THE FUNDING CORPORATION Limitedappellant

19525

VALUE ADDED TAX – Direction to pay costs to the successful party (the Appellant) – rule 29(1) of the VAT Tribunals Rules 1986 – whether costs should be awarded on the standard basis or alternatively on the indemnity basis – CPR rule 44.4 applied by analogy – in the light of their conduct of the litigation, the Commissioners directed to pay costs on the indemnity basis

LONDON TRIBUNAL CENTRE

THE FUNDING CORPORATION LIMITEDAppellant

- and -

THE COMMISSIONERS

FOR HER MAJESTY’S REVENUE AND CUSTOMS Respondents

Tribunal:JOHN WALTERS, QC (Chairman)

MR. CYRIL SHAW

Sitting in public in London on 14 and 15 September 2005, and 29 March 2006

Mr. Andrew Hitchmough, instructed by BDO Stoy Hayward, appeared on behalf of the Appellant

Ms. S. Rahman, of Counsel, instructed by the Solicitor for HM Revenue & Customs, appeared on behalf of the Respondents on 14 and 15 September 2005, and Mrs. Pauline Crinnion, Advocate, appeared on behalf of the Respondents at the adjourned hearing on 29 March 2006

DECISION

This is an appeal against an assessment made on 19 April 2004 but notified to the Appellant by a Notice of Assessment dated 4 May 2004, to recover VAT of £296,185 asserted by the Commissioners to be due by reason of the application of the standard method override in the longer period ended 30 June 2003.
As background to the matter in dispute in the appeal, the Tribunal records that the Appellant is the representative member of a group of finance companies. It makes both taxable and exempt supplies (i.e. it is a partially exempt trader) and is therefore restricted in its ability to recover full credit for input tax. A proportion only of VAT incurred which cannot be attributed exclusively to taxable or exempt supplies (residual tax) may be recovered. The Appellant has been using the standard partial exemption method (rather than a special method) to calculate the recoverable proportion of its residual tax.
From 18 April 2002, any business using the standard partial exemption method has been required to measure the actual use of the supplies upon which input tax had been recovered by its use. Where the difference between the calculations made under the standard method and actual use calculations is substantial, the business is obliged to make an adjustment, known as the standard method override.
In this case, the Appellant and the Commissioners agree that there is such a substantial difference, and that an adjustment must accordingly be made for the longer period ended 30 June 2003. The dispute in the appeal was as to the quantum of the adjustment.
The appeal was called on for hearing on 14 September 2005. On 15 September 2005, the Commissioners’ witness, Mr. Peter Fenner gave evidence and was cross-examined by Mr. Hitchmough in particular as to the reasonableness of methodology of his calculations, which were the basis of the assessment. Most unfortunately, Mr. Fenner became ill during the cross-examination and, although the Tribunal was later able to receive evidence from the Commissioner’s policy adviser, Mr. Donald Bryant, the appeal had to be adjourned to a date to be fixed. Before the adjournment, the Chairman of the Tribunal indicated to the parties the Tribunal’s provisional view that admissions made by Mr. Fenner under cross-examination had undermined his calculations.
The adjourned hearing eventually took place on 29 March 2006. In the interval, the Chairman had been informed by the Tribunal Centre staff that the Commissioners were no longer defending the appeal and that the only issue to be considered at the adjourned hearing would be the issue of costs. On that basis, the Chairman decided to sit without Mr. Shaw (the other member of the original Tribunal) at the adjourned hearing. At the resumed hearing, the Chairman raised the matter of the composition of the Tribunal, but neither party raised any point on that aspect of the matter.
The Chairman was told at the resumed hearing that the Commissioners were no longer defending the appeal, but that they had declined to enter into any agreement to discharge the assessment, pursuant to section 85(1) VAT Act 1994. It therefore remained for the Tribunal formally to allow the appeal on the basis that no opposition to that course was made by the Commissioners. The Chairman did this at the resumed hearing.

The costs issue

The remaining issue of costs includes (besides the basic issue of whether or not the Tribunal will award costs), the evidential issue of the amount of costs incurred, whether the Tribunal will award costs on the indemnity basis or the standard basis, and, in relation to any costs claimed, any question of whether those costs were reasonable or unreasonable.
Mrs. Crinnion, for the Commissioners accepted that they should pay the Appellant’s reasonable costs. There will be an award of costs in favour of the Appellant.
The Tribunal is not able to deal finally with the question of costs at this stage, and in particular is not in a position to find the amount of costs incurred, nor to determine any question of reasonableness in relation to items of costs claimed.
In this Decision the Tribunal deals with the remaining issue, which is the basis on which the costs order should be made.
Mr. Hitchmough applied to the Tribunal to direct costs to be paid on the indemnity basis. Mrs. Crinnion opposed this application submitting that the right direction would be for costs on the standard basis.
Mr. Hitchmough referred the Tribunal to the earlier Tribunal decision in Harrods (UK) Limited v Commissioners for HMRC (Decision 19318, released 1 November 2005).
In the decision in Harrods (UK) Limited, the Tribunal (with the same Chairman as this Tribunal) referred to the jurisdiction to make a direction as to costs, which is contained in rule 29 of the VAT Tribunals Rules 1986 (“the Tribunals Rules”) and noted that where a Tribunal makes a direction under rule 29(1)(b) the provisions of Part 47 of the Civil Procedure Rules 1998 and any supplementary practice directions (“the CPR”) are to apply – the procedure for detailed assessment of costs in the Supreme Court.
As was done in Harrods (UK) Limited, this Tribunal will apply by analogy the general rules about costs contained in Part 44, CPR and in particular rule 44.4, which deals with the basis of assessment. Rule 44.4(1) states that the court will assess costs on the standard basis or on the indemnity basis, but will not in either case allow costs which have been unreasonably incurred or are unreasonable in amount.
Where costs are assessed on the standard basis, the court will only allow costs which are proportionate to the matters in issue and will resolve any doubt which it may have as to whether costs were reasonably incurred or reasonable and proportionate in favour of the paying party (rule 44.4(2)).
Where costs are assessed on the indemnity basis, the court will resolve any doubt which it may have as to whether costs were reasonably incurred or were reasonable in amount in favour of the receiving party (rule 44.4(3)).
It will be seen that the test of proportionality included in the assessment on the standard basis is absent from the assessment on the indemnity basis.
In the light of these differences, the Tribunal can well see why the Court of Appeal said in Kiam v MGN Ltd (No. 2) [2002] 2 All ER 242 that an indemnity costs order made under rule 44 does carry at least some stigma and is of its nature penal rather than exhortatory. In this it is different from an indemnity costs order made under rule 36.21 (where a claimant does better than he proposed in his Part 36 offer), which is part of a case management procedure and so not germane to the issue the Tribunal has to decide in this case.
Indeed, the award of costs on the indemnity basis under rule 44 (which is analogous to such an award made by this Tribunal) is normally reserved to cases where the court wishes to indicate its disapproval of the conduct in the litigation of the party against whom the costs are awarded: Reid Minty v Gordon Taylor [2002] 2 All ER 150 (CA).
The Tribunal therefore proceeds to examine the relevant history of the current dispute.

The relevant history of the dispute

The appeal proceeded normally until Mr. Fenner fell ill in the witness box on 15 September 2006, as recounted above, necessitating an adjournment to a date to be fixed.
Following the September hearing the parties made efforts to reach agreement on the quantum of the standard method override, so that the dispute could be resolved by an agreement under section 85(1) VATA.
On 19 October 2005, on Mr. Fenner’s advice, a notice of assessment was issued to the Appellant assessing tax for the period 06/04 by reference to the standard method override required for the longer period ended 31 March 2004. Mr. Hitchmough informed the Tribunal that the methodology adopted for this assessment was the same methodology as had supported the assessment against which the appeal had been brought.
Negotiations for settlement continued after that. On 24 January 2006 the Appellant’s representatives were informed by email by Martin Roberts, Higher Officer at HMRC that there had been “a decision taken not to defend the assessments further at Tribunal”. No further information was provided at that time.
Mr. Bryant, the Commissioners’ policy adviser, who, as recorded above, had given evidence at the September hearing, wrote to the Appellant on 26 January 2006 as follows:

“VAT Tribunal Appeal Ref: LON/04/0932

I refer to the above appeal, which was heard by the London VAT Tribunal on 14/15 September 2005. As you know, the hearing was adjourned because of illness on the part of one of HMRC’s witnesses. The Tribunal has therefore not yet reached its final decision in the matter.

I understand that Mr. Carroll has been in contact with your advisers on a “without prejudice” basis, but no agreement has been reached.

During the hearing, I indicated to the Tribunal that the Commissioners might well wish to advance further arguments in respect of later over-ride adjustments to the effect that the disputed input costs were not cost components of the price of taxable transactions within the meaning of art. 2 of the First VAT Directive (Dir 67/227) and were not therefore used to taxable supplies of goods sold under the HP agreement. These arguments are explained in more detail in various letters to the Finance & Leasing Association, commencing with my letter of 11 February 2005. In case you do not have copies of those letters, the Commissioners will write and explain the arguments in more detail in due course.

The Commissioners do not wish to enter into any agreement with you under s 85 of the VAT Act 1994 that might prejudice such an argument in future. In the absence of an agreement, they have decided to take the following action in respect of the disputed assessments relating to the 2002/2003 and 2003/2004 over-ride calculations:

Notice of Assessment dated 4 May 2004: The amount of £296,185 will be reduced to £215,581. This has been calculated as follows:

Residual input tax recoverable under the standard method before

applying the over-ride£339,310

(NB: This figure appears in the Commissioners’ letter of

26 March 2004 at the third line from the bottom of the first page)

Residual input tax recoverable after applying your own over-ride

calculation (123,729)

(NB: This figure appears in Appendix A (penultimate column) of

your advisers’ letter of 27 October 2003)

The revised amount due is therefore £215,581

The interest charges will also be reduced proportionately.

Notice of Assessment dated 19 October 2005: The amount of £167,186 will be reduced to nil. The interest charges will also be reduced to nil.

This should not be taken as implying that the Commissioners agree that the amended figures are correct or that a similar calculation should be applied to any other over-ride calculation. It merely reflects the fact that they are unable to re-calculate the revised over-ride amounts following the evidence presented at the hearing, and in the light of concessions made by the Commissioners in respect of the 2002/2003 over-ride calculation.

I am copying this letter to Mr. Stephen Keyhoe of BDO Stoy Hayward Plc.

Yours faithfully”

Mr. Hitchmough informed the Tribunal that the calculation in this letter relating to the Notice of Assessment dated 4 May 2004 was itself flawed, and from subsequent correspondence before the Tribunal it appears that the Commissioners accepted that this was so, and agreement was reached on the resolution of the dispute connected with the two Notices of Assessment.

The parties’ submissions on the costs issue

In applying to the Tribunal to award costs on the indemnity basis, Mr. Hitchmough put forward the following arguments to show that this is a case where the Tribunal might wish to indicate its disapproval of the conduct in the litigation of the Commissioners, bearing in mind that an indemnity costs order carries at least some stigma and is of its nature penal rather than exhortatory.
First, he said, the Appellant brought the appeal not only to resolve its dispute in relation to the assessment appealed against, but to achieve a reliable precedent for the resolution of standard method override issues in future years. The Appellant has been frustrated in this respect by the Commissioners’ decision to withdraw the assessments part way through the appeal process without agreeing an alternative standard method override acceptable to the Appellant.
Secondly, the Commissioners’ conduct in the appeal itself deserves to be recognised by an award of costs on the indemnity basis.
Mrs. Crinnion offered no submissions in response other than that costs should be awarded on the standard basis. She did not seek to defend the Commissioners’ conduct or to say why the Appellant was not entitled to costs awarded on the indemnity basis.

Decision on the costs issue

When considering whether to award costs on the standard basis or alternatively on the indemnity basis, the Tribunal bears in mind that on whatever basis costs are awarded, costs unreasonably incurred, or which are unreasonable in amount, will not be allowed (see: above, paragraph 15). Thus although an award of costs on the indemnity basis would carry some stigma, be penal and would indicate the Tribunal’s disapproval of the conduct of the Commissioners in the litigation, it would not oblige the Commissioners to fund or reimburse any unreasonable costs. Further, to the extent that the Appellant has incurred costs, particularly reasonable costs which are not reimbursed by the Commissioners, the Tribunal bears in mind that this will cause loss to the Appellant, which has been entirely successful in the litigation.
The Tribunal makes it clear that it does not criticise the Commissioners’ decision to withdraw the assessment and refuse to enter into an agreement under section 85 VAT Act, although that decision of course has consequences so far as costs are concerned. Having said that, it is not at all clear to the Tribunal why the Commissioners have refused to enter into a section 85 agreement, which could have been made on a basis without prejudice to any arguments the Commissioners wished to advance on a future standard method over-ride dispute. Entering into a section 85 agreement would certainly have saved some time and costs.
Mr. Hitchmough’s second point seems to the Tribunal to have the greater force in justifying an indemnity costs award. In the administration of VAT it is incumbent on the Commissioners to facilitate so far as they reasonably can achievement of finality and certainty for a trader in the disputed area giving rise to an appeal to the Tribunal. From the text of Mr. Bryant’s letter of 24 January 2006, it appears that the further arguments to which he refers, and the further deployment of which the Commissioners do not want to prejudice, have been formulated since at least early February 2005. In these circumstances it seems to the Tribunal that more ought to have been done by the Commissioners to ensure that, however the instant litigation was decided, it would afford some certainty for the future VAT treatment of the Appellant. As it is, having effectively won this litigation, the Appellant is no further forward in respect of further potential standard method override disputes. This is an avoidable and unfair aspect of the outcome for the Appellant and, in the Tribunal’s view, justifies the award of costs against the Commissioners on the indemnity basis.
We see nothing to criticise in the Appellant’s conduct of the litigation.
In the result, the Tribunal has concluded that it would be right to direct the Commissioners to pay the Appellant’s costs of and incidental to and consequent upon the application and the appeal on the indemnity basis, to be assessed in accordance with rule 29(1)(b) of the Tribunals Rules, if not agreed.
At the hearing on 29 March 2006, Mrs. Crinnion asked the Tribunal to give its reasons for its decision on the costs issue in writing. In this Decision we have done that. This Decision will serve as the Direction to pay costs as per paragraph 36. Both parties have liberty to apply to a Chairman of these Tribunals sitting alone.

JOHN WALTERS QC

CHAIRMAN

RELEASED: 4 April 2006

LON/04/932