Late Payment of Commercial Debts (Interest) Act 1998 and VAT

Late Payment of Commercial Debts (Interest) Act 1998 and VAT

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Introduction

The Late Payment of Commercial Debts (Interest) Act 1998 (“the 1998 Act”) entitles suppliers to statutory interest on unpaid commercial debts. Section 1(1) creates an implied term (in a contract to which the 1998 Act applies) that any qualifying debt created by the contract carries simple interest. The 1998 Act applies to a contract for the supply of goods or services where the purchaser and the supplier each act in the course of a business, other than an excepted contract – see s.2(1). The statutory right to interest and compensation under s.5A can be excluded if the contract contains a substantial remedy for late payment – see s.8(2). Under s.3(1) of the 1998 Act, a “qualifying debt” is “a debt created by virtue of an obligation under a contract… to pay the whole or any part of the contract price“, and interest runs on qualifying debts under s.4(1).

Before the recent decision of Constable J in Pharos Offshore Group Ltd v Keynvor Morlift Ltd [2025] EWHC 2496 (TCC), there was a question about whether interest ran on the VAT element of a debt, or only on the VAT-exclusive amount.

Some argued that VAT should not attract interest:

  1. If the contract defines the contract price as exclusive of VAT, VAT is not part of the contract price for the purposes of the 1998 Act.
  1. The obligation to pay VAT arises from a taxable supply, not from the contract to pay the contract price. It would exist even without a contract (for example, quantum meruit).
  1. Adding VAT to the base principal sum would give suppliers a 20% uplift on interest, which they would not account for as output tax and purchasers could not recover as an input tax, which creates issues for cash accounting systems.

Others argued that it should:

  1. Contracts typically require payment of VAT at the applicable rate, making VAT part of the consideration and a qualifying debt.
  1. Any term excluding VAT from interest may be void under s.8(1) of the 1998 Act if it excluded statutory interest without providing a substantial contractual remedy.
  1. Interest compensates for late payment, and suppliers may not account for VAT on a cash basis.

The principle established

The principle established in Pharos Offshore is that interest under the 1998 Act runs on the VAT element of unpaid debts.

This principle applies whether the contract price is VAT-exclusive (with VAT added) or VAT-inclusive, which ensures a consistent regime for late payment interest. It protects cash flow and aligns with the purpose of the 1998 Act, which is to discourage late payment, and ensure all sums contractually due (including VAT) attract interest when paid late. The judge noted that Parliament would have expressly excluded VAT from qualifying debts if that were its intention, and it did not. The fact that recovery may exceed pure compensation was inherent in the 1998 Act.