England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Royal Courts of Justice Strand, London, WC2A 2LL
		9 February 2004

Mr Justice Field:

Introduction

1. This is an appeal by the Commissioners of Customs and Excise ("the Commissioners") from a decision of the VAT and Duties Tribunal ("the Tribunal") released on 28 January 2003.
2. The Respondent ("GMAC") supplies Vauxhall cars to members of the public on hire purchase ("HP") terms. This involves GMAC purchasing the car from a dealer and then allowing the customer to take possession of the car under one of its standard HP agreements. Whatever type of HP agreement is used, there are two supplies, a supply of goods under s.5(1) of the Value Added Tax 1994 ("VATA") and Schedule 4 thereto, and a supply of credit. The supply of goods is a chargeable supply but the supply of credit is an exempt supply. The VAT payable on the supply of goods is calculated by reference to the total sum payable over the term of the agreement, net of the credit charges ("the sale price") even though the hirer may have an option not to pay all of the sums specified in the agreement. The sale price plus VAT is referred to as the "cash price" in the HP documentation. The supply of goods is regarded as taking place at the time the hirer takes possession of the car (s. 6 (2)(a) of VATA and paragraph 1(2)(b) of Schedule 4 thereto). GMAC accordingly becomes accountable for the whole of the VAT up front. This causes problems when the HP agreement does not run its full course, either because GMAC has terminated it consequent on a breach by the hirer, or because the hirer has terminated it pursuant to a liberty to do so, whether under the agreement or under s. 99 of the Consumer Credit Act 1974. There are problems because when an agreement is terminated GMAC will not have received from the hirer all of the VAT for which it has accounted. There are also problems arising out of the sale ("the resale") of the car by GMAC. GMAC says that, whether the termination was consequent on a breach by the hirer or not, the resale is covered by article 4(1)(a) of the Value Added Tax (Cars) Order 1992 ("the Cars Order") and is thus not a chargeable supply: it is accordingly not accountable for VAT on this transaction. The Commissioners argue that a resale is only within article 4(1)(a) (and thus a de-supply) where the termination was triggered by the hirer's breach; otherwise the resale is a chargeable supply and GMAC is accountable for VAT in the ordinary way.
3. Where the HP agreement is brought to an end by the hirer pursuant to a right to do so, whether contractual or statutory (referred to hereafter as a "consensual termination"), it is common ground that if the documents available to GMAC are sufficient to satisfy the requirements of regulation 24 of the Value Added Tax Regulations 1995, GMAC is entitled under regulation 38 to adjust its VAT account by making a negative entry therein in respect of the decrease in the consideration for the supply. Where the HP agreement is terminated following a breach by the hirer, GMAC argues that clause 9 of their standard HP conditions applies, with the result that in this situation too it is entitled to an adjustment in its VAT account under regulation 38. The relevant parts of clause 9 provide:

We [ie GMAC] may end this agreement and/or the hiring if any of the following events happen …

(a) you do not pay any sum owing to us, or if you break this agreement in any other significant way ..

(b) ….

( c) ….

If we end this agreement as a result of one of the events above … then you must pay us:-

(a) all arrears of instalments and other sums due at the date of termination; and

(b) the cost of putting the Goods into good order, repair and working condition; and

(c) as compensation or liquidated damages for breach of this agreement the rest of the Total of Subsequent Payments^[1] in respect of the Goods and the Services which would have been payable by you under this agreement after the date of termination, less (i) the net resale price of the Goods if repossessed and sold or, if repossessed but not sold within six weeks of the date of termination, their trade value, and (ii) (if this agreement is regulated) on payment, the statutory rebate.

The hearing before the Tribunal and before me proceeded on the basis that clause 9 is an enforceable provision. GMAC argues that the effect of clause 9 is that the sale proceeds are not received as part of the consideration for the supply. The decrease in the consideration is therefore equivalent to the resale proceeds, and GMAC's VAT account should be adjusted accordingly.

4. The Commissioners, on the other hand, contend that where the HP agreement comes to an end following a breach by the hirer, the situation is one of non-payment, not one of a reduced price, notwithstanding clause 9. The result is (they submit) that the relief to which GMAC are entitled is bad debt relief under s. 36 of VATA and not an adjustment under regulation 38. Further, they contend that the bad debt relief to which GMAC is entitled is calculated by setting the resale proceeds off against the sum unpaid. The Tribunal upheld GMAC's contentions on this issue ("the bad debt relief issue"). The Commissioners argue that the Tribunal were wrong to do so.
5. The dispute between the parties where there has been a consensual termination relates to the resale of the car. The Tribunal upheld GMAC's contention that a resale following a consensual termination is a de-supply by virtue of article 4(1)(a) of the Cars Order 1992. The Commissioners appeal against this finding. They contend that such a resale does not fall within article 4(1)(a) so that GMAC are accountable for the VAT in respect of the resale. The Tribunal called this issue "the article 4(1)(a) issue" and I shall adopt the same terminology.
6. The third issue raised in this appeal is concerned with whether the documents available to GMAC are sufficient for the purposes of Regulation 38. The relevant parts of regulation 38 provide:

(1) Subject to paragraph 1A below, this regulation applies where –

(a) there is an increase in consideration for a supply, or

(b) there is a decrease in consideration for a supply,

which includes an amount of VAT and the increase or decrease occurs after the end of the prescribed accounting period in which the original supply took place.

….

….

(2) Where this regulation applies, the taxable person shall adjust his VAT account in accordance with the provisions of this regulation.

(3) The maker of the supply shall –

(a) in the case of an increase in consideration, make a negative entry; or

(b) in the case of a decrease in consideration, make a negative entry,

for the relevant amount of VAT in the VAT payable portion or his VAT account.

7. "Increase in consideration" and "decrease in consideration" are respectively defined in regulation 24 to mean an increase or decrease in the consideration due on a supply made by a taxable person which is evidenced by a credit note or debit note or any other document having the same effect. GMAC did not issue credit or debit notes to hirers when HP agreements terminated. The Tribunal held that the documents covering the specimen transactions put before them had the same effect as a credit or debit note. GMAC was accordingly in a position to claim an adjustment to their VAT account under regulation 38. The Commissioners contend that this finding is erroneous. Like the Tribunal, I shall call this issue "the regulation 24 issue".

The bad debt relief issue

8. The UK legislative provisions relevant to this issue are regulation 38 and section 36 of VATA. Regulation 38 is set out above. The pertinent parts of s. 36 read:

(1) Subsection (2) below applies where –

(a) a person has supplied goods or services and has accounted for and paid VAT on the supply,

(b) the whole or any part of the consideration for the supply has been written off in his accounts as a bad debt, and

( c ) a period of six months (beginning with the date of supply) has elapsed.

(2) Subject to the following provisions of this section and to the regulations under it the person shall be entitled, on making a claim to the Commissioners, to a refund of the amount of VAT chargeable by reference to the outstanding amount.

9. Regulation 38 and s.36 were enacted to give effect to Article 11C.1 of EC Council Directive 77/388 (the 6^th VAT Directive) which provides:

1 In the case of cancellation, refusal or total or partial non-payment, or where the price is reduced after the supply takes place, the taxable amount shall be determined by the Member States.

However, in the case of total or partial non-payment, the Member States may derogate from this rule.

10. In respect of the supply under GMAC's HP agreements, the "taxable amount" referred to in Article 11C.1 is "everything which constitutes the consideration which has been or is to be obtained by the supplier from the purchaser", see Article 11A.1(a).
11. As already stated, the Commissioners accept that where there is a consensual termination of a GMAC HP agreement, there is a decrease in the consideration for the supply for the purposes of regulation 38, assuming that that decrease is evidenced by a credit or debit note or other document having the same effect.
12. An example of a consensual termination is afforded by what was known before the Tribunal as the Linda M transaction. Linda M entered into an HP agreement with GMAC which gave her three choices once she had paid all the instalments save the last, which was a balloon payment of £4,240. She could pay the balloon payment and then sell the car to the dealer from whom she acquired the car at a price to be agreed. Alternatively, she could pay the balloon payment, and keep the car, having thereby obtained title to it. Or, she could elect not to pay the balloon payment, in which case she had to return the car but she had no other monetary obligation under the agreement. In the event, she returned the car to GMAC and opted not to make the balloon payment. The Commissioners accept that, subject to the regulation 24 issue, GMAC is entitled to adjust its VAT account by making a negative entry therein in the sum of £4,240. (As already noted the Commissioners contend that the resale of the car in the Linda M type case is not within article 4(1)(a) and is therefore a chargeable supply).
13. An example of a non-consensual termination is afforded by another case which was before the Tribunal, that of Barry N. Barry N entered into an HP agreement with GMAC on 7 October 1997. The car in question was purchased by GMAC from the dealer for £14,480. Barry N provided £1,608, leaving £12,872 to be paid off under the agreement. Clause 9 of the agreement was in the terms set out above. After Barry N had paid 28 instalments, he defaulted. A few weeks later he wrote to GMAC saying that he no longer wished to keep the car and followed this up with a "voluntary surrender letter", in the terms of a pro forma used by GMAC. Barry N owed £6,505. The car fetched £4,365 at auction, which left £2,631 due from Barry N to GMAC under clause 9. Recovery proceedings were then commenced for this sum, which were settled on payment of £1,500. GMAC accordingly wrote off £1,131.
14. Mr Prosser QC for GMAC submits that Article 11C.1 of the 6^th Directive draws a distinction between a situation of "refusal or total or partial non-payment" and a situation "where the price is reduced". He argues that in the former, the consideration (the price) for the supply has not been reduced, it has simply not been paid in whole or in part: the debt has therefore become bad and bad debt relief is available under s. 36 of VATA. In the latter situation, however, the consideration (the price) for the supply has been reduced (whether by agreement or not) in which case there is a decrease in the consideration and relief can be had under regulation 38.
15. Mr Prosser argues that the fact that clause 9 comes into operation following a breach by the hirer is irrelevant. He submits that the effect of that provision is that the consideration for the supply is decreased because in place of an obligation to pay the cash price, there is substituted an obligation to pay off instalments in arrear, plus the difference between the total of the future instalments and the resale proceeds. He contends that the return of the car is not part of the consideration for the supply and nor are the resale proceeds. The decrease in the consideration is therefore equivalent to the resale proceeds, and subject to the regulation 24 issue, GMAC is entitled to a corresponding adjustment under 38.
16. In support of these submissions, Mr Prosser cited Elida Gibbs Ltd v Customs and Excise Commissioners [1996] STC 1387 and Freemans plc v Customs and Excise [2001] STC 960. In Elida Gibbs, the claimant ("Gibbs") was a manufacturer of toiletries, a large proportion of which it sold to retailers and the remainder to wholesalers or cash-and-carry traders for resale to retailers. It operated two types of coupon schemes. Under the first type, consumers obtained coupons circulated in magazines and newspapers and obtained a price reduction from the retailer who was reimbursed by Gibbs. Under the second type, the consumer could obtain a cash refund from Gibbs. Gibbs requested a repayment from the Commissioners of output tax overpaid by it on the basis that the money refunded on the coupons constituted a retrospective discount reducing the price of its goods so that pursuant to article 11C of the 6^th Directive, the taxable amount ought to be reduced accordingly. The Commissioners refused the request. The ECJ took a different view and upheld Gibbs's claim. In paragraphs 19 –24 and 28 – 31 of its judgement, the Court said this:

19. The basic principle of the VAT system is that it is intended to tax only the final consumer. Consequently the taxable amount serving as a basis for the VAT to be collected by the tax authorities cannot exceed the consideration actually paid by the final consumer which is the basis for calculating the VAT ultimately borne by him.

20. Thus in Staatsecretaris van Financien v Hong Kong Development Council (Case 89/98) [1982] ECR 1277 at 1285, para 6 the court held that it was apparent from EC Directive 67/227 of 11 April 1967 on the harmonisation of the legislation of the member states concerning turnover tax …..that one of the principles on which the VAT system was based was neutrality, in the sense that within each country similar goods should bear the same tax burden whatever the length of the production and distribution chain.

21 That basic principle clarifies the role and obligations of taxable persons within the machinery established for the collection of VAT.

22. It is not, in fact, the taxable persons who themselves bear the burden of VAT. The sole requirement imposed on them, when they take part in the production and distribution process prior to the stage of final taxation, regardless of the number of transactions involved, is that, at each stage of the process, they collect the tax on the behalf of the tax authorities and account for it to them.

23. In order to guarantee complete neutrality of the machinery as far as taxable persons are concerned, the Sixth Directive provides, in Title X1, for a system of deductions designed to ensure that the taxable person is not improperly charged VAT. As the court held in its judgment in Gaston Schul Douane Expediteur BV v Inspecteur der Inverrechten en Accijnzen, Roosendaal (Case 15/81) [1982] ECR 1409 at 1421 at para 10, a basic feature of the VAT system is that VAT is chargeable on each transaction only after deduction of the amount of VAT borne directly by the cost of the various price components of the goods and services. The procedure for deduction is so arranged that only taxable persons are authorised to deduct from the VAT for which they are liable the VAT which the goods and services have already borne.

24. It follows that, having regard in each case to the machinery of the VAT system, its operation and the role of the intermediaries, the tax authorities may not in any circumstances charge an amount exceeding the tax paid by the final consumer.

28. In circumstances such as those in the main proceedings, the manufacturer, who has refunded the value of the money-off coupon to the retailer or the value of the cash-back coupon to the final consumer, receives, on completion of the transaction a sum corresponding to the sale price paid by the wholesalers of the retailers for his goods, less the value of those coupons. It would not therefore be in conformity with the directive for the taxable amount used to calculate the VAT chargeable to the manufacturer as a taxable person, to exceed the sum finally received by him. Were that the case, the principle of neutrality of VAT vis a vis taxable persons, of whom the manufacturer is one, would not be complied with.

29. Consequently, the taxable amount attributable to the manufacturer as a taxable person must be the amount corresponding to the price at which he sold the goods to the wholesalers or retailers, less the value of those coupons.

30. That interpretation is borne out by art 11C(1) of the Sixth Directive which, in order to ensure the neutrality of the taxable person's position, provides that, in the case of cancellation, refusal or total or partial non-payment, or where the price is reduced after the supply takes place, the taxable amount is to be reduced accordingly under conditions to be determined by the member states.

31. It is true that that provision refers to the normal case of contractual relations entered into directly between two contracting parties, which are modified subsequently. The fact remains, however, that the provision is an expression of the principle, emphasised above, that the position of taxable persons must be neutral. It follows therefore from that provision that, in order to ensure observance of the principle of neutrality, account should be taken, when calculating the taxable amount for VAT, of situations where a taxable person, who, having no contractual relationship with the final consumer but being the first link in a chain of transactions which ends with the final consumer, grants the consumer a reduction through retailers or by direct repayment of the value of the coupons. Otherwise, the tax authorities would receive by way of VAT a sum greater than that actually paid by the final consumer, at the expense of the taxable person.

17. In Freemans plc the claimant was a mail order company which sold goods listed in a catalogue. Certain customers bought goods from the claimant as agents with a view to selling the goods to other members of the public. When an agent paid for goods, the claimant set aside 10% of the price in a separate account, the monies in which the agent could withdraw or use to defray sums owed by him or by other customers. Originally the claimant was allowed to deduct the 10% when calculating its VAT liability regardless of whether the agents had drawn down on their accounts. On 1 March 1997, however, a new scheme was introduced, under which the claimant could not deduct the 10% until the discount had been withdrawn by the agent or set against the purchase price of goods. The claimants maintained before the Tribunal that they were entitled to deduct the 10% without having to await drawdown by the agents. The Tribunal referred a question to the court asking whether on the proper construction of Articles of 11A and 11C the taxable amount was the full catalogue of the goods less the discount or the full catalogue price less a reduction as when the discount was withdrawn or used by an agent. The ECJ held that the taxable amount was the full catalogue price, reduced by the amount of the discount at the time it is withdrawn or used in another way by the agent. In paragraph 33 of its judgement, the court said:

In that regard, it suffices to state that the wording of art 11C (1) of the Sixth Directive does not presuppose such a subsequent modification of the contractual relations in order for it to be applicable. In principle, it requires the member states to reduce the taxable amount whenever, after a transaction has been concluded, part or all of the consideration has not been received by the taxable person (see Goldsmiths (Jewellers) Ltd v Customs and Excise Comrs ...Case C-330/95) [1995] STC 1073 at 1086-1087, [1997] ECR 1-3801 at 3822-3823, paras 16, 17 and 18). Moreover, there is no indication that in its judgment in Elida Gibbs the court wished to restrict the scope of application of that provision. On the contrary, it is apparent from the facts of the Elida Gibbs case that there had been no modification of the contractual relations. Nevertheless, the court held that art 11C (1) of the Sixth directive was applicable.

18. As the Tribunal observed in paragraph 42 of their decision, it is clear from this paragraph of the ECJ's judgement that Article 11C.1 is applicable both to a price reduction occurring by operation of the terms of the original agreement under which the supply was made and to a price reduction resulting from a subsequent variation of those agreements.
19. Mr Prosser also relies on Goldsmiths (Jewellers) Ltd v Customers and Excise Commissioners [1997] STC 1073 and paragraph 74 of the Opinion of Advocate General Jacobs and paragraph 65 of the judgement of the ECJ in EC v Germany [2003] STC 301 for the proposition that although Article 11C.1 refers to "conditions which shall be determined by the member states", those "conditions" may not cut down the right given by Article 11C.1 to a reduction in the taxable amount. Instead, the conditions are limited to ensuring that the reduction is justified and not fictitious, for example by requiring proper documentary evidence of payments made.
20. Mr Parker QC for the Commissioners contends that as a matter of substance and reality, if the hirer defaults the situation is one where there is a total or partial non-payment: the relief available is therefore bad debt relief, not an adjustment under regulation 38. He also says that the court should have regard to the situation following the resale of the car. He accepts that where the termination results from the hirer's default the resale falls within article 4(1)(a) of the Cars Order, but he goes on to submit that, this being the case, unless the relief available to GMAC is limited to bad debt relief (which in his submission involves the resale proceeds being set off against the debt owed), there will be under taxation which will undermine the purpose of the European legislation. His skeleton argument contained the following example to illustrate this submission.

A hire purchase company supplies a car to a customer at a total price of £15,000. The customer defaults after paying only £5,000. The hire purchase company repossesses the car and sells it at auction for £6,500.

Commissioner's analysis		VAT
VAT on the original supply	£15,000 x 7/47 =	£2234.04
Subsequent disposal of repossessed car (de-supplied under Art. 4(1)(a) Cars Order)	£6500	£0.00
Bad Debt Relief on remaining amount (£10000 - £6500)	(£3500) x 7/47 =	(£521.27)
Net VAT accounted for		= £1712.77
This reflects the total amount received in respect of the car,	£5000 plus £6500 = £11500 x 7/47 =	£1712.77.
Tribunal decision (which accepted GMAC's argument)		VAT
VAT on the original supply	£15,000 x 7/47 =	£2234.04
Subsequent disposal of repossessed car (de-supplied under Art. 4(1)(a) Cars Order)	£6500	£0.00
Reduction in consideration of £6500	(£6500) x 7/47 =	(£968.08)
Bad Debt Relief on remaining amount (£10000 - £6500)	(£3500) x 7/47 =	(£521.28)
Net VAT accounted for		= £744.68

Here VAT has only been accounted for on the amount received from the original customer, £5000 x 7/47 = £744.68. The further consideration of £6500 is not subject to VAT. And the Commissioners submit that this is contrary to the over-riding principles of VAT.

21. Like the Tribunal, I uphold Mr Prosser's submissions. The effect of clause 9 is that the consideration for the supply of goods is reduced by agreement from the cash price to the cash price less any outstanding instalments and the resale proceeds. It matters not that the agreement providing for the reduced price was contained in the original agreement and was not the subject of a separate, subsequent agreement. The resale proceeds are not paid by the hirer; still less are they paid by the hirer as consideration for the supply. Nor is the redelivery of the car any part of the consideration for the supply. Further, to hold that the effect of Article 11C.1 is that the sale proceeds are part of the consideration for the supply of the goods would involve breaching the fundamental principle that the taxable party is only accountable for the amount of VAT paid by the consumer, in this case the hirer. This is so because, where the agreement terminates and clause 9 applies, the hirer does not pay the full VAT element of the cash price but only the VAT element of the instalments paid or payable at the time of termination and of that part of the outstanding instalments that remains after the resale proceeds have been deducted.
22. I accordingly uphold the decision of the Tribunal on the bad debt issue.

The article 4(1)(a) issue

23. It is common ground that all of GMAC's HP agreements are "finance agreements" for the purposes of Article 4(1)(a) of the Cars Order. The Tribunal's conclusions on this issue are contained in the following paragraphs of the decision:

18. We are satisfied that the term "repossessed" in article 4(1)(a) of the Cars Order is not to be construed as referring only to the situation where the finance company in question has re-taken possession of the motor car following a default on the part of the hirer. It is, we think, equally applicable to all situations where "under the terms of the finance agreement" the finance company has resumed possession of the motor car to the exclusion of the hirer. There is no necessary implication in the wording of the Cars Order that requires us to give it a more restricted meaning. Indeed, it seems to us that the evident purpose of this provision is, as it was said by the 1973 explanatory note to have been, to avoid more than one charge to VAT on the same added value in relation to the same motor car. In reaching this conclusion we recognize that the use of the word "repossess" in the definition (in article 2 of the Cars Order) connotes resumption of possession in exercise of a power given to the hire purchase company (or other "seller"). But that is simply for the purpose of the definition of "finance agreement". In article 4(1)(a) by contrast the word is used in a less qualified sense. The critical thing there is that possession of the car is resumed "under the terms of (the) finance agreement", but not necessarily in exercise of a power given to the hire purchase company; and that is what happened in the case of the Linda M agreement.

19. Before we leave the article 4(1)(a) issue, we mention an argument advanced by the Commissioners. Unless the term "repossessed" is read as confined to situations where a customer has defaulted on his obligations under his hire purchase agreement, a mismatch will (it is argued) result. The Commissioners produced a simple example (which we refer to as "Example A"). The steps in Example A are:

(i) a supply on hire purchase of a car for the total payments of £15,000 (ignoring interest);

(ii) the return of the car by the customer (in exercise of his rights either under the Consumer Credit Act or under the Choices 1,2,3 agreement) after £10,000 of instalments have been paid and

(iii) the sale of the car by GMAC for £4,000.

21. Step (i) in Example A results in £2,234.04 of VAT becoming payable. Step (ii) results in an adjustment under regulation 38 (given that the paperwork complies with the definition of "decrease in consideration" in regulation 24); £744.68 of VAT is repayable to GMAC. So far both parties are agreed, and the net amount of VAT borne by GMAC will be £1,489.36 (i.e. £2,234.04 minus £744.68). GMAC's resale at step (iii) will, say the Commissioners, be outside the scope of article 4(1)(a) with the result that an extra £595.74 of VAT is payable (on the proceeds of sale of £4,000). That makes £2,085.10 of VAT; that is the tax on £14,000 which is the total amount of consideration that GMAC will have obtained from transactions in relation to that particular car. The Commissioners point to GMAC's calculations which accept that £1,489.36 is payable. But, they observe, that is only VAT on £10,000. If GMAC does not have to bear the VAT on the resale price of £4,000 (because the resale is within article 4(1)(a), as GMAC content; there will be a mismatch.
   22. We do not find the Commissioners' argument based on Example A to be persuasive. There is nothing in the VAT code that requires us to link the Cars Order provisions with regulation 38 when we come to construe the words used in the Cars Order. The Cars Order is a much earlier provision than regulation 38, which appears to have been introduced to implement Article 11C. l of the Sixth Directive. But more to the point we are not satisfied that the circumstances of this one particular example are so representative as to demonstrate a necessary implication that the word "repossessed" should be given the narrow meaning relied upon by the Commissioners. Our conclusion on the article 4(1)(a) issue is therefore in GMAC's favour.

24. In support of his argument that the Tribunal's reasoning and conclusion were wrong, Mr Parker submits that article 4(1)(a) must be read in the light of the definition of "finance agreement" in article 2 (1) of the Cars Order which reads: " "finance agreement" means an agreement for the sale of goods whereby the property in those goods is not to be transferred until the price has been paid and the seller retains the right to possess the goods." Read in the light of this provision, the words " who repossessed it under the terms of a finance agreement" in article 4(1)(a) mean, contends Mr Parker, "who repossessed it by the active exercise of a contractual right under the terms of the finance agreement".
25. In the alternative, Mr Parker contends that article 4(1)(a) is ambiguous and should be interpreted in light of the fundamental principle that VAT is a broadly based proportionate consumer tax levied at every stage of commercial supply on supplies of goods and services; pursuant to this principle, given that GMAC will benefit from a regulation 38 adjustment if there is a consensual termination, article 4(1)(a) should be construed as applying only where the hirer is in breach, since in this latter situation GMAC will be entitled only to bad debt relief, this being relief which in Mr Parker's submission involves the proceeds of resale being set off against the debt owed.
26. Mr Prosser submits that the Tribunal's reasoning should be upheld. He contends that the words "repossessed … under the terms of a finance agreement" in article 4(1)(a) do not connote repossession as a result of the active exercise of the right to repossess. Instead the words contemplate any repossession under the terms of a finance agreement; and since all of GMAC's HP agreements expressly provide that where the agreement or the hiring ends without title in the car passing to the hirer, the hirer has to return the car immediately, the sale of a car by GMAC after the hirer has voluntarily given up possession of it (as happened in the case in Linda M) falls within article 4(1)(a).
27. Mr Prosser further submits that the article 4(1)(a) regime and the regulation 38 regime are quite separate and independent and GMAC is entitled to rely on both. He also contends that the Explanatory Note to the first Cars Order --which contained a provision identical to article 4(1)(a) -- can be looked at to determine the article's purpose, because the article is ambiguous. For this latter contention he relied on the decision of the House of Lords in Coventry Waste Ltd v Russell [1999] 1 WLR 2093 at 2103E. The Explanatory Note reads:

"This Order removes from the scope of VAT disposals by finance houses … of certain used cars.  Any such disposals would otherwise be a supply of goods … and would be chargeable to tax even though the goods had previously borne tax."

28. This shows, argues Mr Prosser, that the purpose of article 4(1)(a) is to preclude a second charge to VAT on the resale of a used car which has already borne VAT on the occasion of the first supply to a non-taxable person i.e. the hirer. There are two reasons why there should be no VAT on the resale. The first is that the imposition of the tax on such a transaction would distort the used car market for traders. It would have this effect because many of the sellers in that market are ordinary individuals who do not have to charge VAT. This was explained by the ECJ in EC Commission –v- Netherlands (Case 16/84) [1985] ECR 2355 at 2371, para. 18, and in EC Commission –v- Ireland (Case 17/84) [1985] ECR 2375 at 2380, para. 14, as follows:

"Second-hand goods which are reintroduced into commercial circulation are … taxed once again, whereas second-hand goods which pass directly from one consumer to another remain burdened solely by the tax imposed on the occasion of the first sale to a non-taxable consumer.  Especially where the rate of VAT is high, that difference in treatment distorts competition between direct sales from one consumer to another and transactions passing through ordinary commercial channels, and thus places at a disadvantage branches of trade in which a large number of transactions involve second-hand goods, such as the motor-car trade in particular."

The second reason is that, unless the resale is made a non-chargeable supply, there would be double taxation because there would be residual VAT from the first supply even after the regulation 38 adjustment. Sales of repossessed cars by finance companies have never qualified for the profit margin scheme that is the principal instrument for ensuring that traders are not disadvantaged in the used car market. Article 4(1)(a) was therefore enacted both to avoid double taxation and to relieve finance companies of what would otherwise be a disadvantage in the used car market that would distort competition. It follows that article 4(1)(a) applies as much to a sale where the car was repossessed following a breach by the hirer as to sale where the car was repossessed following a consensual termination.

29. In my opinion, the definition of "finance agreement" in article 2(1) does not lead to the construction of article 4(1)(a) contended for by Mr Parker. In my judgement, article 4(1)(a) is not ambiguous. I hold that when the provision is construed in its context, without reference to the Explanatory Note, its plain and ordinary meaning is that it applies where the reseller has regained possession of the car in accordance with the terms of the finance agreement, whether or not there has been a breach by the hirer and whether or not the finance company has had actively to exercise a contractual right to take the car back. All of GMAC's HP agreements expressly provide that the hirer has to return the car to GMAC if the agreement or hiring is terminated before payment of the cash price. Thus, wherever GMAC resells a car after it has regained possession of it following a consensual termination, the resale is within article 4(1)(a) even if the hirer has voluntarily returned the car. If Mr Parker's construction were right, a resale would be outside article 4(1)(a) where a defaulting hirer has voluntarily redelivered the car, but would be within the provision if the defaulting hirer has had to be proceeded against to deliver up the car. In my view, it was never Parliament's intention that this distinction should be drawn.
30. Even if, contrary to the conclusion I have just expressed, article 4(1)(a) is ambiguous, I still reject the submission that article 4(1)(a) does not apply where there has been a consensual termination. What is now article 4(1)(a) of the Cars Order was first enacted as article 3(a) of The Value Added Tax (Treatment of Transactions) (No. 4) Order 1973 ("the 1973 Order"). At the time the 1973 Order was made, s. 30 of the Finance Act 1972 was in force and provided that regulations could be made to make provision for the adjustment of VAT where the consideration is reduced or no consideration becomes payable. However, no regulations were made to provide for such an adjustment until the VAT (Accounts and Records) Regulations 1989 came into force. Article 4(1)(a) in the 1992 Cars Order must mean the same as article 3(a) in the 1973 Order, and no one knew when the latter Order was made just what provision would be enacted for adjustments to VAT where the consideration is reduced or none becomes payable. It would therefore have been impossible to construe art 3 (a) in conjunction with the adjustment provisions as Mr Parker urges the court to do. In any event, construing article 4(1)(a) in the light of regulation 38 does not help the Commissioners because I have already held that regulation 38 applies where the agreement terminates on the hirer's breach and clause 9 operates.
31. Further, I accept Mr Prosser's submission that if article 4(1)(a) is ambiguous, the Explanatory Note to the 1973 Order may be taken into account in interpreting the article and that it is clear from the Note that the purpose of article 4(1)(a) is to preclude a second charge to VAT on the re-sale of a used car which has already borne VAT on the occasion of the first supply to a non-taxable person. In my opinion Mr Prosser is right when he says that article (4)(1)(a) was necessary because sales of repossessed cars by finance companies were not covered by the profit margin scheme, and such sales had to be made non-chargeable to avoid double taxation (there is residual VAT in the car even after the regulation 38 adjustment) and distortion of the used car market.
32. When article (4)(1)(a) is construed with this purpose in mind, it can make no difference whether the car was repossessed following a breach by the hirer or following a consensual termination, eg where the hirer chooses not to pay the balloon payment. In both cases, the resale by the finance company needs to be a de-supply for the reasons I have identified.
33. Accordingly, for reasons that differ somewhat (but not much) from those of the Tribunal, I uphold the Tribunal's decision on the article 4(1)(a) issue.

The regulation 24 issue.

34. GMAC did not issue credit or debit notes to hirers following the termination of the HP agreement. The question is whether the documents they did issue satisfy the requirements of regulation 24. The precise wording of the regulation is as follows:

"In this Part – "increase in consideration" means an increase in the consideration due on a supply made by a taxable person which is evidenced by a credit note or any other document having the same effect and "decrease in consideration" is to be interpreted accordingly."

35. The Tribunal's decision on the meaning and effect of regulation 24 in the context of this case was as follows:

42. Article 11 of the EC Sixth Directive provides for the determination of the "taxable amount". This covers, in article 11A.1(a) – "everything which constitutes the consideration which has been or is to be obtained by the supplier from the purchaser". Article 11C.1, which is the Directive provision covering rule 38, states that –

"In the case of cancellation, refusal or total or partial non-payment, or where the price is reduced after the supply takes place, the taxable amount shall be reduced accordingly under conditions which should be determined by Member States."


Article 11C.1 was interpreted by the European Court of Justice in Freemans v Customs and Excise Commissioners [2001] STC 960 as applicable both to a price reduction occurring by operation of the terms of the original agreements under which the supply was made and to price reductions resulting from subsequent variations of those agreements. See paragraphs 32 and 33 of the Court's decision. Here we are concerned with hire purchase agreements. The United Kingdom VAT provisions impose liability as if the whole supply takes place in the start and on the full amount of the consideration prospectively payable (financing charges omitted). All the agreements with which this appeal has been concerned contain built-in mechanisms for reductions in price. They expressly state the customers' rights under section 99 of the Consumer Credit Act. The Choices l, 2, 3 agreements contain the further option by which a hirer can put his car back on GMAC instead of paying the balloon instalment. Two things follow from this. First, these reductions in prices through the operation of the hire purchase agreements will be within the scope of Article 11C.1 as interpreted in Freemans and adjustments to the taxable amount ought to be available to the hire purchase company. Second, it would be odd in the extreme if GMAC actually did issue a credit note or something to the same effect to the likes of Linda M who have provided GMAC with no more and no less than their due under the hire purchase agreement.

 43. So, what does the expression "credit note or other document having the same effect" mean in the context of the present hire purchase agreements? If this is possible those words must be construed in a way that produces a result that complies with Article 11C.1. Otherwise GMAC will be able to rely on their Community law rights. And those Community law rights given by Article 11C.1 cannot be cut down by "conditions which shall be determined by Member States" such as an over-restricted definition of "decrease in consideration".
 44. To make the price adjustment provisions of Article 11C.1 and their counterparts in the United Kingdom code work, there must be we recognize be something that evidences that "decrease" in consideration. This must be more than [the] hire purchase agreement itself and any accompanying document entered into at the outset (such as the User Agreement applicable to the Linda M arrangements). It must be a document that comes into being at or after the time of the decrease in consideration and which by some means records the acceptance by both parties that the event triggering the decrease has occurred. Moreover, that document taken on its own or with others must disclose the reduced price. So far we are with Mr Brennan on most of the five key features that the relevant documentation must possess if they are to qualify as evidence amounting to a document having "the same effect as" a credit note. We do not think it essential that all the documents relied on should pass from issuer to the person receiving the credit. It is enough that the hire purchase agreement itself should have that effect. The actual reduction will be fully recorded in the hire purchase company's records but, so far as the person receiving the credit was concerned, no news may be the goods news he was hoping for when he relinquished possession of his car. Nor do we think it essential that the document or documents evidencing the decrease in the price should identify the VAT element. The hirer of a private car will never have any interest in the VAT consequences of the transaction. As already noted he will not have received a VAT invoice when the original supply was made. He has to carry the liability as final consumer and gets no input tax relief. The same, we understand, goes for most commercial hirers of cars who are affected by the block on input tax relief.
 

36. Mr Parker contends that regulation 24 should be read in the light of regulation 38(3) and (4) which, as set out above, provides:

38 (3) The maker of the supply shall –

(a) in the case of an increase in consideration, make a positive entry; or

(b) in the case of a decrease in consideration, make a negative entry, for the relevant amount of VAT in the VAT portion of his VAT account."

38 (4) The recipient of the supply, if he is a taxable person, shall –

(a) in the case of an increase in consideration, make a positive entry; or

(b) in the case of a decrease in consideration, make a negative entry, for the relevant amount of VAT in the VAT portion of his VAT account."

37. It follows, submits Mr Parker, that the documentation required by regulation 24 has to be sufficient to allow the customer to adjust his accounts, even if in fact he is not a taxable person. This means that the documents must refer to the original documentation serving as the invoice and indicate the decrease in consideration or change to the agreed price sufficiently for customers who need to make an adjustment under regulation 38(4). The documents also have to show the reduction in VAT. Mr Parker also takes a point that was not taken below. He submits that the documentation must show how the decrease in consideration is split between capital and interest. It was therefore not good enough if the documentation showed only the extent by which the total cash price due under the agreement had been reduced.
38. I agree with the reasoning of the Tribunal. In my judgement, read consistently with Article 11C.1 and in the light of regulation 38, the purpose of regulation 24 is: (i) to ensure that increases in the consideration are recorded by those parties to the supply who are taxable persons; (ii) to guard against fictitious claims for adjustments; and (iii) to enable the Commissioners to verify adjustment entries in a taxable person's VAT account by inspecting that person's books and records. Regulation 24 is not to be construed as setting a common standard that applies regardless of whether the recipient of the supply is entitled to input tax relief, and regardless of whether the agreement under which the supply was made contains a built-in mechanism for a reduction in the price. It follows that wherever the hirer under a GMAC HP agreement is not entitled to input tax relief (whether because he is a non-taxable person or is affected by the block on such relief) regulation 24 does not require GMAC to issue a document to the hirer post termination setting out the decrease in the consideration. Instead, as the Tribunal found, there must be a document that comes into being at or after the time of the decrease in the consideration and which by some means records the acceptance by both parties that the event triggering the decrease has occurred. Moreover, that document taken on its own or with others must disclose the reduced price, although there is no requirement that the documents relied on as evidencing the decrease are served on the hirer.
39. What of Mr Parker's new point that the documents must show the reduced price net of the interest element? I agree that the documentation available to GMAC must evidence the split between capital and interest in the reduced consideration. Mr Prosser told me (and I accept) that GMAC has stored in its computer files the information that would show how the interest and capital have been apportioned in respect of each transaction and that that information can be printed off in documentary form. In my judgement, if the documentation produced over the life of a transaction does not show how the apportionment has been made, documentation specifically generated from GMAC's computer showing how the apportionment had been made would sufficiently evidence this element in the reduced price for the purposes of regulation 24.
40. The Tribunal examined the documentation covering the specimen transactions put into evidence for the purpose of the appeal. They were satisfied that that documentation satisfied the requirements of regulation 24. I uphold that finding as far as it went. However, they did not undertake their examination with a view to seeing whether the documentation showed the split (if any) in the decrease in consideration between capital and interest. Mr Prosser took me through the documents that were before the Tribunal and demonstrated that in the case of each specimen transaction the documents showed the split between capital and interest. Even if he had been unable to do this, the split could have been adequately proved by reference to information stored in GMAC's computers which can be printed out. It follows that for the reasons given by the Tribunal and in light of the fact that the reduced consideration net of interest is deducible from documents available to GMAC, I am satisfied that the decrease in consideration on which GMAC relies for the purpose of adjusting its VAT account satisfies the definition of "decrease in consideration" in regulation 24. GMAC accordingly succeed on the regulation 24 issue.

Conclusion

41. Notwithstanding Mr Parker's attractive submissions, GMAC has succeeded on all three issues raised in this appeal. The Commissioners' appeal is therefore dismissed.

Note 1   Ie.the total payable under the agreement, including the cost of the credit, less the deposit and the trade-in value.    [Back]