Act: K. Campbell QC; Office of the Solicitor to the Advocate General

Alt: Wolff QC; Delibegovic-Broome; Simpson & Marwick

12 April 2013

Introductory

[1] This is an appeal under section 13 of the Tribunals, Courts and Enforcement Act 2007 by the Commissioners for Her Majesty's Revenue and Customs - "HMRC" - from a decision of the Upper Tribunal (Tax and Chancery Chamber). It relates to an assessment to value added tax - "VAT" - made by HMRC on a firm of solicitors, Simpson & Marwick - "S&M". The assessment in question was the subject of an appeal by S&M to the First-tier Tribunal, which rejected the firm's appeal. The amount at issue, were the making of the assessment to be well founded, was however agreed before the First- tier Tribunal. The decision of the First-tier Tribunal was appealed by S&M to the Upper Tribunal, which allowed the firm's appeal and set aside the assessment. HMRC now seek to have the assessment, in the agreed amount, restored. S&M have a cross appeal contending that the Upper Tribunal, while it accepted the firm's argument based on domestic law, erred in rejecting an argument advanced to that tribunal based on alleged breach of article 1 of protocol 1 to the European Convention on Human Rights to the effect that the making of the assessment was contrary to their Convention rights under the Human Rights Act 1998; and hence also contrary to EU law.

[2] The appeals are concerned with bad debt relief claimed by S&M in their VAT returns between 1 May 2004 and 30 April 2007 in respect of VAT which they had paid on certain supplies of legal services. The particular feature of those supplies relevant to the issues in the case is that they were supplies of legal services in cases in which S&M had been instructed by an insurance company which had provided indemnity insurance, or property risk insurance, to the policyholder in question. Typically, in the former case the policyholder would be the defending party in a claim by a third party; in the latter the policyholder would be the nominal pursuing party, the claim having been subrogated to the insurer.

[3] As is recorded by the Upper Tribunal judge (Lord Drummond Young), and was not in dispute, while in such cases the initial and continuing instruction of the solicitor comes from the insurer, the solicitor nonetheless has a professional responsibility towards the policyholder. If matters proceed to litigation, the solicitor's client is seen in those court proceedings as being the insured. This is not without practical reality, since often the insured may not be wholly indemnified by his policy; and the insured may have, in regard to the outcome of the litigation, wider concerns for the conduct of his enterprise or his professional standing to which the solicitor must have regard and upon which he must take the view of the insured.

[4] At some point in time relatively shortly before February 1985 discussions took place between the British Insurance Association and other insurance bodies on the one hand and HM Commissioners for Customs and Excise on the other respecting practices which might be followed in regard to VAT on legal services provided in regard to claims covered by insurance. This resulted in an agreement between the Commissioners and the British Insurance Association (and the other insurance bodies). A copy of the document containing that agreement was not produced to either of the tribunals below nor to this court, and it may well be that the agreement or understanding was not recorded in formal written terms. The best account of the terms of the agreement available to the tribunals below and this court is a letter from the British Insurance Association to the Law Society of Scotland published in the Journal of the Law Society of Scotland in March 1985. The letter, which the Upper Tribunal judge sets out in paragraph [5] of his judgment, reads:

"HM Customs and Exercise have reviewed the application of VAT to legal services in relation to insurance claims. Following discussions with the BIA, Customs have extended their view that such services are normally supplied to the policyholder to encompass claims in which the insurance company exercises its right of subrogation. Furthermore, and for lawyers' invoices issued on or after 1^st January 1985, Customs have agreed that if the claim relates to the policyholder's business then legal services supplied to the policyholder are for the purposes of that business and, if registered, the policyholder can recover the VAT incurred - subject of course to the normal rules for input tax deduction.

The insurance company will therefore indemnify the policyholder in respect of an amount net of VAT. Where such a policyholder is partially exempt, for example a bank, the policyholder will not be able to recover all the VAT as input tax. The insurance company will therefore have to indemnify the policyholder in respect of an amount which will include some VAT. This VAT will not be recoverable from Customs by the insurance company. If, however, the insurance does not relate to the policyholder's business and/or the policyholder is not registered for VAT, the insurance company will indemnify the policyholder in respect of an amount which will include VAT. This VAT will not be recoverable from Customs by the insurance company.

The procedure for UK solicitors' services will depend on whether or not the policyholder is registered for VAT and whether the claim appears to relate to his business or private activities. If the policyholder is registered and can recover VAT from Customs, the solicitor is obliged under the VAT regulations to address a tax invoice to him. This will request payment of an amount equal to the VAT and it will state that the balance of the account will be settled by the insurance company. A copy of the invoice will be sent to the insurance company endorsed to indicate that the policyholder has been asked to pay the VAT amount and that the insurance company should settle the balance. If the policyholder is not registered for VAT and/or cannot recover the VAT from Customs, for example because the claim does not relate to his business, then the Solicitor will address his invoice to the policyholder and send it to the insurance company for settlement. Copy invoices sent to insurance companies for settlement will be endorsed to the effect that they are not tax invoices and care should be taken at VAT on supplies to policyholders is not counted as input tax by the insurance company."

[5] Although, perhaps understandably, not a matter of express finding in the judgment of the Upper Tribunal, we understood counsel to accept that the commercial considerations which may be assisted by the agreement are that - as a broad generality - most services supplied by insurers are not liable to VAT. Consequently the ability of the insurance company to offset the VAT element of the solicitors' bill as an input against the insurer's output liability to HMRC is constrained. On the other hand, the business of the policyholder may frequently be that of making supplies upon which the policyholder is liable to pay VAT, with the consequence that the policyholder may have a greater possibility of offsetting the VAT on the solicitors' bill. It should also be noted that the agreement described in the British Insurance Association's letter proceeds upon the view that the client of the solicitor in the supply of legal services is the policyholder not only in indemnity claims but also in subrogated claims.

[6] In paragraph [6] of his judgment, the Upper Tribunal judge states that from 1 January 1985 (the date from which the arrangements described in the letter from the British Insurance Association were to apply) S&M:

"...issued their fee notes in duplicate in cases where the policyholder was registered for VAT. The principal fee note claiming payment only of fees and outlays was sent to the insurer. A duplicate was sent to the policyholder, who was asked to pay only the VAT on fees and outlays. In the covering letter it was made clear that the insured person would not be out of pocket because they should be able to recover as input tax VAT that they were being asked to pay. That procedure has been followed until the present...."

However, we would observe at this point that in light of the specimen invoices in the appendix to the appeal, to which our attention was drawn, that account of matters may not be wholly accurate. It appears that what was sent, in the specimen, to the policyholder client while headed as a VAT invoice and described as a "VAT invoice", was an invoice only for VAT. Again, according to the specimen, what was issued by S&M to the insurance company client was not a duplicate but a different invoice, no doubt reflective of the same prestation of services, described as a "fee note" and expressly stated to be "not a VAT invoice".

[7] In a number of cases in which S&M thus acted for insurers on behalf of the insured and adopted that invoicing arrangement in light of the published terms of the letter from the British Insurance Association, the insured policyholder client became insolvent, or the conditions were met upon which any debt due by the policyholder client might be written off for the purposes of VAT bad debt relief. As respects the quarterly periods in question in this appeal S&M treated as deductible by way of bad debt relief the whole sum invoiced to the policyholder client, being a sum equivalent to the entirety of the tax for which they were liable, as the taxable person, on the supply which they had made, notwithstanding that the firm had otherwise been paid in full by the insurance company in question.

[8] Following an inspection by HMRC on 13 June 2007, HMRC questioned the treatment followed by S&M in the quarters in issue of regarding the full amount of VAT as qualifying for bad relief where the bad debt relief requirements might be satisfied as respects the policyholder client. The supply of professional services was a single supply; bad debt relief was restricted to the VAT fraction (7/47, the rate of VAT throughout the period having been 17.5%); and accordingly S&M were entitled to relief consisting of 7/47^th of the amount unpaid by the policyholder client and written off by S&M. The assessment, in the amount agreed, reflects the sum due to HMRC on the basis that the relief available to S&M is restricted to 7/47^th of the amount written off, rather than the entirety of the amount written off by S&M as unpaid by the policyholder client.

The legislative texts
[9] While the principal provision respecting bad debt relief is section 36 of the Value Added Tax Act 1994 as amended - "VATA" - it is convenient first to refer to or set out certain other provisions of VATA.

[10] The definition of the person liable to pay VAT is set out in section 3 of VATA. It is not in dispute that S&M is a taxable person in respect of the supply of legal services which the firm makes. It is also not in issue that such a supply is a taxable supply and that VAT is payable by the firm on the value of such a supply.

[11] The value of a supply is treated in section 19 of VATA, sub-section (2) of that section being the provision pertinent to the present case. The sub-section states:

"If the supply is for a consideration in money its value shall be taken to be such amount as, with the addition of the VAT chargeable, is equal to the consideration."

[12] Bad debt relief, where the taxable person has paid the VAT for which he is liable but has not been paid in full, or at all, by the person to whom the supply was made is treated in section 36 of VATA, the provisions in the section pertinent to the issues in this appeal being:

"36- Bad debts.

(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 6 months (beginning with the date of the supply) has elapsed.

(2) Subject to the following provisions of this section and to 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.

(3) In subsection (2) above `the outstanding amount' means-

(a) if at the time of the claim no part of the consideration written off in the claimant's accounts as a bad debt has been received, an amount equal to the amount of the consideration so written off;

(b) if at that time any part of the consideration so written off has been received, an amount by which that part is exceeded by the amount of the consideration written off;

and in this subsection `received' means received either by the claimant or by a person to whom has been assigned a right to receive the whole or any part of the consideration written off."

The Upper Tribunal Decision
[13] In the course of paragraph [16] of his judgment the Upper Tribunal judge, having set out the relevant terms of section 36 of VATA, notes that the purpose of that section

"....is that, when a bad debt is written off, the taxpayer who made the relevant supply is entitled to a refund of the amount of VAT chargeable on the part of the debt that is not paid."

Having then referred to section 19(2) VATA, which gives meaning to the term "consideration" in section 36, the Upper Tribunal judge observes:

"Thus when goods or services are supplied for money consideration, it is assumed that the total consideration represents both the net price and the VAT that is chargeable."

[14] In the two succeeding paragraphs of his judgment the Upper Tribunal judge writes:

"[17] It follows from the terms of section 19 that the consideration for a supply of goods or services, and the corresponding debt owed by the customer to the supplier, is taken to comprise two components: the net price and the VAT exigible on that price. The supplier pays the VAT element to the tax authorities and, in the standard case where the customer is solvent and pays its debt to the supplier, the supplier is reimbursed by the customer. If the consideration for the supply is not paid at all, whether owing to insolvency or simple default, the supplier can claim bad debt relief on the VAT component; if VAT is at 171/2%; that entitles the supplier to a refund of 7/47 of the total consideration. If only part of the consideration is unpaid, bad debt relief is limited to the VAT component of the amount unpaid; that appears from section 36(3)(b). That is clearly quite fair because the amount received by way of bad debt relief is the VAT component of the unpaid consideration. The result is this tax-neutral as far as the supplier is concerned; the bad debt relief exactly balances the unpaid VAT.

[18] In the 'normal' case, where the unpaid consideration consists of both net price and VAT, any other rule on part payments could create a problem, in that the supplier would be enabled to attribute the amount it had received to the net price rather than the VAT component, and thus claim bad debt relief on an amount that represents the whole of the VAT component in the supply, as if the consideration had been wholly unpaid. That is plainly not justifiable, because part of the total consideration has been paid and it is only reasonable that that part payment should be reflected in the VAT bad debt relief."

[15] Thus far, the Upper Tribunal's construction of the statutory provisions is in accord with the wording of the legislative text and the contention of HMRC. However, in the succeeding paragraph, the Upper Tribunal judge goes on to state:

"[19] The speciality in the present case is that the unpaid amount consists entirely of VAT and, importantly, is clearly identifiable as consisting entirely of VAT. That is because the unpaid amount is contained in invoices that are for VAT only, as it is only the VAT component that is payable by the policyholders; the net price of the appellants' services is paid by the insurance companies. HMRC's position is that this makes no difference. The rule is set out in section 36 of the VAT Act 1994 at para. 20, and the provisions of that section, in particular subsections (2) and (3), must be given literal effect, so that the relief is limited to a notional VAT component in the total amount unpaid. That construction at section 36 is disputed by the appellants, who argue that the invoices that relate only to VAT should be treated according to their terms."

[16] The judgment then examines three cases heard before the VAT and Duties Tribunal which are consistent with the position for which HMRC contended. These are AW Mawer & Co v Commissioners of Customs and Excise [1986] VATTR 87; Caernarfonshire Fatstock Group Limited v Commissioners of Customs and Excise MAN/98/748 and Engineering Services (Bridgend) Limited v Commissioners of Customs and Excise LON/01/161. The judgment of the Upper Tribunal thereafter refers to, and contrasts, the tribunal decision in Palmer t/a R & K Engineering v Customs & Excise Commissioners MAN/92/724. The particular circumstances of that case were that registration by the trader as a taxable person had been materially delayed through administrative fault on the part of the Commissioners with the consequence the trader was unable to issue VAT invoices during that extensive delay and on registration being granted with retroactive effect the trader, who had received payment of the principal sum, issued "VAT only" invoices to customers who, in the interval, had become insolvent. At paragraph [24] of his judgment in the present case the Upper Tribunal judge says that the case of Palmer is similar to the present case in that the invoice issued was only for VAT. Having properly recorded that it could not be suggested that there was any culpability on the part of the Commissioners or HMRC in the present case the Upper Tribunal judge goes on to say:

"Nevertheless, the VAT only invoices issued by the appellants [S&M] were sent because of a specific instruction given by Customs and Excise. While blame cannot be attributed to the tax authority, it was their instruction that was responsible for the issuing of such an invoice."

The judge in the Upper Tribunal thereafter proceeds, in paragraph [25], to express the view that in Palmer the tribunal took a "purposive approach to the legislation" as opposed to a "literal construction", which he, in effect, acknowledged as being in accord with the contentions of HMRC.

[17] The judgment of the Upper Tribunal then continues:

"[26] Tax statutes must generally be construed strictly, and a strict construction will frequently, perhaps normally, be a literal construction. Nevertheless, a strict construction is not the same as a literal construction, and if a literal construction is at odds with the clear and obvious purpose of the legislation I am of opinion that the literal construction must if possible give way to a purposive construction. If, for example, the literal construction produces a result that is perverse, or contrary to elementary standards of fairness, or which ignores the basic structure of the tax regime in question, it may be appropriate to try to achieve the underlying purposes of the legislation rather than accepting the manifestly unsatisfactory result produced by a literal approach. The construction adopted in such a case can still be regarded as strict, but it is a construction informed by the objectives of the legislation. To do anything else cannot be regarded as intellectually acceptable.

[27] In my opinion this is such a case. The appellants issued VAT-only invoices, on the instructions of Customs and Excise, and when one of these was unpaid it is obvious that the amount that was not recovered all represented VAT. Consequently elementary fairness demands that it should be refunded as if it were all VAT. This point was recognized in Mawer, where the VAT Tribunal described the result of their decision as 'a material extension of the burden on taxpayers of acting as unpaid tax collectors'. The purpose of section 36 is to permit the refunding of VAT in respect of bad debts, to ensure that the taxpayer who collects the VAT on behalf of HMRC is not left out of pocket by a failure to obtain payment from his customer. That purpose requires that the whole of the VAT that has not been recovered from the customer should be refunded; otherwise the taxpayer is out of pocket. Section 36, reading the first three subsections together, permits 'a refund of the amount of VAT chargeable by reference to [an amount equal to the amount of the consideration so written off]'. The amount written off is, demonstrably, all VAT. The compound preposition 'by reference to' indicates that in determining the amount of the refund reference must be had to the consideration that is written off. If that amount is only VAT, that fact must in my opinion be taken into account in determining how reference is to be made to the consideration written off. If that is done, it is clear that the consideration so written off is all VAT, and the refund should be calculated accordingly. When regard is had to the purpose of section 36, I am of opinion that that is a more probable construction than the alternative, that only a percentage should be refundable."

Support for that view is then suggested by reference to the European Council directives and, particularly, the judgment of the Court of Justice of the European Communities in case C-317/94 Elida Gibbs Limited v Commissioners of Customs and Excise [1996] ECR 1-5339.

[18] Finally, the Upper Tribunal thereafter addresses and rejects the argument for the taxpayer based upon article 1 of protocol 1 of the ECHR and EU law which is the subject of the cross appeal.

Contentions of the parties
[19] In very brief summary, counsel for HMRC submitted that the supply of the service in each transaction in question was a unity. It mattered not whether one or more person might benefit. HMRC had taken the view - in or before 1985 - that in the case of the supply of legal services in insurance claims the supply was properly to be seen as a supply to the policyholder client. That view was sound. There was no proper basis for the Upper Tribunal's having divided the transaction into two separate liabilities, with a liability for VAT only on the policyholder and the principal sum being a liability only on the insurer. The First-tier Tribunal reached a correct decision and the court should therefore "remake" the decision of the Upper Tribunal by affirming the assessment in the agreed amount.

[20] In the course of his submission counsel for S&M recognised that the core issue might be seen as being whether the Upper Tribunal was entitled to make the finding that the unpaid amount in each transaction was entirely VAT. If so, counsel founded upon the tribunal decision in Palmer t/a R & K Engineering v Customs & Excise Commissioners as authority for the proposition embraced by the Upper Tribunal judge that, if the unpaid invoice were a "VAT only" invoice, full relief for the entirety of the VAT in that "VAT only" invoice was available. As a specialist tribunal, the Upper Tribunal was entitled to reach the conclusion that the sum unpaid was entirely VAT. The Upper Tribunal was also correct to interpret the statutory provisions purposively. A tax statute fell to be interpreted in the same way as any other statute (Barclays Finance Ltd v Mawson [2005] 1 AC 684). The interpretation adopted by the Upper Tribunal was consistent with what was said by the Court of Justice of the European Communities, particularly at paragraph 30, in its judgment in Elida Gibbs v Commissioners of Customs & Excise.

[21] As respects the cross appeal, counsel for S&M accepted that, whether one approached matters via European Union law or went directly to article 1 of protocol 1 to the European Human Rights Convention, the same issue arose. In agreement with counsel for HMRC, who had accepted that measures to secure the payment of taxes required to strike a fair balance between the general interest and the individual's property rights, the matter came down to one of proportionality and balance. The short submission was that, given the arrangement agreed with the British Insurance Association, the burden imposed on this taxpayer was disproportionate.

Discussion
[22] It is, in our view, evident from the terms of the judgment given by the Upper Tribunal that central to that tribunal's decision was the proposition that the determining speciality of the case was that the unpaid amount written off by the taxpayer was "entirely VAT", the invoices to the policyholder client being for an amount equal to the VAT payable in respect of the taxable supply. As we understood him, counsel for S&M accepted during the debate before us that merely identifying the unpaid amount as being a sum constituting the element of VAT in the consideration for the supply in question could not justify bad debt relief being given for the entirety of that element; to do so would allow the supplier and customer to agree to attribute the latter's partial payment to the element of the consideration not representing VAT; and would be inconsistent with the statutory provisions. In its judgment the Upper Tribunal recognised this at paragraph [17]. However, the judgment of the Upper Tribunal appears, on our reading of it, to proceed upon the basis that the normal construction and effect of section 36 VATA was displaced by the circumstance that in 1985 the Commissioners of Customs and Excise had given a "direction" that solicitors were to issue "VAT only" invoices to the policyholder client - see paragraphs [4], [24] and [27] of the tribunal's judgment. That notion enabled the Upper Tribunal to derive some support for its approach from the decision in Palmer t/a R & K Engineering v Customs and Excise Commissioners.

[23] Before us, counsel for S&M recognised that the published account of the understanding reached between the British Insurance Association (and other collective insurance bodies) and the Commissioners did not constitute a "direction" issued by HMRC or its predecessor. Moreover, given that the analysis that the client, or customer, to whom the taxable supply of legal services was made was the policyholder, underlay the whole agreement or understanding, such a direction would have been contrary to, and thus a derogation from, the delegated legislation respecting the requirement to issue a VAT invoice to the client or customer. In our view, a reading of the letter from the British Insurance Association to the Law Society of Scotland which was published in the March 1985 issue of the Society's journal makes it clear that no such derogation was contemplated. Thus the letter states:

"The procedure for UK solicitors' services will depend on whether or not the policyholder is registered for VAT and whether the claim appears to relate to his business or private activities. If the policyholder is registered and can recover VAT from Customs, the solicitor is obliged under the VAT Regulations to address a tax invoice to him. This will request payment of an amount equal to the VAT and it will state that the balance of the account will be settled by the insurance company. A copy of the invoice will be sent to the insurance company endorsed to indicate that the policyholder has been asked to pay the VAT amount and that the insurance company should settle the balance." [emphasis added]

Accordingly where a solicitor chose to utilise the facility afforded by the agreement narrated in the letter to the Law Society of Scotland from the British Insurance Association, the solicitor was not relieved from his duty to issue a proper VAT invoice to the policyholder client. The covering note or request for payment by the policyholder of "an amount equal to the VAT" with a statement that "the balance of the account will be settled by the insurance company" simply constitutes, in our view, an administrative recognition that, while the policyholder is treated as the client to whom the supply of taxable services is made, the insurance policy allows for his being indemnified in respect of the solicitor's bill; that indemnification would, in the case of a VAT registered client and a claim related to the client's business, be restricted by the fact that the client's ability to claim VAT on the solicitor's bill as part of his input tax reduces the sum for which the indemnifier would be responsible.

[24] Moreover, as we have already noted, in so far as the specimen invoices are illustrative of what was done by way of invoicing S&M in the periods in question - and counsel for S&M did not suggest otherwise - it appears to us that in fact those arrangements did not wholly accord with the British Insurance Association's understanding of the arrangement arrived at with the Commissioners in 1984 or 1985. We therefore have to say that, in so far as the Upper Tribunal judgment proceeds upon the basis that the issuing of "VAT only" invoices by S&M to its policyholder clients was in accordance with a direction by the Commissioners of Customs & Excise, that basis is, in our view, flawed.

[25] As we have already mentioned, having in our view rightly accepted that the British Insurance Association's letter could not be a direction to issue a "VAT only" invoice, counsel for S&M analysed matters as being whether the Upper Tribunal was yet properly entitled to find that the outstanding amount, in respect of which S&M claimed full relief, was entirely VAT and identifiable as such in which event, it was contended, full relief would be available. Notwithstanding counsel's invocation of the specialist nature of the Upper Tribunal, we do not consider that that question can be answered otherwise than adversely to S&M. While it may no doubt be that one can readily establish that the part of the consideration outstanding is equal to the amount of the VAT payable on the services provided, it does not appear to us that so establishing can take one beyond the situation in which the supplier and customer have attributed the partial payment to what might be described as the principal sum (the inadmissibility of which for bad debt relief is not disputed).

[26] On the assumption that one can identify the unpaid debt as being wholly or partially the amount of the VAT in the consideration the issue then arises whether section 36 VATA allows for the possibility of that being wholly available as relief. In our opinion the proper construction of section 36 VATA is the construction for which HMRC contend. The refund to which the taxpayer is entitled is stipulated in section 36(2) as the "amount of VAT chargeable by reference to the outstanding amount". The words "outstanding amount" are defined in sub-section (3) by reference to the amount of the "consideration", or the extent to which the "consideration" has been written off. But as section 19 VATA makes plain, the "consideration" is an amount inclusive of VAT. There is nothing in the text which gives any warrant for an exercise of seeking to identify the extent to which the amount is "demonstrably all VAT". While counsel for S&M submitted that the construction of section 36 for which he contended did not involve the reading in of qualifying words, or words of exception, we are unable to agree with that submission.

[27] We quoted earlier paragraph [27] of the judgment of the Upper Tribunal. In it the Upper Tribunal says, under an invocation of "elementary fairness":

"The purpose of section 36 is to permit the refunding of VAT in respect of bad debts, to ensure that the taxpayer who collects the VAT on behalf of HMRC is not left out of pocket by a failure to obtain payment from his customer. That purpose requires that the whole of the VAT that has not been recovered from the customer should be refunded; otherwise the taxpayer is out of pocket. Section 36, reading the first three subsections together, permits 'a refund of the amount of VAT chargeable by reference to [an amount equal to the amount of the considerations written off'. The amount written off is, demonstrably, all VAT. The compound proposition "by reference to" indicates that in determining the amount of the refund reference must be had to the consideration that is written off. If that amount is only VAT, that fact must in my opinion be taken into account in determining how reference is to be made to the consideration written off. If that is done, it is clear that the consideration so written off is all VAT, and the refund should be calculated accordingly".

For the reasons which we have already given, and indeed for the reasons which the Upper Tribunal itself recognised in paragraph [17] of its judgment, we do not consider that it is open to the taxable person to demonstrate that the amount written off by him is "demonstrably all VAT". But beyond that, we have difficulty in seeing the existence of some consideration of "elementary fairness" to which the judge in the Upper Tribunal refers and which the Upper Tribunal Judge regards as dictating a "purposive approach". Put shortly, S&M provided a taxable service for which they received partial payment of the consideration and we have to say that we cannot see any real basis whereon it is inequitable, or contrary to elementary fairness, that they should not be responsible, in the normal way, for the proportionate amount of VAT on the part-consideration which they received.

[28] The Upper Tribunal sought support for its decision in the judgment of the Court of Justice of the European Communities in case C-317/94 Elida Gibbs Limited v Commissioners of Customs and Excise, and in particular paragraph [24] of that judgment, in which, having earlier observed that the ultimate burden of value added tax is in reality borne by the final consumer, rather than the taxable person, the Court of Justice said:

"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."

[29] However, in our view, that paragraph must be seen in the context of the particular issue before the Court of Justice, namely the consequence in terms of the liability of a taxable person to VAT in a commercial arrangement whereby the taxable person, the manufacturer, redeemed "money-off" coupons to the final consumer purchasing from the retailer to whom the manufacturer had supplied the goods. Redemption of the coupons meant that the consideration received by the manufacturer, upon which output VAT had been paid, was ex post facto reduced by the redemption of the coupons. Not to recognise that ex post facto consequence would result in an additional liability on the manufacturer for VAT, which would not transmit ultimately to the consumer. The case was therefore concerned with liability for VAT in a chain of supply which involved the retroactive redemption of coupons. The assumption was that throughout the chain the parties were solvent. The case was not concerned with bad debt relief, although the Court of Justice noted, at paragraph 30 of its judgment, article 11(C)(1) of the Sixth Directive in terms which appear to be us to be consistent with the interpretation of section 36 VATA advanced by HMRC. Put shortly, we are unable to find in the judgment in case C-317/94 Elida Gibbs Limited v Commissioners of Customs and Excise any proper support for the view that where partial payment of the consideration has been made by the customer and that partial payment may be identified as payment of the principal sum, with the practical consequence that the amount unpaid, and written off, may be identifiable as the VAT element, the taxable person is entitled to bad debt relief on the entirety of the element of the consideration equivalent to the VAT and not a proportionate part thereof.

[30] As was no doubt foreshadowed by the submissions before and the judgment of the Upper Tribunal, counsel for S&M submitted to us that the tribunal decision in Palmer t/a R & K Engineering v Customs and Excise Commissioners was supportive of his contentions. Counsel submitted that if it were correct in that case to ask if the amount unpaid was wholly VAT, and if so, to give bad debt relief for that entirety, it must in principle be open to inquire whether the amount outstanding and written off was, as a matter of fact, VAT. In paragraph [25] of his judgment the Upper Tribunal judge states that: "In Palmer, by contrast, the tribunal expressly adopted a purposive approach to the legislation." For our part we are unable to see in the judgment given in Palmer any attempt by the tribunal to offer a "purposive" construction of the provisions of section 36, or any other provision, of VATA. While it may be that in the very peculiar circumstances of that case, which involved notable administrative fault on the part of the Commissioners, the decision may be seen as a possibly understandable exercise of a broad praetorian or equitable jurisdiction on the part of an administrative tribunal confronted with admitted administrative fault on the part of the administrative authority , the tribunal in that case does not seek by way of detailed examination of the statute to reconcile its decision with the terms of the statutory provisions. In our view, the decision in Palmer - which is in any event not binding on us - is of no real assistance.

[31] For these reasons we have come to the conclusion that the criticism made by HMRC of the judgment of the Upper Tribunal is well founded, with the consequence that unless the cross appeal on behalf of S&M is sound the appeal by HMRC must succeed.

[32] Accordingly we now turn to the grounds of cross appeal advanced by S&M. In the event, there was relatively little by way of contestation over this aspect of the case. Counsel on both sides were agreed that ultimately the only issue was one of proportionality. Counsel for S&M submitted - in very brief terms - that given the arrangement reached between the Commissioners and the British Insurance Association, the burden placed upon his client as the taxable person was disproportionate. In his oral submissions counsel S&M did not elaborate on that contention. The written argument for S&M is largely founded upon the notion that the arrangements constituted a "direction" by the commissioners. But for the reasons already given, we consider that notion to be misplaced.

[33] The written note of argument for S&M also appears to proceed upon the view, perhaps reflective of the views expressed by the Upper Tribunal judge at paragraph [10]ff of his judgment questioning - under reference to WHA Limited v Customs and Excise Commissioners [2004] EWCA Civ 559; [2004] STC 1081 - the soundness of the underlying proposition of treating the supply of legal services in the particular circumstances of this category of case as being made to the policyholder, and not the insurer. Having taken instruction, counsel for S&M clearly distanced himself from that view. He stated that he did not base any of his submissions on the proposition that HMRC were not entitled to take the view that the supply of the legal services was a single supply to the policyholder, which - cancelling out the negatives- we take to be an acceptance that the appeal proceeds on the longstanding view that in insurance claims the VAT supply client is the policy holder client of the solicitor.

[34] In these circumstances, and bearing in mind what we have already said respecting elementary fairness in paragraph [27] supra, we are unable to see that there can be said to be any disproportionate burden placed upon S&M in requiring that, as a taxable person, they pay the proportionate amount of VAT on the substantial part of the consideration which they have unquestionably received in respect of their taxable supply to the client.

Decision
[35] We therefore conclude that the cross appeal by S&M falls to be refused and that the appeal by HMRC must be allowed. We shall therefore "remake" the decision of the Upper Tribunal by affirming the assessment in the amended and agreed sum.