional.
23. This construction is, of course, only possible because there is express reference, albeit rather badly drafted, as to how VAT is proposed to be dealt with. If there were no mention at all of VAT then the sums quoted would simply be the consideration for the purchase and it would be a matter for the vendor to sort out the VAT liability on his own.
24. The question of implying a term therefore does not arise. In my judgment, it did not arise on any footing. To approach the matter as a question of an implied term simply begs the question whether VAT is payable additionally or not. If Clause 7 in fact means that it is payable additionally then no implied term to that effect is necessary. If Clause 7 does not mean that VAT is payable additionally then implying a term that it is, is not possible or justifiable.
25. The plaintiff's claim to the amount of VAT on £400,000 therefore stands or falls on the true meaning of Clause 7. In my judgment, and although it is very poor drafting, that meaning is really tolerably clear in the context of a commercial property transaction between two commercial entities, and it is that any VAT on the sums stipulated as payable under the agreement is to be an additional charge to the purchaser. I will, therefore, dismiss this appeal.
26. MR McDONNELL: My Lady, I am grateful. The only matter that remains to be dealt with is the summons to transfer the balance of this action to the Central London County Court. I do not know whether that is agreed by my learned friend.
27. MR McKAY: My Lady, it is not, but the simple point is that the action is already here. Further delay will be produced. My instructing solicitors have some experience of matters somehow not being completely and fully transferred to the County Court so that further delays will creep in. So from the point of view of avoiding delay we would resist my learned friends application.
28. JUDGE: What is the presumption as far as this matter is concerned? The matter is already here. Is the burden on Mr McDonnell to convince me that it ought to go to the County Court or are there some sort of parameters of the action which suggest that it ought to go to the County Court unless there is good reason for keeping it here?
29. MR McKAY: Your Ladyship of course has power to transfer to the County Court if your Ladyship sees fit.
30. The balance of this application this is the counterclaim which your Ladyship will see on pages 12 to 14 of the bundle. It concerns some very minor matters, if I can just summarise it briefly for your Ladyship. It concerns stored building materials, sand and concrete, which were left or allegedly left on a property at completion for some short period. It concerns alleged soil contamination of essentially the residue of diesel oil which falls between the acceptable contamination standards for public open space and for a private garden and it concerns a small building in one corner of the site which formerly had an electric substation and there is some dispute whether that building should be removed.
31. All of those matters the plaintiff says are very small and they only occur because there is this larger action for the £70,000, but the plaintiff estimates that if there is any value to them at all it is approximately £3,000, I believe. In the context of that counterclaim the value of the claim and the nature of the claim is really too small to be a matter for the High Court.
32. JUDGE: The County Court norm at the moment is about £50,000 at the moment, is it not, in damages? I have lost track of where the County Court limit has got to, I have to say.
33. MR McDONNELL: I regret to say that I cannot assist you. In any event the plaintiff says it is smaller.
34. JUDGE: As a matter of general impression, it appears to me that these are relatively minor matters and probably more appropriate in the County Court, subject to anything that Mr McKay has to say about the level of damages and subject to any point about delay.
35. MR McKAY: My Lady, I have no instructions to the value so I am unable to assist your Ladyship there. The only submission I did make, your Ladyship heard me a moment ago, was as to delay and there it is really.
36. JUDGE: I have no evidence about that all. All I have then is, as it were, counsel saying on previous experience that there tend to be delays in the County Court as to which I have really no evidence one way or the other, have I?
37. MR McKAY: My Lady, I have only been in the County Court twice in my life so this is on instructions. I have no real feel of what goes on there, I am afraid.
38. MR McDONNELL: My Lady, the plaintiff would say that the matter will actually be quicker in the County Court because of the automatic directions and also we observe that this counterclaim is at a very early stage because a request for further and better particulars of it was entered last August. No further and better particulars have yet been received. They have been ordered to be produced by 1st February 1999, but clearly there has not yet been discovery. The action is at an early stage.
39. JUDGE: At present, you are at the moment, this is the balance of the summons and you seek to make the submissions it should go to the County Court. Mr McKay, all you say is that in fact you resist that on the grounds that it is likely to delay the action. Is that the summary of the difference between you? Well, in that case to my mind this is a claim which looking at its nature is more appropriate to go to the County Court. I am not convinced that there is going to be any delay in the County Court and I will, therefore, exercise my power to transfer it to the County Court. I think that will make it the Central London Chancery list at Bloomsbury Marylebone. I am not certain but I think that will be on the face of it the County Court to which it would ordinarily be transferred. I think it has now become the Central London County Court, whatever it is, court centre or something.
40. UNIDENTIFIED SPEAKER: Doubtless if your Ladyship sends it to the County Court.
41. JUDGE: It will go to the right one. It is probably the right one, but whichever is the right County Court on that basis it should be transferred to the County Court. Do I make any other directions or is that all? It is probably all you need because any further directions will be made there.
42. Thank you both very much for your assistance on the VAT aspect of this which was very interesting and fascinating.
43. MR McKAY: I think my learned friend might have an application. MR McDONNELL: My Lady, we would apply for costs.
44. JUDGE: That must follow, must it not, I think. You succeeded on the appeal so very well the appeal dismissed with costs.
45. I am also asked would you please produce a minute because we are without an Associate today so we will have to rely on counsel to produce a form of order.
(The Court adjourned)

We hereby certify that the above is an accurate and complete record of the proceedings, or part thereof. Signed: SMITH BERNAL REPORTING LIMITED