18713

00 908 PIERHEAD HOUSING ASSOCIATION LIMITED Colin Bishopp  Manchester 21 July Hilary Thompson, of KPMG, for the appellant James Puzey, of counsel, instructed by the Solicitor's Office of HM Customs and Excise, for the Respondents 
	VALUE ADDED TAX  — input tax — architects’ services supplied to registered trader making exempt supplies — novation of architects’ agreements to builder — whether trader making taxable  supply of architects’ services to builder — whether input tax on architects’ fee recoverable — no — appeal dismissed

MANCHESTER TRIBUNAL CENTRE

 
 	
	PIERHEAD HOUSING ASSOCIATION LIMITED	Appellant

	- and -

	THE COMMISSIONERS OF CUSTOMS AND EXCISE	Respondents

				Tribunal:	 Colin Bishopp (Chairman)

Sitting in public in Manchester on 21 July 2004

Hilary Thompson, of KPMG, for the appellant

James Puzey, of counsel, instructed by the Solicitor's Office of HM Customs and Excise, for the Respondents

	© CROWN COPYRIGHT 2004

DECISION

1.	In this appeal Pierhead Housing Association Limited (“Pierhead”) challenges the refusal of the Commissioners, conveyed by letter of 1 October 2001 to its advisers, to allow Pierhead input tax credit in respect of the tax included in the fees charged to it by two firms of architects.  The principal facts of the case were undisputed, and I take what follows from the statement of agreed facts which the parties had prepared.
2.	As its name implies, Pierhead is a housing association registered, I understand, as a social landlord in accordance with section 1 of the Housing Act 1996.  It has been registered for VAT since October 1993.  In 1994 it entered into a regeneration scheme for the redevelopment of some redundant or semi-redundant buildings and land at the Antiques Triangle in Birkenhead.  The property was to be redeveloped so as to provide a mix of residential flats and shops.  The redevelopment was divided into four phases.  The architects for phases I and II were Ainsley Gommon Wood (“AGW”) and for phase IV Garry Usherwood Associates (“GUA”); the arrangements for phase III are immaterial to this appeal.  Pierhead also entered into a standard form JCT contract for the construction of phases I, II and IV with Watkin Jones & Sons Limited (“WJS”) pursuant to which AGW and GUA were identified as the architects for phases I and II, and phase IV, respectively.  Pierhead’s quantity surveyors were Walfords.
3.	Unfortunately work did not proceed as quickly as had been intended and the continuing and accumulating delays were of increasing concern to Pierhead.  The causes and consequences of the delays were not dealt with by the agreed statement of facts and were to some extent controversial, and I shall return to them later.  They led, however, to the conclusion that the contractual arrangements should be altered.  Pierhead would no longer have separate contracts with WJS, AGW and GUA but would instead enter into a single design and build contract with WJS, to which its two contracts with the architects would be novated.  Although the copy agreements provided were all undated, it was common ground that the deed of variation with WJS, by which the JCT contract was altered, and the two novation agreements were entered into in February 2001.
4.	The appellant accepts that, had the original contract remained in place until completion of the project, the VAT it incurred on the architects’ fees would be irrecoverable since their services would be used in the making of exclusively exempt supplies.  I add parenthetically that I deduce that Pierhead was unable or did not intend to waive the exemption in respect of any part of the redevelopment premises which were to be used for commercial purposes.  However, it says, the benefit of the architects’ services which it had hitherto received was supplied by it to WJS when the arrangements were changed and that was a taxable supply; hence the input tax Pierhead had incurred then became recoverable.
5.	At this point it is necessary to look a little more closely at the delays.  On this topic I had the oral evidence of Kevin Hubbard, at the relevant time Pierhead’s project manager with responsibility for this scheme, and the unchallenged statement of Edward Holmes, who was at the time Pierhead’s development director.  
6.	It was clear from their evidence that the principal reason for changing the contractual arrangements was that it was considered that the revised structure would be more efficient because, in particular, it would eliminate the risk of continuing delay and the consequent increase in cost.  One of the problems Pierhead faced was that the old buildings were Grade II listed as they were architecturally significant.  They were also in a conservation area.  All of the work proposed by Pierhead had, therefore, to be approved, in this case by English Heritage which was also providing some of the funds which paid for the redevelopment.  It was perceived that the existing contractual structure was itself causing delay in the transmission of design information from the architects to WJS.  It had also become apparent that the technical complexity of the project had been underestimated – in particular, Mr Hubbard said, by WJS – and it was considered that a closer relationship between the design teams and the contractor might reduce such difficulties, or at least address them more effectively.  Some unforeseen problems had been encountered; Mr Hubbard mentioned some asbestos which had been discovered buried beneath the site, and which had to be removed before development work could continue.
7.	Mr Hubbard told me that Walfords had identified a number of possible claims which WJS might make against Pierhead, amounting in value to about £200,000.  WJS had, he said, intimated a possible claim although it had not been quantified.  However, as James Puzey, counsel for the Commissioners, was able to show in cross-examination of Mr Hubbard the only possible claim for which there was documentary support in the bundle of documents produced at the hearing was one arising out of the discovery of the buried asbestos, which had been valued at around £14,000 (a trivial sum, as I am satisfied, in the context of an overall contract value of £4.3 million).  Within the bundle was a long letter written by Walfords to Pierhead in August 2000 discussing the benefits of the proposed contractual reconstruction.  The letter deals with a number of topics, including the delays.  It is conspicuous that nowhere in the letter is it suggested that Pierhead was to blame for any of them.  Some criticism is made both of the architect and of WJS and it is apparent that the discovery of the asbestos is not a matter for blame but no more than an unexpected eventuality for which, as Mr Hubbard conceded, there was a contingency provision in the building contract.  The letter also identified 101 separate architects’ instructions which had been issued in relation to phases I and II of the project and which, it seems, had resulted in an increase in cost and some delay.  The evidence did not suggest, however, that those instructions were not within the contemplation of the original building contract or that they could in some way lead to a claim for breach of the contract.  The deed of variation refers to those architects’ instructions as an item taken into account in the calculation of the contract sum which, to reflect a number of factors, differed from that prescribed by the original contract.  
8.	In my view the terms of the deed of variation do not support Mr Hubbard’s suggestion that there was a waiver, even impliedly, by WJS of any claim it might have against Pierhead, for delay or otherwise, save in respect of those architects’ instructions.  On the contrary, the deed provides that “the terms of the Original Contract shall remain in force and have full effect save and insofar as they are amended by this Deed and the Replacement Contract”.  I am not persuaded on the evidence before me that Pierhead’s motive for entering into the reconstruction of the contractual relationships was in part attributable to a desire to escape any possible claim by WJS nor, by design or by accident, that the contractual documents have the effect of relieving Pierhead from any such liability.
9.	It was a term of the deed of variation that WJS would accept responsibility for the entire design, that is including those elements of the design process which related to the condition of the works as they were at the time the deed of variation was executed.  That assumption of responsibility was reflected in the agreement by the architects, contained in the novation agreements, that they would treat WJS as if it had been the employer from the outset.  The operative clause in each novation agreement, identical save for the name of the architects, reads: 
“The Employer [Pierhead] is substituted and replaced as Employer under the Appointment by the Contractor [WJS] and the Appointment will take effect as if the same had been entered into originally between the Contractor and the Consultant [AGW and GUA respectively].”
10.	It is worth mentioning that the deeds of novation contain warranties that the employer, Pierhead, has paid to the architect all its fees “due prior to the date of its novation to the contractor, which fees are not repayable by the contractor to the employer.”  
11.	Hilary Thompson, for the appellant, argued that a novation is, in principle, capable of representing a taxable supply; it amounts to a surrender of rights and therefore comes within section 5(2)(b) of the Value Added Tax Act 1994.  The respondents do not dispute that proposition, so far as it goes.  Mrs Thompson accepted, however, that if the appellant is to succeed in its appeal it must show that the novations were made in return for consideration.  The consideration in this case, she said, was the transfer by Pierhead to WJS of the benefit of the architects’ work to the date of the novation.  If that was right, it followed that Pierhead was making a taxable supply of that benefit and was entitled to credit for the input tax it had incurred in procuring the architects’ services.  Alternatively, if the proper conclusion was that part of those services had already been consumed by incorporation in the development (I take it that some at least of the design work then completed related to work yet to be done) the supply to Pierhead had been used by it in making both taxable and exempt supplies and an apportionment was necessary.
12.	I mention at this point my puzzlement about this feature of Mrs Thompson’s argument.  If she is right that the supply to Pierhead of the architects’ services was, as a result of the novations, utilised by it exclusively in making taxable supplies, it is true that it would be entitled to credit for the input tax; but it would also be required to account for output tax of precisely the same amount (assuming the onward supply was made at cost) and would, even though for different reasons, be in precisely the same financial position as it is now.  When I put the point to her Mrs Thompson agreed that this would be so but she told me that she nevertheless wished to pursue the argument.  I recognise that there may be other factors of which I am unaware which are relevant to Pierhead’s position and, despite my puzzlement about the apparent lack of purpose to the appeal, I propose to deal with Mrs Thompson’s arguments.  Mr Puzey pointed out, incidentally, that there had been significant changes to the arguments which had been advanced on behalf of Pierhead in the correspondence which had been exchanged between its representatives, KPMG, and the respondents before the hearing, and that Mrs Thompson was advancing somewhat different arguments again at the hearing.  That is true – as Mrs Thompson also conceded – but it does not necessarily follow that her arguments as they were advanced at the hearing are any the less strong.
13.	The central plank of her argument was that the novation amounted to a barter.  WJS supplied a warranty for the entirety of the work and assumed the responsibility for instructing and paying the architects.  In return, Mrs Thompson said, Pierhead supplied to WJS the benefit of the architects’ work to date.  Each amounted to the consideration for the other.  
14.	The term “consideration” had to “be given the broadest possible meaning”: see Naturally Yours Cosmetics Ltd v Customs & Excise Commissioners (Case 230/87) [1988] STC 879 at 887, paragraph 16.  The agreements conferred advantages on Pierhead in the elimination, or at least the reduction, of future risk and the obtaining of WJS’s warranty of the work.  WJS had received the benefit of the architects’ services, without which it would not have been able to continue with the development and without which, therefore, it could not have performed its side of the design and build contract.  Those benefits had a subjective value which could be expressed in money, namely the cost to Pierhead of obtaining the architects’ services which it gave in return for the benefits it obtained from WJS: see Empire Stores Ltd v Customs & Excise Commissioners (Case C-33/93) [1994] STC 623 at 632, especially paragraph 18 (the Advocate-General) and at p 636, paragraph 19 (the Court).  Even though, as she accepted, Mr Hubbard’s evidence about potential claims was not supported by the documentation in the bundle it was, she maintained, Pierhead’s perception that by entering into the contractual reconstruction it would obtain a waiver of any possible claims which WJS might make and, since subjective value could be taken into account, that too was a benefit obtained by Pierhead, to be taken into account in reaching the conclusion that Pierhead received value. 
15.	For the Commissioners Mr Puzey pursued two arguments.  First, he said, there was no difference of significance between a novation and an assignment; Pierhead could have procured precisely the same benefits by entering into a new contract with a different builder as it had obtained by entering into this contractual reconstruction with its existing builder.  Secondly, he said, Mrs Thompson’s argument confused motive with consideration.
16.	It does not seem to me that the first of Mr Puzey’s arguments takes the matter any further.  Even if it were true (and I am not sure that it is) that the same benefits could have been obtained by entering into an entirely new contract, it is in my view impossible to disregard the fact that Pierhead was already in contractual relationships with WJS, AGW and GUA and it could not simply put them to one side; it had to renegotiate from the position in which it found itself.  That process of renegotiation, like any other, led to a variety of gains and losses on all sides.  It may well be true, as Mr Puzey said, that the gains and losses cancel each other out but that fact does not lead to the conclusion that there was no consideration.  It is, however, necessary to marry a supply with the consideration given in return for it.
17.	For that reason I think there is rather more in Mr Puzey’s point that motive and consideration have been confused.  There is, in my view, no real room for doubt that Pierhead, WJS and the architects all gained, in one way or another, from the change in the arrangements, and that they all gave something up; whether gain and loss exactly match in value is not material.  However it is not, in my view, sufficient to show that there were gains and losses and then to contend, for that reason alone, that from each of the parties’ point of view what it gave up was the consideration for what it gained.  A much more analytical approach is required.
18.	When the documents which set out the contractual changes are examined, it becomes clear why this appeal must fail.  Pierhead’s case stands or falls by the correctness of its assertion that it made a supply of the architects’ services to WJS.  As I read the deed of variation and the novations, however, that is incorrect.  Each of the novation agreements contains, at paragraph one, the provision which I set out at paragraph 9 above.  The contracts between Pierhead and the architects are to be read as if they had been entered into between WJS and the architects from the outset.  It necessarily follows that the architects’ services are deemed, as between the parties, to have been supplied, at all times, to WJS.  That supply is reflected in WJS’s assumption of the design responsibility, for the past and for the future.  Certainly WJS had the benefit of the architects’ work, but it was not Pierhead which supplied it; it was not in its power to do so.  
19.	It is true that Pierhead had paid the architects’ fees to date and that WJS did not reimburse those fees but it would have been a pointless exercise to do so since WJS would merely have charged the same amount again to Pierhead.  Instead, the pragmatic course of reflecting only future architects’ fees in the revised contract price was adopted.  It could, I suppose, be argued that the architects should reimburse Pierhead and instead charge WJS which would then issue an additional invoice to Pierhead but the net effect would be the same.  Before they were novated, the architects’ services were supplied to Pierhead in order that it could make onward exempt supplies.  Had there been no novation, that would have remained the position.  The effect of the novation was that the architects’ services were supplied to WJS which made a supply of designing and building to Pierhead, again in order that it could make an onward exempt supply.  The notion that what had been supplied to Pierhead prior to the novation was in some way transferred seems to me to be contrary to the contractual documents and contrary to the reality of what happened. 
20.	As I have indicated the appeal must be dismissed.  I make no direction in respect of costs.

COLIN BISHOPP
CHAIRMAN
Release Date 28/07/2004
MAN/00/908