How do I amend my payment terms for VAT self-billing?

Since the 1 May 1998, the Housing Grants, Construction and Regeneration Act 1996 (Construction Act) has required the construction sector to have an adequate payment mechanism in its construction contracts. If a construction contract fails to comply with the Construction Act then the standard terms from the statutory instrument, known as 'the Scheme', will be imported into the construction contract to rectify the deficiencies.  Parties to a construction contract cannot 'contract-out' of the Construction Act.

Notwithstanding this, the parties are free to agree a payment mechanism which complies with the Construction Act. For example, some payment mechanisms make it a pre-condition that an application for payment has to be made within a specified date for it to be considered that month. It is also relatively common for payment terms to include a payment application process but, as pre-condition of payment, the receipt of VAT invoice will start the payment period.  For example, a clause could say that the final date of payment would be the later of, 30 days from the due date and the receipt of a VAT for the amount due. This pre-condition of a VAT invoice seemed to some, reasonably fair, as the party who was to receive payment was in control over when it submitted a VAT invoice.  However, in the recent judgment of Rochford Construction Ltd v Kilhan Construction Ltd  there was a 'by the way' comment from the Judge which indicated that the final date of payment should be calculated from the due date and such period should not be subject to the receipt of a VAT invoice. Whilst this comment is not binding, and no doubt the point will be raised in another case, the NEC has amended its Y(UK)2 payment terms whereby the receipt (or lack of receipt) of a VAT will postpone the due date and not the final date of payment. I would expect others to adopt a similar arrangement.

Within the context of VAT invoicing, the Government recently updated its guidance Self-billing (VAT Notice 700/62). In essence, the self-billing process allows the paying party to raise a VAT invoice on behalf of the party who is going to be paid. It is for the paying party to decide if they want to have this arrangement for a particular supplier. In order to have this process, the parties must sign a 'self-billing agreement' which complies with the guidance. The agreement can specify the period during which it valid or, relate to a specific project.  The advantages of this process are listed in the guidance and no-doubt, the recent legal requirement for reverse VAT charging to be used will also make self-billing more popular.  One of the advantages listed in the guidance is that it allows the paying party to raise a VAT invoice for the amount it has determined is due.

However, within the context of the Construction Act, if a VAT invoice initiates the payment mechanism, is the paying party allowed to raise a VAT invoice on behalf of the supplier, for an amount less than the supplier's application?  In other words, can the paying party reduce the supplier's application for payment, by raising a reduced VAT invoice? Another question also arises as to whether a paying party can postpone the due date because it has not raised a VAT invoice?

In respect of the second question, it is submitted that the doctrine; a party should not benefit from its own breach of contract, should apply. It is unlikely that the Courts would support a delay in payment unless the paying party had a legitimate reason – which would probably have to relate to the supplier having delayed the process – e.g. not giving its VAT number.

In respect of the first question, it is a question of whether it is an 'adequate mechanism' which has a payment arrangement which allows the paying party to reduce a VAT invoice from that amount included in the supplier's application for payment.  This arrangement has the effect of undermining the purpose of the Construction Act. The Construction Act provides a framework for payment which obliges the parties to be transparent on establishing how much is due and when it is to be paid. In particular there are notification obligations if a lesser amount is to be paid and, if there is a dispute on the payment amount then the matter can be referred to adjudication. It seems to me that an entitlement to reduce the amount owed by issuing a reduced VAT invoice without having to give notice, doesn't seem to be an adequate mechanism.

The outcome of all of this is that if a VAT invoice is required as part of the payment process and/or the paying party wishes to adopt the self-billing process, the payment clauses need to be drafted in a way which complies with the Construction Act and it can't be assumed that the usual published forms of building contracts or appointments deal with these points.