Pharos Offshore Group Ltd v Keynvor Morlift Ltd

[2025] EWHC 2496 (TCC)

The judgment dealt with a number of consequential matters that the parties had been unable to agree following a main judgment, where Constable J determined that the balance owed to Pharos after setting off the counterclaim, net of interest, was £495k inclusive of VAT. One of those matters was whether interest was payable on the VAT.

KML accepted that interest ran pursuant to the Late Payment of Commercial Debts (Interest) Act 1998 (“LPA”) in principle but argued that the VAT element was not a qualifying debt. A qualifying debt is defined in section 3(1) of the LPA as:

“A debt created by virtue of an obligation under a contract to which this Act applies to pay the whole or any part of the contract price is a ‘qualifying debt’ for the purposes of this Act, unless (when created) the whole of the debt is prevented from carrying statutory interest by this section.”

KML said that the VAT element itself did not form part of the contract price, both as “a statement of the obvious”, but also by virtue of clause 6.1 of KML’s standard terms and conditions which provided:

“The Contract Price is fixed and firm, exclusive of VAT and inclusive of packaging and any delivery and insurance costs as stated in the Purchase Order.”

The obligation to pay the VAT element was created by virtue of the provision of a taxable supply by Pharos to KML – namely the services that Pharos supplied to KML under the contract – which would have arisen even if there had been no contract. If interest upon the VAT element did apply, Pharos would receive an unwarranted windfall (and a purchaser in the position of KML would suffer an equally unwarranted penalty) in the form of a 20% uplift on LPA interest whenever the underlying debt giving rise to the claim for LPA interest constituted consideration for a taxable supply. A supplier would not be liable to account for that windfall to HMRC as output tax, nor would such a purchaser be entitled to recover that sum as input tax, because the sum would not itself constitute VAT.

Pharos argued that any attempt to remove the VAT element from the scope of the LPA was void under section 8(1) of the LPA, which provides:

“Any contract terms are void to the extent that they purport to exclude the right to statutory interest in relation to the debt, unless there is a substantial contractual remedy for late payment of the debt.”

The judge noted that, usually, a contract price agreed between parties – unless it is stated specifically to exclude VAT – would include any VAT which is required to be paid. The obligation to pay this contract price (inclusive of VAT) would “plainly” be a qualifying debt for the purposes of section 3(1) of the LPA. Whilst it was right that if the effect of the LPA was to require enhanced interest to run on the VAT element of a contract price, the recipient may receive a sum in excess of its likely losses – and potentially significantly so if accounting for VAT on a cash basis, at least in the default position where any contract price is deemed to include VAT – that was precisely the effect of the LPA. If the intention had been for VAT to be excluded from the definition of a qualifying debt, the statute would have said so:

“The purpose of the Act was to discourage late payment of commercial debts, and the fact that the recovery by the recipient under the Act is in a sum in excess of purely compensatory interest is inherent in the LPA.”

Further, the definition of “Contract Price” within the particular contract in this case as excluding VAT did not mean that VAT was excluded from constituting a “qualifying debt” for the purposes of the LPA:

“The contract between KML and Pharos required KML to pay not just the sum which was contractually defined as the 'Contract Price', but applicable VAT. That obligation was not created merely by the statutory tax laws, but expressly on the face of the Purchase Orders themselves. The express contractual obligation upon Pharos to charge the applicable VAT was plainly met with the reciprocal obligation to make payment of that sum, as a matter of contract.”

Therefore, for the purposes of the LPA, VAT formed part of the “contract price”. The obligation to pay the Contract Price gave rise to the (contractual) obligation to pay the applicable VAT upon the Contract Price. The judge finally noted that this result also led to: “a coherent regime where LPA interest applies in the same way whether the contract is based upon a VAT-exclusive price (to which VAT is added by the payor) or a VAT-inclusive price”.

Back to the previous page

Click to download PDF