Southern Cross: compromise agreement not ultra vires

The Upper Tribunal’s decision in HMRC v Southern Cross Employment Agency Ltd [2015] UKUT 0122 (TCC), although concerned with legal matters, is of practical significance. Southern Cross having made a claim for repayment under VATA 1994 s 80 reached settlement with HMRC. HMRC’s attempt to get out of the settlement agreement failed before the First-tier Tribunal ([2014] UKFTT 088 (TC)). Mr Justice Newey in the Upper Tribunal also dismissed HMRC’s appeal holding that:

• VATA 1994 s 80(7) did not bar HMRC from entering into a binding agreement with Southern Cross. HMRC could enter into such an agreement under its care and management power.
• The agreement HMRC entered into was not ultra vires and was not void.
• The FTT was entitled to find that a compromise agreement had been formed between Southern Cross and HMRC on the facts and that such finding could not be disturbed.

Both the FTT and the Upper Tribunal in essence held that although the initial claim for repayment was made under s 80, HMRC repaid the money under the compromise agreement rather than strictly pursuant to s 80. That in effect took the matter outside s 80. HMRC had power to enter into such a compromise agreement of that claim. The effect of the payment being made under the compromise agreement was that s 80(4A) could not bite, so HMRC could not make the recovery assessments. Subtle legal concepts at play had practical significance on the outcome of the case.

The facts

Southern Cross is an employment agency that supplied dental nurses to dentists. The original VAT issue underlying the appeal was whether Southern Cross’s supplies were exempt.

Southern Cross had accounted for VAT on the supplies. Considering its supplies to be exempt, it initially claimed repayment for the period 1998 to 2001. HMRC agreed that the supplies were exempt and repaid VAT for that period.

In 2009, Southern Cross submitted a Fleming claim for repayment for the period 1973 to 1997. HMRC raised the defence of unjust enrichment. Southern Cross’s advisers Horwath Clark Whitehill (HCW) strongly disputed HMRC’s entitlement to rely on the unjust enrichment defence. HCW maintained that there had not been unjust enrichment. HMRC claimed that Southern Cross’s competitors were charging VAT on their supplies. HCW argued that some competitors were not charging VAT on their supplies so there was ‘VAT free competition’. Neither side referred to any specific evidence, as such negotiations were conjecture based. HMRC’s officer communicating with HCW accepted the argument in part, and in March 2010 proposed to pay 50% of Southern Cross’s claim with interest. HCW, maintained that there was no unjust enrichment, but invited HMRC to offer 74% of the amount claimed with interest, which Southern Cross would accept. HMRC’s officer accepted the proposal to repay 74% of the claim and arranged payment of circa £1.4m in April 2010.

In July 2010, HMRC raised assessments to recover the circa £1.4m from Southern Cross under VATA 1994 ss 80(4A) and 78A on the grounds that the claim should not have been paid. There was a pending dispute in another case. In May 2011, the FTT in Moher v HMRC [2011] UKFTT 286 (TC) held that relevant supplies of staff were made to dentists (and taxable) and not to patients. That decision was later upheld by the Upper Tribunal. Southern Cross disputed HMRC’s ability to resile from the agreement reached between them.

The FTT’s decision

The FTT held that:

• There was a binding common law agreement between HMRC and Southern Cross (issue 1) because Southern Cross had given up 24% of the claim in order to achieve settlement which was valuable consideration.
• That agreement was not ultra vires because HMRC had power to enter into such an agreement with Southern Cross under its care and management power (issue 2). When HMRC reached settlement with Southern Cross, Moher had not been decided and there was no clarity as to the correct VAT treatment. The agreement reached was a ‘genuine and realistic approximation of the actual amount due to Southern Cross, made after detailed discussion and negotiation’. Later discovery that the deal reached was not a good one for HMRC could not render the agreement unlawful.
• HMRC was not entitled to make assessments under ss 80(4A) and 78A(1) to recover the sums paid under a common law agreement (issue 3). In s 80 terms, strictly, it had not been established at that time that Southern Cross had accounted for output tax ‘that was not output tax due’.

The Upper Tribunal’s decision

The scope of s 80(4A)

The Upper Tribunal considered issue 3 on s 80 first. The Upper Tribunal held that s 80(4A) is precluded from applying where there has been:

• a judicial determination (R v C&E Commrs, ex parte Building Societies Ombudsman Co Ltd [2000] 892); or
• a deemed judicial determination by the settlement of an appeal under an agreement under VATA 1994 s 85 (R (on the application of DFS Furniture Co Plc) v C&E Commrs [2003] STC 1)

Accordingly, ‘the better view ... is that, where no appeal is pending, HMRC’s liabilities can similarly be fixed for the purposes of s 80(1) and (4A) by means of a contractual agreement outside s 85’ (para 37(f)).

Mr Justice Newey also held, relying on IRC v Nuttall [1990] STC 194, that HMRC could enter into a binding agreement outside VATA 1994 s 85, just as it could enter into binding agreements relating to direct taxes outside TMA 1970 s 54 (the direct tax equivalent of s 85).

Section 80(7) prevents taxpayers from seeking the recovery of overpaid VAT by common law claims for restitution or through their tax return, just as it does not apply to judicial determination or deemed judicial determination under s 85 agreements; however, it is noteworthy that it does not apply to agreements reached under HMRC’s care and management power

Therefore, HMRC could enter into a settlement agreement outside s 85 even though no appeal had been made. That agreement had a similar effect to a judicial determination or deemed judicial determination under s 85 and as such formed a third exception to cases outside s 80(4A) where HMRC could not make recovery assessments. HMRC therefore argued that even if such an agreement could be made, it was ultra vires and void.

The agreement was not ultra vires and it was not void

Southern Cross did not dispute that if the agreement was ultra vires, it was void. It argued that the agreement was not ultra vires, and therefore it was not void.

HMRC argued that an error of law had been made in reaching settlement which made the compromise agreement void. Both tribunals found that when the agreement was entered into, Moher not having been decided, there was uncertainty in the law. There was no evidence that HMRC had excluded the possibility of the supplies being exempt. However, by reaching the settlement, HMRC did not misdirect itself as to the law or failed to have regard to relevant considerations. Mr Justice Newey referred to authorities establishing that HMRC has a managerial discretion under its care and management powers to enter into agreements for the ‘good management’ of taxes. Good management of taxes permit ‘concessions [to] be made where those facilitate the overall task of tax collection’ (R (Wilkinson) v IRC [2003] EWCA Civ 814, [2003] STC 1113 at para 45, quoted at para 44 of Mr Justice Newey’s judgment).

The exercise of discretion can only be challenged if it is ‘Wednesbury unreasonable’ or ‘irrational’ (see para 48) or there is ‘some extraneous or ulterior reason’ (see para 50). No improper purpose for entry into the agreement between HMRC and Southern Cross had been identified. Nor could ‘it be maintained that HMRC acted irrationally’ because the VAT status of the supplies had not been established. Mr Justice Newey held that HMRC could not disavow the agreement simply on the grounds that the law had been clarified.

A compromise agreement was formed on the facts

Mr Justice Newey also rejected HMRC’s argument that the FTT ought to have decided that no contract had been formed.

Firstly, Southern Cross had given good consideration because forbearance of a bona fide right to litigate a question of law or fact which is not vexatious or frivolous constitutes giving up something of value (Miles v New Zealand Alford Estate Co (1885) 32 Ch D 266), which constitutes good consideration.

Secondly, HMRC’s argument that there was no evidence of any intention to create legal relations outside the VAT regime (i.e. outside the framework of s 80) failed. The FTT held that is was not ‘simply a case of HMRC seeking to ascertain the amount properly due’. HMRC did not unilaterally decide that Southern Cross was entitled to repayment under s 80. Mr Justice Newey agreed with Mr Peter Mantle on behalf of Southern Cross that the pattern of correspondence pointed towards ‘a process of negotiation and, in the end, an intention to conclude a contractual agreement.’

Conclusion

This decision exposes limitations on HMRC’s ability to make assessments under s 80(4A) and (7).

Perhaps most significantly, both tribunals held that the agreement entered into was not ultra vires. At the time the agreement was entered into HMRC did not make any error of law by entering into the agreement, so it was a reasonable one. It was not ultra vires because it turned out that HMRC had not been liable to repay VAT to Southern Cross. Payment became due to Southern Cross under that agreement. HMRC could not, therefore, make the recovery assessments. The opposite conclusion would have had ‘far reaching implications’ as ‘any agreement between HMRC and a taxpayer could ... be reopened if it involved HMRC paying more than proved to be due’.

Such cases may be rare in practice. They are likely to be fact sensitive. The case illustrates that there must be merit in closely reviewing whether a compromise agreement has been entered into where a repayment has been agreed by HMRC, if it seeks to reopen it and recover the repayment.

Monckton Chambers represented the taxpayer in this case