18769

VAT — unjust enrichment — debt management services — originally classified as standard rated but following tribunal decision in appeal by Debt Management Associates(Decision No 17880) accepted by Customs as two discrete exempt services — Customs further acceptance that VAT on appellants initial service did not result in unjust enrichment —whether VAT paid on appellants management services would result in its being unjustly enriched — finding on facts that it would — appeal dismissed

MANCHESTER TRIBUNAL CENTRE

BAINES & ERNST LTD Appellant

- and -

THE COMMISSIONERS OF CUSTOMS AND EXCISERespondents

Tribunal: Mr J D Demack (Chairman)

Sitting in public in Manchester on 27, 28 and 29 July 2004

Mr David Milne QC instructed by Messrs Horwath Clark Whitehill, chartered accountants, London, for the Appellant

Mr Peter Mantle of counsel instructed by the Solicitor for the Customs and Excise for the Respondents

© CROWN COPYRIGHT 2004

DECISION

Introduction

  1. On 9 April 2003, the appellant company, Baines & Ernst Ltd (“B&E”) submitted a voluntary disclosure to the Commissioners of Customs and Excise seeking repayment of £5,969,399 it had paid as VAT which was not due. (It later reduced the claim to £5,951,579). The claim related to the excess of output tax declared over input tax. The disclosure was submitted following the Commissioners’ acceptance that debt management services provided by B&E, which had previously been standard-rated, were exempt. The Commissioners rejected the disclosure on 21 August 2003, and confirmed rejection on 15 October 2003, on the basis that B&E would be unjustly enriched were they to act on it. It is against the rejection on review that B&E now appeals.
  2. B&E’s debt management service is available to individuals who are unable to repay unsecured debts on their creditors’ agreed terms. The service consists, first, in an initial service of negotiating with the creditors an agreed plan of repayments the client can afford, and, secondly, in a management service of collecting monthly payments from the client for distribution among his creditors in terms agreed with each of them. For the initial service, the client pays a single flat-rate fee; and for the management service, further fees calculated as a percentage of each monthly aggregate payment.
  3. Initially, the Commissioners rejected the voluntary disclosure in its entirety. But, shortly before the hearing, they accepted liability for that part of it which reflected the VAT paid in respect of B & E’s initial services. Consequently, my decision deals only with the claim for recovery of VAT on management fees.

The facts

  1. I make the following findings of fact from the parol evidence of Mr R B Cochrane, a director of B&E, Mr C J Kirkland, a senior Customs officer, and the contents of two bundles of copy documents provided by the parties. (Unless otherwise stated, all page references to documents relate to the main bundle).
  2. B&E was formed in 1996 as a debt collection agency. As such, it made standard-rated supplies and registered for VAT. But not long after beginning trading, on its share capital being acquired by Mr J O’Neill, it changed to providing the debt management services referred to at para 2 above. When the change took place it contacted its local VAT office for advice as to its future liability to tax. It was informed that all aspects of debt management services were standard-rated supplies. The company acted on that advice, and continued to charge VAT on its services.
  3. Mr O’Neill knew nothing about debt management services and therefore initially decided to follow the practices of the then leader in the industry, Gregory Pennington Ltd (“GP”). GP operated, and continues to operate, a service seemingly identical in all material respects to that of B&E. Mr O’Neill obtained a copy of the terms and conditions on which GP dealt with its clients, and instructed solicitors to plagiarise them for B&E’s own use.
  4. In particular, as Mr O’Neill had no idea what to charge for B&E’s new services, it followed GP’s example in charging 15 per cent plus VAT (i.e. 17.625% in total) of clients’ disposable incomes for “on-going management services,” and a flat rate negotiation fee (including VAT) equal to a client’s first monthly payment.
  5. The plagiarised form of GP’s charging clause for management fees, used by B&E from 1996 until late 1999, took the following form:

“6.1. Unless we agree otherwise with you we will take from each monthly payment under the Monthly Payment Plan a fee equal to 15% of the periodic payment under the Monthly Payment Plan. This figure is subject to a minimum fee of £25 per month and does not include VAT, which we have to charge by law. (At present this total sum amounts to 17.625%).”

  1. The terms and conditions of B&E’s contract defined Monthly Payment Plan as one produced by it in consultation with the client “by which you can pay off your creditors out of your disposable income at rates you can afford. The Monthly Payment Plan will let you make monthly payments to us and will take account of your creditors and our Fees. It will not take account of any matters you have not told us about… It will also take account of the differing requirements of your different Creditors, if there is more than one”.
  2. (Until the hearing, B&E had not produced to the Commissioners a copy of the contract it used in its early years of trading, and had maintained that until 1999 its charging clause for management fees was in terms indicating that clients were simply charged 17.625 per cent, and ignored all reference to VAT. Mr Milne QC, for B&E, apologised for its having misled the Commissioners).
  3. When Mr Cochrane became a co-director of B&E with Mr O’Neill in 1997, he assumed particular responsibility for finance and administrative matters. He acquired 40 per cent of its ordinary share capital, Mr O’Neill continuing to hold the remaining 60 per cent.
  4. Mr Cochrane also claimed that in 1998 or 1999 he identified as a “specific problem” the possibility either that B&E’s VAT status, or the standard rate of tax, might change during the course of a repayment plan, increasing or, less likely, decreasing its liability to tax, with a resultant impact on profits. He maintained that since all clients were individuals, and thus not VAT registered, “their only interest was in the gross cost to them of the service provided, so we worded the contract in such a way that the fee payable to the company would remain the same no matter what the applicable VAT rate”. Further, Mr Cochrane added, the company, or perhaps I should say Mr O’Neill as principal shareholder, decided that its management fees should not then, or in the future, fall below 17.625 per cent, whether liable to VAT or not, and irrespective of any price reductions its competitors might make in the event of fees being found to be exempt from VAT: it had determined not to compete with its competitors on price, but rather on service. I shall deal with that decision shortly.
  5. At some time very late in 1999, B&E introduced a new form of contract containing the following sub clause relating to management charges:

“6. How you pay us.

6a. Unless we agree otherwise, we will deduct, from payments we issue to your creditors, a fee equal to 17.625% of the monthly payment you make to us under the monthly payment plan. However, we have a minimum fee of £29. The actual amount of our fee is shown in the monthly payment plan.”

  1. Following introduction of the new contract, Mr Cochrane maintained that, on a client entering into it, B&E dispatched his “Credit Commitment and Financial Statement Details” to him and to his creditors (pp 47-48), but, he contended, the details sent to creditors differed from those sent to the client in one, very important, respect. In the section dealing with credit commitments in the creditor’s copy, B&E’s management fee was shown as “15% + VAT”, whereas in the client’s copy it was simply shown as 17.625 per cent. Mr Cochrane’s evidence on the point was less than convincing, so that I am not satisfied on the balance of probabilities that both forms were in use, or, if they were, they were dispatched as Mr Cochrane claimed.
  2. When Mr Kirkland paid a control visit to B&E in January 2000 the sample Monthly Payment Plan with which he was provided (p.72) showed the management fee to be 15 per cent plus VAT. Mr Kirkland’s Visit Report (pp. 88-89) confirmed that B&E was charging its clients 15 per cent plus VAT for management services.
  3. Reading the clause set out in para 13 above in the context of the whole of the evidence, but particularly in the light of that in the penultimate and last preceding paragraphs, in my judgment it was simply an alternative way of expressing the fact that B&E continued to charge 15 per cent plus VAT for its management services. It did not represent a change in price: nor did it represent a change whereby B&E, although accounting for VAT on supplies, did not charge its clients tax. The very fact that B&E continued to account for VAT reflects a recognition on its part that it was still charging 15 per cent plus VAT, even if it was not explicitly informing its clients of the fact.
  4. Also in 1999 B&E sought further advice from the Commissioners as to the VAT liability of its services, maintaining that they were exempt. With its correspondence B&E submitted a form of contract intended for use by a new subsidiary company. The contract included a charging clause for management services identical to that at para 13 above except that the rate of charge was 17.5 per cent. As the new subsidiary never traded, B&E did not introduce the 17.5 per cent charge rate. It was not until 25 August the following year that the Commissioners rejected its claim for exemption (letter p.35). However, when they eventually did so, they admitted that there was an argument for exempting B&E’s collection and money handling services which might have been persuasive had not those services been but an element in a “larger administrative service”. B&E could have appealed the Commissioners’ decision to the tribunal, but did not do so.
  5. Unknown to B&E, at sometime in 1999 for a limited, undisclosed period the Commissioners accepted that at least some of GP’s services were exempt. During that period GP charged its clients 15 per cent for management services.
  6. Mr Cochrane maintained that the market was not at all sensitive to the rates of fees, claiming that that was demonstrated by B&E having increased its market share whilst charging 17.625 per cent during the period GP was making exempt supplies and charging 15 per cent management fees. He explained that from having no market share in 1996 when GP had 80 per cent of the market, B&E had overtaken it by 2001. He added, “Indeed, the only price resistance we have experienced is from those who believed that a service such as ours should always be provided free of charge to the consumer”. Whilst accepting that B&E increased its market share as claimed, I am unable to accept Mr Cochrane’s statement for early in 2001 the Office of Fair Trading (“the OFT”) wrote to B&E following complaints about the manner in which it presented its charges (see p.160 of the main bundle and pp.32-33 of the supplemental bundle) and pointed out that under the Unfair Terms in Consumer Contracts Regulations 1999 “unfair terms are not binding on consumers”.
  7. The OFT indicated that it would not take court action against B&E if it were to withdraw or amend its terms and conditions to include, inter alia, in a prominent position on the front page of its contract a statement of its fees and show how they were made up. In evidence, Mr Cochrane said, and I accept, that the OFT would not accept terms which included no reference to VAT; the OFT required all references to fees to have added “plus VAT”. But in the event, in a contract introduced early in 2001, B&E answered the question, “How much do our services cost?”, as follows:

“You will pay us an initial fee and then a monthly management fee. The initial fee is an amount equal to a single payment under your monthly payment plan as at the time you sign these terms of business. This payment includes VAT …

The monthly management fee is equal to 17.625% (including VAT), rounded to the nearest pound, of each monthly payment plan. However, you will have to pay us at least our minimum monthly fee of £29 (including VAT). We collect the monthly fee when we pay your creditors.”

  1. In my judgment, both those clauses, whether read separately or together, would quite clearly have indicated to a client of B&E that he was paying fees for its services which included VAT. And when read in conjunction with Mr Cochrane’s admission that the OFT required all reference to fees to be “plus VAT”, notwithstanding that the terms introduced were not strictly those so required, I also find that such clients were charged VAT: it was not merely being accounted for by B&E. I am unwilling to read the term “including VAT” as “including VAT (if any)”, as Mr Milne submitted I should. (see para 42 below). Further I am unable to accept that the words “including VAT” were inserted solely to indicate to clients that they would not be expected to bear the burden of any change in the VAT position, as B&E claimed. (Even as late as 8 April 2003, in what appeared to be a standard letter addressed to a Mr Saxby, a client of B&E, (p.128), and which Mr Cochrane was unable to explain either in terms of origin or content, B&E specifically stated that it charged its clients VAT on management fees).
  2. There matters rested until, in Debt Management Associates Ltd v CEC (2002) Decision No 17880, the tribunal decided that negotiation and management services in all respects identical to those of B&E were two discrete exempt services. The Commissioners then accepted that B&E’s services were also exempt and de-registered it for tax. That resulted in B&E making the voluntary disclosure out of which its appeal arises, and increasing its charging terms for management to 17.625 per cent.
  3. Having dealt with the charging terms B&E used between 1996 and 2003, I must now deal with other aspects of its business that may impact on its claim. First, I should explain that B&E’s business expanded at a phenomenal rate in the period in question. In the year to 30 June 1997 turnover was a mere £16,095; by 2002 it had increased to £24,277,434.
  4. The turnover comparison between B&E and GP in the years between 1996 and 2002 was as follows:

1996 / 1997 / 1998 / 1999 / 2000 / 2001 / 2002
B&E / 0 / 16,095 / 388,937 / 1,727,923 / 6,148,240 / 21,512,740 / 24,277,434
G|P / 2,800,000 / 2,800,000 / 2,800,000 / 2,800,000 / 6,270,809 / 7,945, 545 / 9,558,671
  1. It will be recalled that in 1998 or 1999 B&E claimed to have decided under no circumstances in future to reduce its management fees below 17.625 per cent, whether exclusive or inclusive of VAT (see para 12 above). But in a discussion paper produced in December 2002 (pp 118-122), in proposals which incidentally were never effected, B&E invited creditors to consider the following “alternative approach” to dealing with debtors:

“Our proposal is that creditors should commit to write off any balance of a client’s debt if that client makes 72 payments or repays at least 90% of his total debt, whichever occurs first. We believe that this arrangement would have a dramatic effect on client longevity since it offers the client a far greater potential benefit than just having the fee paid. We believe that the result of this concession would be to reduce the current decay rate by at least 2/3.

We recognise that this concession by creditors would be of benefit to Baines & Ernst, so we would be willing to reduce the management fee retained on debts to creditors accepting this arrangement to 10% rather than the existing 15%, thus increasing the actual amounts paid to participating creditors.” (emphasis added)

  1. (I understand the phrase “decay rate” to be used to describe the rate at which contracts are terminated. Apparently, after about 2 years, most clients of B&E’s choose to make their own arrangements for repayment with creditors, or continue repayment direct on the terms arranged by B&E).
  2. The creditors addressed in the discussion paper were not local traders but major organisations and companies such as Barclaycard and Co-op Bank. Since each would be concerned to recover its own debt as quickly as possible, it would undoubtedly consider most carefully the whole of any proposed repayment package put to it, having the power to reject the whole package. It is against that background that I turn to consider B&E’s conditional proposal to reduce its management fees from 15 per cent to 10 per cent.
  3. I am quite sure that the reference to existing management fees of 15 per cent in the discussion paper was deliberate, and no mere error on the part of B&E. The paper was addressed to a group with the ability effectively to determine its level of fees, and it was essential that B&E presented a case showing those fees to be reasonable. (Indeed, in evidence, Mr Cochrane admitted that creditors were consulted about B&E’s level of charges). I find that it represented to creditors that its management fees in December 2002 were 15 per cent, albeit subject to VAT. The proposal to reduce fees from 15 per cent to 10 per cent clearly indicated a willingness substantially to reduce its management fee level if creditors were prepared to create conditions likely to increase the length of the term clients would remain committed to B&E (estimated to increase from 22 months to 43 months).
  4. I find that, after B&E changed its contract terms in 1999, it continued to charge its clients 15 per cent plus VAT for management services until it de-registered for VAT.
  5. I do, however, accept that B&E charged new clients management fees of 17.625 per cent after the Commissioners accepted that its services were VAT exempt, and continues to charge at that rate. But I am unable to accept that B&E necessarily would have continued to charge at 17.625 per cent irrespective of an adverse effect on its business of a change in rate by a major competitor, being told by creditors that its charges were too high and had to be reduced, or being faced either with the possible consequences of the OFT re-opening its case on the presentation of its charges, or with a client claiming its contract terms to be unfair. (Those consequences, I remind myself, include unfair terms not binding on consumers). I find that B&E now has by far the largest share of the debt management market and maintains its dominant position despite the fact that certain of its smaller competitors have reduced their rates slightly below the 17.625 per cent rate. I should also add that B&E produced a discussion document dated 17 October 2002 (p. 111) entitled, “Subject: reduce our management fee” which was on the agenda for a board meeting on 21 November 2002 (minutes pp. 114-115) as was an agreement between Debt Management Associates and Barclaycard offering free management services to clients which would have been of obvious concern to the B&E board. No evidence was adduced to indicate that the proposals in the document at p. 111 were acted upon.
  6. Mr Cochrane gave as another reason B&E would never have reduced its management fees from 17.625 per cent to 15 per cent the fact that it would have found itself making losses. I accept that it was most unlikely that it would have done so had its fees in the disclosure period been exempt from VAT, for its irrecoverable input tax would then have been a charge on profits and may well have resulted in losses. But in the period with which I am concerned, its services were throughout treated as fully taxable, so that different considerations apply. As B&E’s voluntary disclosure shows, during the first year of the disclosure period, input tax and output tax were little different, due mainly, I infer from the whole of the evidence, to B&E having spent very large sums in advertising its services, and on other items that contributed to its very rapid expansion. In the year to 30 June 2001 B&E increased its turnover from approximately £6 million to over £21 million, and overtook GP as market leader. In the last two years of the disclosure period output tax was considerably in excess of input tax, again I infer from the whole of the evidence, because B&E continued to obtain advantage from earlier expenditure on advertising etc and thus had to spend little, if anything, on further expansion in the latter part of the disclosure period.
  7. Mr Cochrane freely admitted that, were I to allow the appeal, B&E intended to return to its clients none of the moneys to be repaid. Referring to contracts entered into up to and including 1999, he maintained that the company could not refund moneys estimated at £1.7 million to persons on those contracts in the voluntary disclosure period as it did not know where they were. I am unable to accept that, without making any attempt to contact them, it is unaware of the whereabouts of all such persons; a single standard letter to former clients would produce some responses on which B&E could act. And, Mr Cochrane added, B&E would not be refunding moneys to those who contracted with it from 1999 onwards as they had not been charged VAT. In my judgment, all of B&E’s clients, whether pre- or post 1999 would be entitled to the return of moneys it charged as VAT which was not due were I to allow the appeal, they, as I have already found, having been charged the tax in question.
  8. I might also observe that the instant case differs from those cases involving retailers for B&E entered into individual contracts with clients and must necessarily have known their names and addresses, whereas retailers were unlikely to be able to identify individual customers.

The Law

  1. The only relevant statute law is s. 80 of the Value Added Tax Act 1994, subsections (1) and (3) whereof provide as follows:

“80 Recovery of overpaid VAT

(1) Where a person has (whether before or after the commencement of this Act) paid an amount to the Commissioners by way of VAT which was not VAT due to them, they shall be liable to repay the amount to him.