The High Court held that, on a careful analysis of a netting agreement, whereby each new contract between parties in a series was amalgamated with existing contracts, the Revenue and Customs Commissioners had made an assessment for the incorrect period which was accordingly invalid.

Facts

The taxpayer carried on business as a wholesale supplier of gas and electricity. In November 2001, an administration order was made in the High Court in respect of the Enron corporate group.

Morgan Stanley and Enron had entered into a series of forward transactions with each other and accordingly were mutual counterparties to physical gas and electricity trades. When Enron went into administration Morgan Stanley gave notice to Enron that an event of default had occurred under the netting agreement between them and designated an early termination date on which all outstanding transactions would be terminated. Morgan Stanley performed the calculations required under the netting agreement in respect of the terminated transactions and provided Enron with a calculation statement specifying the net amount payable to Enron under the netting agreement as £655,858.

The calculation statement and underlying exhibits showed, amongst other things, that Enron had supplied Morgan Stanley with electricity and natural gas totalling £38,319,606 in value which was unpaid;

Morgan Stanley had supplied Enron with electricity and natural gas totalling £27,341,033 in value which was unpaid; and the unpaid output tax relating to the supplies of electricity and natural gas made by Enron to Morgan Stanley amounted to £6,705,931 (£264,574 for electricity and £6,441,356 for natural gas). Pursuant to the terms of the netting agreement Morgan Stanley paid Enron £655,858 in accordance with the calculation statement dated 21 February 2002. The administrators of the Enron corporate group declared output tax on the value of the payment received in the taxpayer's VAT return for the period ending 30 September 2002. Customs made the disputed assessment in the sum of £6,608,250, in respect of the total supply of £38,319,606 in respect of the VAT period 09/02 on the basis that the unpaid purchase price was paid and discharged on 6 August 2002 when Morgan Stanley paid the sum of £655,858 to Enron.

The taxpayer's case was that the assessment related to tax allegedly due on supplies made by its subsidiary to Morgan Stanley and that, in accordance with reg. 86 of the Value Added Tax Regulations 1995, a supply was treated as taking place each time a payment was received by the supplier or a VAT invoice was issued in respect of the supply, whichever was earlier; therefore the only payment received in the period ending 30 September 2002 was the amount shown on the return for that period and the assessment was wrong in law in that it sought to impose an output tax charge in respect of supplies that did not take place in the VAT accounting period concerned.

The VAT tribunal considered the period during which the sums paid pursuant to the netting agreement were paid to the taxpayer's subsidiary and what effect, if any, the netting agreement had as to the date when the tax point arose and the interaction between the agreement and reg. 86(1) of the 1995 Regulations. It allowed the taxpayer's appeal, holding that the netting agreement provided for a novation (and not payment) netting and the replacement of a liability on the part of Morgan Stanley to pay the outstanding purchase price of £38,319,606 with the different obligation to pay the sum of £655,858; and that no tax point arose in respect of any sum other than the £655,858 in the relevant period ([2006] BVC 2,031; Decision No. 19,180). Customs appealed.

Issue

Whether the assessment relating to the period ending 30 September 2002 was made for the correct period.

Decision

Lightman J (dismissing the appeal) said that where the amount of consideration payable under a transaction was affected by a set-off arrangement, for example where goods were taken in part exchange, there were usually two separate supplies involved by way of barter and it was therefore necessary to identify the mutual supplies so that VAT was charged and accounted for in each direction. Further, in barter transactions the supply by one party was also the consideration for the supply by the other party. Each party therefore had to determine the monetary value of the supply it made and account for VAT accordingly. At the same time each would be able to recover as input tax the VAT it had been charged, subject to the normal rules.

In this case, the netting agreement provided that, on service of the notice, a six-part process should be undertaken in respect of outstanding transactions and indebtedness: (1) cancellation of executory contracts;

2) the process of the calculation of the sums due between the parties (the taking of the ‘account’); (3) in the course of such process the set off of the sumslculated as due between the parties; (4) the provision of the calculation statement; (5) the invoicing by the party entitled to payment to the other party of the sum due which became payable five days later; and 6) payment of the sum invoiced. The issue was at which of those stages the prior entitlement and indebtedness of the parties to each other was discharged and cancelled out and replaced by the obligation of one party to pay the balance due. On a careful analysis of the netting agreement, the pre-existing indebtedness survived the notice and the early termination date and the cancellation of executory contracts. The provision to the effect that no further payment should be made did not discharge the indebtedness. It imposed a moratorium prior to its subsequent discharge. The subsequent calculation exercise was designed to take account of the sums which continued to be due (though not payable) and to carry out an exercise in set off. It gave effect to a contractual set-off. The calculation exercise was completed and the set off was effective to discharge the pre-existing indebtedness when, but not before, the calculation statement was provided. When it was so provided, the accounting exercise was completed, the exercise in set off was effective and preexisting liabilities were discharged. The calculation statement was binding on the parties as soon as it was provided. There was no deferment of its binding effect pending verification or agreement. The balance so calculated alone was due and this only became due and payable five working days after receipt of the invoice. In this case the balance became ‘due’, reflecting the completion of the netting process and the discharge by way of set off of the pre-existing liabilities, on 21 February 2002 when the calculation statement was provided by Morgan Stanley to Enron. The payment of unpaid purchase price of £38,319,606 was accordingly paid and discharged on that date. The payment of the balance of £655,858 on 6 August 2002 had no effect on that (previously discharged) liability. The payment discharged the new liability to pay that sum which arose from the provision of the calculation statement. The assessment was accordingly invalid.

Chancery Division.Judgment delivered 12 April 2006.