Phones 4u Ltd & Anor, Re

This is my extemporary judgment in the case of Phones 4U Limited and eight other companies. This is the hearing of an application by the insolvency office holders of nine companies within the Phones 4U group seeking certain directions and declarations under section 112 of the Insolvency Act 1986 (as amended) and/or paragraph 63 of Schedule B1 to that Act relating to each of the companies' liability to account for and to pay VAT to Her Majesty's Revenue and Customs.

The application concerns the application of the VAT Regulations to the provisions for the calculation of amounts of commission payable by EE Limited and Vodafone Limited under two mobile network operator contracts pursuant to which EE and Vodafone respectively agreed to pay commission to Phones 4U in respect of customers procured by Phones 4U for EE and Vodafone. The two mobile network operator contracts represented the vast majority of the business of Phones 4U, generating commissions of between £700 million and £800 million each year prior to the administration of the relevant companies.

The relevant VAT charges arise subsequent to the date on which each of the companies entered into administration or liquidation. Of the companies, six are presently in administration. They are Phones 4U Limited, Phosphorus Holdco plc, MobileServ Limited, Phones 4U Finance plc, Phosphorus Acquisition Limited and Phones 4U Group Limited. Apart from Holdco, all of those companies entered into administration on 15 September 2014. Holdco entered into administration a little later, on 8 October 2014. Three of the nine companies are presently in liquidation, Life Mobile Limited, Jump 4U Limited and 4U Wi-Fi Limited. Those three companies had previously entered into administration on 15 September 2014 but they then moved into creditors' voluntary liquidation on 2 September 2015.

Each of the companies is a member of the Phones 4U VAT group, which is treated as a single taxable person for VAT purposes. The companies are jointly and severally liable to Revenue and Customs for any VAT debts of the VAT group. Phones 4U is the representative member of the VAT group such that the joint administrators of that entity are required to ensure that Phones 4U accounts for the VAT due on supplies made by the group to third parties outside the group. The relevant VAT liabilities of the companies arise out of the two commercial agreements entered into between Phones 4U and EE and Vodafone on, respectively, 10 October 2012 and 16 August 2011. The mobile network operator contracts govern the terms under which EE and Vodafone respectively agreed to make certain commission payments to Phones 4U in consideration for the services supplied by Phones 4U, primarily the procurement by Phones 4U of new and upgrade customer connections to the mobile networks which were operated by EE and Vodafone.

The application which is before the court was issued by the insolvency office holders of the nine companies on 8 June 2016. In addition to the substantive relief sought, the application also sought confidentiality relief directed to preserving the confidentiality of certain documents, in particular the second witness statement of one of the insolvency office holders, Mr. Ian David Green dated 6 June 2016 and certain documents, copies of which were exhibited to that witness statement. That confidentiality order was made by Mr. Registrar Baister on 7 June 2016 at the same time as he abridged time for this hearing on the grounds of urgency.

At the commencement of the present hearing I was invited to make a similar confidentiality order in relation to the supporting skeleton argument prepared by the three counsel instructed by the applicant insolvency office holders, Mr. Roderick Cordara QC, Mr. Antony Zacaroli QC and Ms Georgina Peters dated 18 July 2016, together with its three appendices. I duly made such a further confidentiality order. I was also invited to hear this case in private pursuant to the provisions of CPR 39.2(3)(c) as applied to insolvency proceedings by the Insolvency Rules on the footing that the hearing involved confidential information, including information relating to personal financial matters and publicity would damage that confidentiality.

It was Mr. Zacaroli who addressed me in support of that private hearing direction. The application was founded on the fact that each of the two mobile network operator contracts contains certain provisions requiring the parties to maintain the confidentiality of confidential information. Phones 4U is contractually obliged to keep confidential the mobile network operator contracts and, in addition, those contracts, and certain other of the documents described in and exhibited to Mr. Green's witness statement, contain commercially-sensitive information. Between 12 April and 29 April 2016 Allen & Overy, the solicitors acting for the joint administrators and liquidators who are the present applicants, were engaged in correspondence with each of the mobile network operators, and in one case its solicitors, to agree the optimal approach to preserve the confidentiality of the relevant documents. Each of the two operators requested that the applicant should pursue what was described in correspondence as the “fully private regime” under which the applicants would apply to the court to seal the evidence (including exhibits) in support of the present application to the extent that it referred to and exhibited any confidential provision of the mobile network operator contracts and would also apply to the judge to have the applications heard in private.

The solicitors for EE, Addleshaw Goddard, wrote to Allen & Overy on 22 April pointing out that there was sensitive confidential information in numerous clauses within EE's mobile network operator agreement and therefore Addleshaw Goddard considered that a partial disclosure regime would not be workable. Given the potentially serious impact on EE of disclosure of the sensitive information from both its own commercial perspective and from a wider competition law perspective, EE's preference was for the administrators to proceed by way of a fully private regime. If the court was not minded to agree that the entirety of the application should be held in private, then Addleshaw Goddard requested Allen & Overy to ask the court for at least those parts of the hearing that referred to any of the contents of the agreement to be held in private.

On 29 April 2016 Vodafone wrote a similar letter to Allen & Overy. Among other things, it invited Allen & Overy to note that disclosure would show how Vodafone had structured its agreement, what pricing methodologies had been used, and precisely what the actual pricing had been. To Vodafone's competitors, it would demonstrate how Vodafone's contracts were structured and potentially remove a source of competitive advantage; and it would also demonstrate the levels of investment Vodafone was prepared to make in a competitive environment. To Vodafone's trading partners, present or future, it would demonstrate the terms Vodafone had used in the past and suggest a baseline commercial level that they would negotiate to, or seek to leverage, in future. Given that the pricing structure and pricing amounts appear to be at the heart of the insolvency office holder's application, Vodafone did not believe that this was one of those cases where privacy concerns could be addressed by only the key clauses being aired in public, given that pricing issues were an obvious matter of commercial sensitivity for Vodafone.

It was on the basis of those concerns that the applicants invited me to direct that this hearing should take place in private on the footing that it involved confidential information and publicity would damage that confidentiality. I was referred to observations of Floyd J in the case of Re Shuldham [2012] EWHC 1420 (Ch) at paragraphs 17 and 18. That was the hearing of a claim for the rectification of a written instrument. In the course of his judgment, Floyd J said this:

Those provisions have, of course, been invoked and operated in the present case by the order of Registrar Baister and the supplemental order that I made at the outset of yesterday's hearing.

The considerations which in the instant case are said to justify a hearing in private are as follows: (1) the confidence which requires protection belongs to third parties, EE and Vodafone, both of whom have refused to relax the confidentiality obligations imposed on Phones 4U; (2) if the confidential information were to become public, in particular if it fell into the hands of competitors and trading partners of Vodafone and EE, it would be likely to cause damage to Vodafone and EE since, among other things, it would disclose to competitors the pricing methodologies, actual pricing and the levels of investment they were prepared to make in a competitive environment, and it would provide to counterparties a commercial advantage in any negotiations; (3) given that the pricing structure is at the heart of the arguments to be aired at the hearing, it will be practically impossible to conduct the hearing in a way which does not involve trespassing on those confidential and commercially-sensitive matters so that there is no alternative to the whole of the argument being heard in private.

During the course of the hearing I enquired whether it might be possible to adopt the alternative regime suggested in Allen & Overy's letter of requiring only those parts of the hearing that refer to any of the contents of the agreements to be held in private. Mr. Cordara, who was to conduct the hearing on the VAT issues, made it clear that that was not a realistic way forward. That was because a holistic approach to the structure and terms of each mobile network operator agreement was required. This was a hearing that was estimated to last half a day and which, in the event, took a little under three hours yesterday afternoon. It would not be practicable for the court to move into and out of a private hearing during the course of such limited submissions. I accepted those submissions and I indicated that, for the reasons I have just given, which would be incorporated in my substantive extemporary judgment, this hearing should take place in private. However, I also indicated that provision should be made within my order to seek to ensure that as much of this judgment as possible could be published. As a result, it is proposed that my order should incorporate, as paragraph 6, a provision in the following terms:

It seemed to me that that would ensure, in so far as possible, that members of the public and media would, if so minded, be able to know what had transpired during the hearing and to know the reasons for my judgment. It seems to me that that is the appropriate way forward.

I turn then to the substance of the application. The evidence in support is contained within two witness statements - the second and third witness statements - of Mr. Ian David Green, both dated 6 June 2016, together with exhibits IDG 2, 3 and 4. Mr. Green is a licensed insolvency practitioner and a partner in PricewaterhouseCoopers. He is the joint administrator of the six companies presently in administration. He is one of the former joint administrators, and now one of the joint liquidators, of the three companies presently in liquidation. The principal evidence in support of the substantive application is contained within Mr. Green's second witness statement. The structure of the witness statement is as follows. It begins with a brief introduction and, in section 2, an executive summary. Section 3 then sets out an overview of the application and section 4 sets out brief background to the administration and liquidation of the companies. Section 5 sets out the possible VAT issues. Section 6 sets out the history and rationale of the calculation and payment provisions of the mobile network operator contracts. The detailed calculation and payment provisions of those contracts are considered in annexes 1 and 2 to the witness statement. Section 7 contains extracts from those annexes, considering some of the key provisions of the calculation mechanisms under the two contracts and the proper construction of the relevant provisions. Section 8 sets out the administrators’ proposals for the treatment of VAT on the settlement of claims arising under one or both of the two contracts. Section 9 sets out an analysis of the applicable VAT legislation. Section 10 summarises the correspondence between the administrators and Revenue and Customs on the matter. Annex 1 then considers the relevant provisions of the contract with EE while annex 2 considers the relevant provisions of the Vodafone contract. Annex 3 contains the applicable VAT regulations.

It is convenient at this stage to refer to Mr. Green's executive summary at paragraphs 12 through to 19 of his second witness statement. The provisions within the EE and Vodafone contracts for the calculation of commissions are complicated. In substance, each of them provides for an initial payment on account to Phones 4U when each customer contract is entered into, which is then subject to various subsequent adjustments made for the purposes of ensuring that the revenue earned from each customer contract over its life is shared in agreed proportions. The subsequent adjustments were and are necessary because the initial payment in each period was necessarily based on estimates and forecasts. It needed to be adjusted and “trued-up” in the light of subsequent events. The contractual wording describing these adjustment mechanisms has caused concern in that it could conceivably be interpreted as providing not merely for adjustments of earlier payments but for gross refunds and subsequent revised gross payments, including by way of set-off. That is not how the contracts were understood or operated in practice. However, as will be seen, the receipt of payments can be linked in the legislation to the crystallisation of tax points, and refunds can be linked with retrospective changes in the VAT account. The theoretical accounting or timing consequences of such matters were not addressed because the way the contracts were understood and operated properly did not give rise to them. However, the view has been taken that these matters are required to be definitively sorted out at the present stage.

The court is invited to note that all of the commercial parties are fully taxable in VAT terms and that all moneys passing between them by way of output VAT are fully recoverable as input tax by the paying party. As such, in normal circumstances, the Commissioners would always be tax neutral.

This application is unopposed by Revenue and Customs. As will become apparent, they have stated that, based on the information presented to them, the administrators' understanding of the applicable VAT legislation is correct and although they will not support, nor will they raise any objection to the application. However, there is no means under English law for a taxpayer, including the administrators, to obtain a binding ruling on a taxation matter from Revenue and Customs. The administrators are under a statutory duty to distribute the realisations from their administration to the persons properly entitled to them and they need certainty in relation to the extent to which VAT in respect of the mobile network operator contracts is payable as an expense of the administration in order to make such distributions. The administrators consider that it is clear from the language of both mobile network operator contracts, and an understanding of how the trading relationship evolved between EE and Vodafone on the one part and Phones 4U on the other, that the provisions for calculation of commission under the two contracts are just that: they are provisions which set out the items which the parties agreed to take into account in computing commission payable by EE or Vodafone to Phones 4U on each regular payment date under the mobile network operator contracts.

Consistently with this, and with the relevant VAT regulations, which impose a charge to VAT each time a payment is received, Phones 4U has accounted for VAT in respect of the stream of commission payments actually received by Phones 4U and has not treated any part of the mutual accounting between itself and the mobile network operators as involving actual refunds for prior received consideration, which, in principle, brings with it rights to reclaim earlier VAT, etc. Specifically, Phones 4U has accounted for VAT on receipt of each payment on account from EE and Vodafone as and when received, and where the various adjustment provisions produce a further cash payment to Phones 4U, Phones 4U has accounted for VAT on that additional cash payment.

At no stage have either Phones 4U or the mobile network operators taken a backward-looking posture, on the basis that there should be revisions of earlier tax points and liabilities when the adjustments are made. They have all been commercial and forward looking in their approach. This means that, over all, Phones 4U has incurred, and accounted to Revenue and Customs for, VAT at the applicable rate of 20% on all the cash consideration received for its services. It will continue to do so. The administrators consider this to be the correct approach and propose to continue accounting for VAT on this basis. This will result in VAT being paid to Revenue and Customs as an administration expense at the rate of 20% on the cash commissions actually received by Phones 4U under the mobile network operator contracts during the course of the administration. Phones 4U has not yet received any payments of commission from either EE or Vodafone since the date of administration; but it considers that it is, or will be, entitled in due course to very substantial payments and VAT will, in due course, be accounted for on such payments.

The concern which has given rise to the need for this application is that it might be argued that the items which the parties agreed to take into account in computing the commission payable under the mobile network operator contracts constituted separate and independent claims, capable of separate suit or assignment, which were set off against each other in a technical legal sense pursuant to the mobile network operator contracts. Both contracts, in different terms, use the term "set-off" to describe at least part of the process of reconciliation of the amount of payment on account of revenue share received by Phones 4U in respect of each customer contract which it procured to the actual amount of revenue share to which Phones 4U is entitled in respect of that contract.

The administrators consider that such an argument is plainly incorrect. However, if, notwithstanding their view, that argument were correct, then on one possible construction of the applicable VAT regulations, the VAT accounting history of Phones 4U would be rewritten, moving from a straightforward approach led, in essence, by actual net cash flows and net payments to one based on deemed, and repeated, refunds and grossed-up payments, having the effect of magnifying, multiplying and complicating the VAT liabilities of Phones 4U for both past and future periods. The administrators, rather than accounting for VAT at the rate of 20% on the cash received under the contracts during the administration, could be required to account for VAT on the notional payments deemed for tax purposes to be received by Phones 4U during the administration, but not actually received by virtue of set-off, without obtaining the benefit of the corresponding credit for the notional payments deemed to be made by it by virtue of set-off. If this were the case, the administrators would potentially be obliged to pay up to £100 million of the net realisations from the assets of all the companies (which, as at 20 January this year, were approximately £158.5 million) to Revenue and Customs as expenses of the administration, as opposed to distributing that amount to other creditors. The administrators consider that the construction of the mobile network operator contracts referred to earlier, and a construction of the VAT Regulations which led to this result, would clearly be wrong.

For the reasons set out in Mr. Green's witness statement, the administrators consider that the correct VAT treatment in relation to the contracts is for the administrators to account to Revenue and Customs for cash which Phones 4U actually receives from EE or Vodafone under the contracts in respect of VAT on the services supplied to them by Phones 4U under the contracts. As previously indicated, Revenue and Customs have stated that, based on the information provided to it, the administrators' understanding of the relevant VAT regulations is correct.

I have been taken to the correspondence with Revenue and Customs. On 1 May 2015 PricewaterhouseCoopers wrote to Revenue and Customs: see bundle 5, divider 10, pages 343 to 357. Having set out the background, having referred to the mobile network operator contracts in brief and in detail, and having summarised the arrangements between Phones 4U and the mobile network operators, PricewaterhouseCoopers addressed the issue of VAT accounting at paragraphs 36 through to 40.

Having stated that the administrators considered that the consideration adjustments that took place under each of the two contracts was simply that, namely adjustments, and that these “true-ups” of consideration only resulted in payments becoming due between the parties in amounts equal to the net cash payments actually required to be made by the mobile network operators, PricewaterhouseCoopers stated that, on the basis of that analysis, they considered that actual payments made by the mobile network operator to Phones 4U, net of any set-off applied by the mobile network operator, were the amounts which qualified as consideration for a supply for the purposes of VAT. Such net payments were said to represent consideration for continuous supplies of services for VAT purposes, separately and successively supplied at the earlier of the following times: (a) each time that a payment in respect of the supplies was received from the supplier; or (b), each time that the supplier issued a VAT invoice relating to the supplies. Given that the commissions were based on a share of the revenue derived from customers by the mobile network operators, the operators were better placed to calculate the commissions payable. Consequently, self-billing arrangements had been put in place under which the operators would issue self-billing invoices once or twice a month, usually making payments simultaneously. Self-billing invoices were not VAT invoices for the purposes of the “time of supply” rules. That meant that VAT became due, and was duly accounted for, each time a payment was received by Phones 4U in relation to its supplies to the mobile network operators. Those actual payments were calculated using a complex mechanism of payments on account, computations of actual payment entitlement, and “true-ups” between the two to arrive at the final sum payable to Phones 4U for that period. It was that net payment, made from the operators to Phones 4U, upon which VAT was accounted for on the self-billing invoices. PricewaterhouseCoopers considered this to have been the correct approach. As a matter of commercial reality, the advance revenue share payments, being initial cash payments on account, were said to be consideration for taxable supplies for VAT purposes and treated as such. That consideration was not thereafter reduced or repaid as a result of any subsequent consideration adjustments or set-off. For reasons set out at paragraphs 41 and following of the letter, PricewaterhouseCoopers concluded that Phones 4U's insolvency did not affect that analysis.

At paragraphs 55 to 66, PricewaterhouseCoopers considered whether there was any alternative VAT analysis which might be applied. They said that they had considered from a VAT principles perspective two alternative scenarios: (a) whether VAT should be accounted for by Phones 4U in circumstances where it had not received a cash payment from the mobile network operator because a set-off had been exercised by it; and (b), whether any supplies would be made by the mobile network operators to Phones 4U. PricewaterhouseCoopers did not consider that either of those alternative analyses had any merit, but they proceeded to include the analyses for completeness.

At paragraph 60 they stated that it seemed clear that the arrangements between Phones 4U and the mobile network operators provided a mechanism to determine the amounts payable over the life of the contracts which resulted in VAT being charged and accounted for on the cash amounts paid to Phones 4U for its services as the operator's agent in respect of the provision of marketing services and the procurement of customer contracts. The insolvency event had impacted both the cash flows and, in the case of [one of the mobile network operators], the amounts used to determine the sums payable to Phones 4U, which, in the short term, would result in a pause to payments being made to Phones 4U. However, PricewaterhouseCoopers expected Phones 4U to be in a position where it received payments such that the amount of VAT which was accounted for on those contracts over their term equated to the sums actually due and payable to Phones 4U. It seemed wrong in principle for Phones 4U to be required to account for VAT on any amount other than the sums which were paid by the mobile network operators. For those reasons, PricewaterhouseCoopers did not think it was correct to conclude that Phones 4U should account for VAT in the absence of a cash payment.

At paragraph 66, PricewaterhouseCoopers stated that the calculation used to determine the value of Phones 4U's supplies to the mobile network operators was in part dependent upon the value generated at the operator level. Where those operators incurred costs upfront with a view to increasing the value of the contract over the term of the contract, the Phones 4U mobile network operator relationship similarly reflected that. The payment terms between Phones 4U and the mobile network operator took account of the reduction in profitability, given effect by a reduction to the amount due to Phones 4U, and the expected increase in profitability over the life of the contract, given effect by an expected increase in actual revenue share due to Phones 4U at some later point.

At paragraphs 67 to 69 PricewaterhouseCoopers stated that they would be grateful for the Revenue's confirmation that it agreed that the administrators might adopt the following course of action, namely that (subject to a point noted in paragraph 6 earlier in relation to the last bill of exchange), Phones 4U would account for output tax only upon receipt of cash amounts paid by the mobile network operators. That would result in payment of VAT on approximately £40 million of payments (based on the figures known at the date upon which Phones 4U entered administration), which was the net amount which was at that time estimated to be due to Phones 4U under the mobile network operator contracts.

Revenue and Customs responded to that letter on 11 August 2015 (at pages 4 and 5 of bundle 2, divider 7). Having referred to the non-statutory clearance service guidance available on Revenue and Customs' website, the letter stated that one of the conditions under which Revenue and Customs would not provide guidance was where Revenue and Customs did not think that there were genuine points of uncertainty. In reviewing PricewaterhouseCoopers' letter of 1 May, the writer was unclear as to what PricewaterhouseCoopers regarded as the uncertainty. The letter at paragraphs 36 to 40 was said to contain an accurate analysis of the applicable VAT accounting tax points; and PricewaterhouseCoopers were said not to have provided any reason why they believed that those would not apply to the post-administration periods. As such, the writer did not believe that uncertainty existed; and, as such, he could not provide advice under the clearance procedures. That remained, and remains, Revenue and Customs' position. That position, as most recently stated in an email of 21 March 2016 (at bundle 1, divider 5, page 19) is that Revenue and Customs will not support the application to the court but will not raise any objection to the application. Revenue and Customs have been supplied with the application and relevant supporting evidence.

At paragraphs 14 through to 20 of the skeleton argument in support of the application, counsel for the applicants explained that there are three interrelated reasons why the present application for the court's directions is required to be made. First, no binding ruling is possible from Revenue and Customs. There is said to be simply no means under English law for a taxpayer to obtain a binding ruling on a taxation matter from Revenue and Customs. Secondly, there is the magnitude of the tax exposure if the alternative argument were correct. It is said that the unfunded VAT liability accruing to Revenue and Customs could, if the alternative argument were to be correct, amount to up to £100 million. The effect on the insolvency estate is thus said to be sufficiently significant to warrant the court's directions on the issue. Thirdly, the applicants require the court's directions in order to enable distributions to be made to creditors of the Phones 4U group. The resolution of the issues in this VAT application is said to be critical to the joint administrators' ability to make distributions to creditors because of the risk that VAT payable to Revenue and Customs during the course of the administration would constitute an administration expense, payable in priority both to the distribution of realisations that are subject to a floating charge and, by means of the prescribed part, to any distribution of funds to unsecured creditors of the company. Absent resolution of the issue as to the basis on which the VAT charges are payable, the joint administrators are unable to compute and account for such VAT charges, leaving them unable to compute and pay distributions to floating charge secured creditors or, by way of the prescribed part, to unsecured creditors.

While the applicants therefore consider that the only correct basis for the companies’ VAT liability under the mobile network operator contracts is that VAT should be accounted for, and paid, in respect of cash payments actually received by Phones 4U, the applicants cannot safely distribute the company's net realisations without the certainty that there is no risk that the alternative basis would render the companies liable to pay VAT as an expense of the administration in respect of Phones 4U's gross actual revenue share computed under the mobile network operator contracts.

The Tax Tribunal has no jurisdiction to assist the applicants because there is no dispute between them and Revenue and Customs; nor is there any appealable decision, which is a prerequisite of the application of section 83 of the VAT Act, which governs appeals to the Tax Tribunal.

The directions sought on this application are set out at paragraph 32 of Mr. Green's second witness statement. He sets out the possible VAT issue in section 5 of that statement, at paragraphs 55 to 56, and he gives an example of the way in which the provisions might be interpreted at paragraph 57. He then provides what the administrators suggest is the correct solution to the potential problem at paragraphs 59 through to 61.

Having regard to the history, and the commercial rationale for the calculation of payment provisions of the mobile network operator contracts, Mr. Green states that it is clear that the various payment flows provided for under the operator contracts are a mere calculation mechanism for a complex arrangement, the commercial purpose of which was to produce a stream of commission payments from the relevant operators to Phones 4U amounting, in aggregate, to [an agreed percentage] of the relevant operator's margin over the life of each customer contract. That calculation mechanism neither requires nor contemplates set-offs of mutual debts. Mr. Green states that it is clear as a matter of construction that the payment flows provided for under the operator contracts are part of a calculation mechanism designed for that purpose. In particular, notwithstanding use of the phrase "set-off" in the calculation and payment provisions, it is clear, both from the context in which those phrases occur and from the operator contracts as a whole, that separate and independent mutual debts capable of set-off were not intended to be created. In any event, even if the mobile network operator contracts did create mutual debts which were set off for the purpose of determining the net payment obligations of the relevant operators to Phones 4U, on a proper construction of the relevant VAT legislation it is said that Phones 4U would still only be required to account for VAT on the net cash payments which it receives in the course of the administration.

Mr. Green addresses the construction of the operator contracts at paragraphs 115 and 116. He states that a proper interpretation of the operator contracts indicates that the notional payment flows are not separate and independent legal obligations capable of separate suit or assignment. Rather, they are part of a calculation mechanism needed to arrive at the remuneration payable to Phones 4U for its services. The calculation of this remuneration necessarily involves a series of complex adjustments. But the ultimate purpose of all of those mechanisms is to determine the payments which need to be paid to Phones 4U to ensure its overall remuneration. On that basis, the notional payment flows from Phones 4U to the mobile network operators are not the subject of any set-off, nor are they free-standing payments in any real sense, and they are not therefore relevant for VAT purposes.

At paragraph 120, Mr. Green emphasizes that the economic reality is that all of the notional payments, including those made during the administration, must, by definition, relate to services actually provided by Phones 4U on a continuous basis prior to the date when Phones 4U ceased to trade and entered into administration.

In the course of his submissions, Mr. Cordara took me to observations of Lord Reed, speaking for the majority of the Supreme Court (comprising also Lord Hope and Lord Walker), in the case of Revenue and Customs Commissioners v. Loyalty Management UK Limited [2013] UKSC 15, reported at [2013] STC 784, at paragraph 66. There Lord Reed stated that the speeches in the House of Lords in Customs & Excise Commissioners v. Redrow Group plc [1999] 1 WLR, 408 "should not be interpreted in a manner which would conflict with the principle, stated by the Court of Justice in the present case, that consideration of economic realities is a fundamental criterion for the application of VAT. Previous House of Lords' authority had emphasised the importance of recognising the substance and reality of the matter ...... and the judgments in Redrow cannot have been intended to suggest otherwise. On the contrary, the emphasis placed upon the fact that the estate agents were instructed and paid by Redrow, and had no authority to go beyond Redrow's instructions, and upon the fact that the object of the scheme was to promote Redrow's sales, indicates that the House had the economic reality of the scheme clearly in mind." The questions posed by Lord Hope and Lord Millett in that case "should be understood as being concerned with a realistic appreciation of the transactions in question."

In the course of his oral submissions, Mr. Cordara emphasised: (1) the need for a realistic appreciation of the transactions in question and (2) a proper consideration of the economic realities. He pointed out that because VAT is a self-assessed tax, those tests need to be applied not by highly-qualified legal minds but by commercial persons and hard-pressed revenue officials. He also referred me to the approach of the First-Tier Tax Tribunal in the recent case of Agilisys Contact Services Limited v. The Commissioners for Her Majesty's Revenue & Customs , Appeal TC/2014/05445, [2016] UKFTT 0289(TC). The correct approach to the determination of the issue was to start with the contractual position and then test whether that really reflected the precise way in which performance satisfied the interests of the parties: see paragraphs 40 to 43.

In his written skeleton argument, Mr. Cordara identified three alternative routes which, in the course of his oral submissions, Mr. Cordara indicated were but different ways of viewing the commercial reality of the situation. He submitted that they led to the conclusion that one should treat the additional payments, but nothing more than the additional payments, as a further tax point, creating an additional, but non-cumulative, liability for VAT.

Mr. Cordara's first route was to apply an economic-reality analysis to the two mobile network operator contracts. Since I agree with Mr. Cordara's first route, it is unnecessary for me to refer further to his two alternative routes, focusing upon whether any set-off should be recognised for VAT purposes, and the value of the supply.

Mr. Cordara considered under his first route how the competing interpretations of the payment arrangements under the two mobile network operator contracts satisfied the interests of the parties. He submitted that any suggestion of a refund and then a restoration would have satisfied no identifiable interest and would have served no commercial purpose. That conclusion is said to be amply supported by an analysis of the contracts in their appropriate factual matrix. The evidence of Mr. Green is, in essence, that the parties neither had, nor rationally could have had, any reason to structure the payment arrangements so as to involve a stage where the initial payments were actually or notionally restored and recharged a second time. That would have made no commercial sense. It was not done, at least in terms of actual money movements. There is said to be no stronger manifestation of commercial reality than the actual movement of funds. That pattern of movement in the present case is said to be consistent only with Phones 4U's preferred interpretation. At the level both of economic reality, and the satisfaction of the interests of the parties, the commercial purpose of the payment provisions in the operator contracts was to provide for each relevant operator to remunerate Phones 4U by paying to it [an agreed percentage] of the margin made by the relevant operator over the life of each customer contract. That was consideration for the supply of services by Phones 4U. It was an obvious commercial motivation for the supplier to have in its hands unconditional and permanent cash payments, subject only to adjustments up or down based on the planned “truing-up” of the payments at the next stage. It was also in the interests of the customer - the mobile network operator - to have discharged its debt (pro tanto) once and for all through the initial round of payments. The supposed alternative view would involve the restoration, in all cases, of the payment and -- even if only for a scintilla temporis -- the re-opening of the debt. There is said to be no possible reason why that should be the underlying economic reality of the payment arrangements because it satisfies no identifiable interest of the parties.

Accordingly, Mr. Cordara submits, the various notional payment flows under the operator contracts should be treated for VAT purposes as what they really are (irrespective of nomenclature), namely, a calculation mechanism which produces a stream of net commission payments to Phones 4U amounting in aggregate to [an agreed percentage] of the relevant operator's margin over the life of each customer contract. They are merely the product of the inherent complexity of the adjustment process and not a sign of an odd arrangement whereby the initial, taxable, consideration was refunded. The ultimate purpose of all of these mechanisms, it is said, was to determine the payments which needed to be made to Phones 4U to ensure that its overall remuneration was [an agreed percentage] of the margin made by the relevant network operator over the life of each customer contract. The proper interpretation of the operator contracts indicates that these notional payment flows were not separate and independent legal obligations capable of separate suit or assignment. Rather, they were a part of a calculation mechanism needed to arrive at the remuneration payable to Phones 4U for its services.

On that basis, the notional payment flows from Phones 4U to the mobile network operators were not the subject of any set-off, nor were they free-standing “payments” in any real sense, and they were not therefore relevant for VAT purposes. The question of how regulation 38(6) of the VAT Regulations applies did not arise as there was no reduction in the consideration for any supply by Phones 4U. There was only additional consideration in the form of net cash payments to Phones 4U made as a result of the adjustment calculation, on which Phones 4U would account separately for output VAT.

In my judgment, that analysis is correct. In essence, there was an additional deferred payment for the earlier supply of services.

I am satisfied that, on their true construction, and as a matter of commercial reality, the two operator contracts created two discrete constructs. One was a pre-estimated payment stream, and the other was a final payment stream. The pre-estimated payments were paid over once and for all, and they represented value received and retained by Phones 4U. I am satisfied that there was no unwinding of the pre-estimated payments and that Phones 4U did not return anything which it had previously received by way of prepayment. That is manifestly clear from the terms of the EE contract and the way in which it was operated. As Mr. Cordara acknowledged, the EE agreement was the easier of the two contracts to analyse. But, in my judgment, it is equally so with the Vodafone contract as well, particularly if one has regard to the way in which the Vodafone contract also was operated. The evidence of Mr. Green as to the way in which the arrangements operated in practice is important. It is clear that there was no actual refund of anything.

I was at one stage troubled by the terms of clause 7.24(e) of the Vodafone contract; but, on analysis, I am satisfied that it should in no way be treated as any exception to the overriding provisions of clause 7.24(d)(ii).

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I am therefore satisfied that, in relation to each of the EE and the Vodafone contracts, the commercial reality was that payments were never unwound or given back. In reality, the pre-estimated payments were never ever repaid to the mobile network operator. In reality, there was an additional deferred payment for the earlier supply. In my judgment, the use of the term "set-off" is inappropriate in the present context. The procedure that was in reality applied to each of the two operator contracts with which the court is concerned was not one of mutual set-off of payments due to and from two separate parties but was rather the unilateral netting off of payments due to and from a single party. To adopt Mr. Cordara's graphic phrase, it was a "unidirectional adjustment". I am satisfied, for those reasons, that VAT is chargeable only on the cash element of net payments actually received during the course of the relevant insolvency process, be it liquidation or administration.

For those reasons, I am satisfied on the evidence that the applicants are entitled to the declaratory relief that they seek, with the consequences that are set out at paragraphs 3 and 4 of the draft order that was placed before me this morning. For those reasons, I will make an order in the terms of the draft.