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A court ruling has thrown into doubt a company's right to reclaim VAT relating to goods that it later repossessed. The ruling could undermine the usefulness of businesses retaining the right to repossess goods they supply to other businesses.

The Court of Appeal has told car maker Ford that it could not escape liability for value added tax (VAT) on goods which it was not paid for and had to repossess, unless its contract with a car dealer foresaw that situation or it had subsequently agreed its actions with the dealer.

Ford supplied cars to dealer Brunel but held on to legal ownership of the vehicles until it had received full payment for the cars. Ford issued invoices for the price of the cars and the VAT, which it would later owe to HM Revenue & Customs (HMRC), having collected it from Brunel.

When Brunel went into administrative receivership, Ford was entitled to be paid for the cars, but Brunel could not pay. Under its agreement, Ford was able to repossess the cars. It issued Brunel with a VAT credit note to cancel its previous demand for VAT payment and claimed a refund of the VAT debt from HMRC.

Administrative receivers later challenged the arrangement and the credit note and claimed a repayment from HMRC of the VAT Brunel had paid as a result of the credit note.

The Court of Appeal said that it was not for Ford to unilaterally issue credit notes, and that such a procedure does not change the fact that a supply had taken place on which VAT was due. The Chancellor of the High Court said in his ruling that such a move can only wipe out the VAT debt if the original supply had been effectively cancelled by the parties.

"The taxable consequences of the original supplies of vehicles by Ford to Brunel can only be discharged by some subsequent contractual rescission or novation which is evidenced by the credit notes," he said.

The Court said that the facts uncovered by the Tribunal were not sufficient to make a definitive ruling. It said that the case should return to the Tribunal and they should find out if the contract had been cancelled and the resulting VAT adjustments were valid. If the Tribunal finds that Ford had not established a legal right to cancel the original supply contract, then the car maker could be liable to pay VAT to HMRC that it never collected from Brunel on cars which it had to repossess.

Clare Francis of Pinsent Masons, the law firm behind OUT-LAW.COM, said that such situations were likely to be more common with the economy in decline.

"This decision will impact on supply agreements, particularly in the current economic climate with an increasing number of businesses looking to rely on retention of title provisions," she said. "If the VAT is not recoverable this could potentially limit the attractiveness of enforcing the retention of title provisions."

Francis said that retention of title provisions were likely to become more closely scrutinised as suppliers seek to cover themselves for the eventuality of a customer going out of business. She said that companies should ensure that their contracts give them cover for a situation like Ford's.

Contracts should make it clear that if the customer goes insolvent then repossession of goods will discharge the contract the two companies had agreed, allowing for valid VAT credit notes to be issued.

"Many suppliers are looking to strengthen retention of title provisions in their agreements to mitigate the risk of a customer becoming insolvent while holding the supplier's stock. If you are one of them you should review your supply terms to ensure this issue is effectively covered off," she said.

Copyright © 2009, OUT-LAW.com

OUT-LAW.COM is part of international law firm Pinsent Masons.

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