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paul hyett

Ex-gratia payments are not 'supply' in the eyes of the tax court - so no VAT

Here's a story regarding valued added tax (VAT ) with big implications for architects who settle a fee dispute outside the courts - that is, after issuing proceedings but before judgement.

Essentially, it means that where you accept a lesser sum (which might, I guess, be as much as 99.9 per cent of the full amount claimed) you and your client may argue that the payment is VAT exempt.

This is not a 'ruse'; it is based on a judgment in the case of Reich v The Commissioners of Customs and Excise which was heard at no less an authority than the Manchester VAT tribunal in December 1992.

The facts: the appellant worked as a merger broker and in that capacity he charged fees on a commission basis - either against the vendor, the purchaser, or partly against each.

Commission had been charged from travel company Hogg Robinson relating to work which had involved research, information and an introduction to a firm owning travel shops which were to be sold.

Having obtained agreement to his fee proposal, and after providing the services mentioned, the appellant received a letter from Hogg Robinson advising that it wished to proceed no further. Later the appellant learned that his ex-client had, however, proceeded to acquire the travel shops without further contacting him. (This story is all too familiar to those architects who have been shafted by developer clients. ) Hogg Robinson refused to pay and litigation was commenced by the appellant for £45,000 plus costs. VAT was applicable on top of this figure. However, after a good round of haggling, an offer of £35,000 inclusive of all costs was accepted at the court doors 'in full and final settlement'.

That sum was duly paid and banked by the appellant but, later, VAT officers noted that no VAT had been charged on the sum. They subsequently brought an action for VAT at the standard rate on the £35,000 which they alleged was a part payment against the £45,000 fee (net of VAT ) billed to Hogg Robinson. Surprisingly, the Manchester tribunal found in favour of the appellant - that is, no VAT was chargeable. So what logic supported this decision?

Firstly, the tribunal decided that although VAT would be chargeable where a taxpayer sues and recovers judgement for an amount of an invoice on which VAT is properly applicable 'as being in respect of a supply', it is quite another situation where judgement has not been obtained. (This case was, remember, settled before judgment. ) Hogg Robinson had never admitted that a taxable supply had been received: it had merely made a payment to avoid the embarrassment, cost and risk of a trial.

The tribunal deemed that it must be apparent that something has been done, as well as done for a consideration, in order to give rise to a taxable supply as provided under Section 3(2)(b) of the VAT Act 1983!

Apparently, sums received by way of settlement of litigation, such as in this case, represent consideration of a complex nature.

What element of legal costs are included?

What element of a payment which is 'in full and final settlement' relates to embarrassment that a defendant would otherwise cause to a plaintiff - financial or otherwise, in pursuing a claim? In conclusion, the tribunal decided that the parties in the case outlined above had placed on the claim an agreed estimate of its worth as a claim, not because they recognised that consideration was being paid for a supply that had been made or for the transfer of any benefit such as copyright.

The appeal against the Customs and Excise demand for VAT on the settlement figure was therefore successful.

But, as TVpresenter Davina McCall says: 'Don't try this at home.' And don't conspire to defraud - you must not collude with a client to construct a false dispute and 'settlement'. As Robert Hogarth, of solicitors Reynolds Porter Chamberlain, who provided me with this intriguing story says, you should always ensure proper legal and accounting advice in any similar circumstances.

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