[2009] UKFTT 235 (TC)

                                                                                                TC00184

            Appeal number LON/09/0343

VAT – default surcharge – reasonable excuse – insufficiency of funds – unexpected closure of adviser’s business – s 71 VATA

FIRST-TIER TRIBUNAL

TAX

                            PILLARS PROPERTY CLEANING AND

                                       MAINTENANCE LIMITED                      Appellant

                                                                      - and -

                                 THE COMMISSIONERS FOR HER MAJESTY’S

                                             REVENUE AND CUSTOMS (VAT)         Respondents

                                                TRIBUNAL: ROGER BERNER (Judge)

                                                                        ROBERTA JOHNSON (Member)

Sitting in public in London on 29 July 2009

Mr and Mrs Olawale Olajide for the Appellant

Mr S Chambers, HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2009

DECISION

1.     This was an appeal by Pillars Property Cleaning and Maintenance Limited (“the Appellant”) against default surcharges for the periods 02/08 to 08/08.

2.     Evidence was given by Mr and Mrs Olawale Olajide, the proprietors of the Appellant, and we were referred to a large bundle of documents.

The Facts

3.     We find the following facts from the oral evidence and documents before us:

(1)  The Appellant is a provider of cleaning services to premises.  Mr Olajide established the business in 2004 when he was made redundant from a previous employment.

(2)  The Appellant effectively has one customer only, R Ltd, a business that requires cleaning services at multiple sites.  R Ltd accounts for 99% of the Appellant’s turnover.

(3)  The normal credit terms for the Appellant’s business are 30 days, but R Ltd never makes payment of the Appellant’s invoices in that timeframe.  Payments are made irregularly, on average after three months, but sometimes much later.  It is often not possible for the Appellant to relate the payments received to the invoices to which those payments relate.

(4)  It is not possible for the Appellant to put too much pressure on R Ltd to pay more promptly, as R Ltd would then be likely to withdraw its business.  This had already happened in respect of at least one site when the Appellant had pressed for payment.

(5)  The Appellant has a long history of default in submission of VAT returns and payment of VAT.  This stretches back to 06/05 when the Appellant was late in both the submission of the return and payment of VAT.  HMRC wrote to the Appellant on 12 August 2005 offering help and support, including reference to the cash accounting scheme, but at the same time warning the Appellant that default could result in the imposition of a surcharge.

(6)  When the business was initially established Mr Olajide was approached by a number of advisers offering services, including services in relation to VAT compliance.  One of these was CDUK Services (“CDUK”), and Mr Olajide appointed CDUK to deal with the making of returns, VAT payments and compliance generally, as well as with other financial matters such as the Appellant’s payroll.

(7)  On 22 August 2005 CDUK wrote to HMRC noting that the Appellant was on monthly VAT returns and requesting that this be altered to quarterly returns.  HMRC replied on 15 September 2005 to the effect that, as the business was newly-registered, it had been directed to submit monthly returns to establish a history of compliance.  A change to quarterly returns would only be considered once a suitable period of compliance had been achieved.

(8)  On 12 January 2007 HMRC wrote to the Appellant referring to default surcharges for 05/06, 07/06, 08/06 and 09/06.  The letter refers to advice given to the Appellant in March 2006 that:

“…if the cash accounting method were used, you do not need to declare unpaid invoices on your VAT return until they have actually been paid.  This is to avoid the situation where you would have to pay VAT not received from your clients.  You are advised to make use of this scheme for future returns.”

This letter also referred to the Appellant’s request to go on to quarterly returns:

“As regards going on to quarterly returns, I enclose a copy of the letter sent to your accountant in September 2005.  You will note that a condition of going on to quarterly returns was that you should submit a minimum of 6 returns with payment by the due date.  Unfortunately you have incurred surcharge warnings/penalties for each month since 09/05 so this condition has not been met.”

(9)  CDUK carried out all the VAT compliance work for the Appellant.  The system was that Mr Olajide would put all the business’s paper invoices and receipts in envelopes and send these to CDUK.  The business itself maintained on Excel a sales ledger only and no purchase ledger.  For each period CDUK would prepare both the VAT return and the cheque for the VAT payment (although these were often late) and Mr Olajide would simply sign.

(10)   In the early part of 2008 Mr Olajide had to travel urgently and unexpectedly to Nigeria because of the ill-health of his mother.  Whilst he was away Mrs Olajide contacted CDUK concerning certain details regarding the payroll and was informed by the receptionist at that firm that the business had closed down.  This came as a complete shock to Mrs Olajide; there had been no indication from CDUK that this was about to happen.  Mrs Olajide asked for the return of all the Appellant’s papers and records, including those relevant for the VAT periods 02/08 and 03/08.  This request was refused, ostensibly because the papers and records would not be released until the Appellant had settled CDUK’s fees.  The information had not, at the date of the hearing, yet been obtained, and the Appellant was engaged in separate court proceedings against CDUK in this respect.

(11)   Having regard to this unexpected development, Mrs Olajide, who is herself an accountant, though at the time she was herself in full time employment, set up a separate SAGE accounting system with effect from 1 April 2008.  She was, however, unable to record any figures for 02/08 or 03/08 because of the absence of the papers and records that had been retained by CDUK.

(12)    The table below sets out the VAT amount due and the credit balances on the Appellant’s bank account on the due dates for payment of VAT for the relevant periods:

The Law

4.     There was no dispute that the VAT payments for the relevant periods were made late.  The only issue before us was whether there was a reasonable excuse for the late payments for all or any of the periods in question.

5.     The provision for default surcharge is contained in s 59 of the Value Added Tax Act (“VATA”).  Section 59(7), so far as is material to this appeal, provides that:

If a person who, apart from this subsection, would be liable to a surcharge under subsection (4) above satisfies the Commissioners or, on appeal, a tribunal that, in the case of a default which is material to the surcharge—

…

(b)     there is a reasonable excuse for the return or VAT not having been so despatched,

he shall not be liable to the surcharge and for the purposes of the preceding provisions of this section he shall be treated as not having been in default in respect of the prescribed accounting period in question (and, accordingly, any surcharge liability notice the service of which depended upon that default shall be deemed not to have been served).

6.     However, a claim of reasonable excuse is limited by s 71(1) VATA which provides that:

For the purpose of any provision of sections 59 to 70 which refers to a reasonable excuse for any conduct—

(a)     an insufficiency of funds to pay any VAT due is not a reasonable excuse; and

(b)     where reliance is placed on any other person to perform any task, neither the fact of that reliance nor any dilatoriness or inaccuracy on the part of the person relied upon is a reasonable excuse.

(2) In relation to a prescribed accounting period, any reference in sections 59 to 69 to credit for input tax includes a reference to any sum which, in a return for that period, is claimed as a deduction from VAT due.

Discussion

7.     For all periods in question the Appellant relied on the excuse of insufficiency of funds.  It was argued that the Appellant’s (almost) sole customer, R Ltd, paid its invoices on average after three months and not 30 days, paid irregularly and sometimes delayed payment for longer than three months.  This meant, it was claimed, that the Appellant was unable, because it was on monthly accounting, to pay the VAT on invoices delivered in a particular month on time.

8.     In Customs and Excise Commissioners v Steptoe [1992] STC 757, a case that reached the Court of Appeal, the taxpayer also worked almost exclusively for one customer, in that case a local authority.  That customer paid late, as a result of which in the relevant period the taxpayer was without sufficient funds to pay the tax.  In the Court of Appeal it was held that, although under what is now s 71 VATA insufficiency of funds could never of itself constitute a reasonable excuse, the cause of that insufficiency, the underlying cause of the taxpayer’s default, might do so.

9.     We do not consider that much can be gained from a comparison of the facts in Steptoe with the facts of this case.  Lord Justice Scott (dissenting from the majority) would have allowed the Commissioners’ appeal on the basis that he disagreed with the conclusion of the Chairman of the Tribunal that the customer’s late payments were “not something that can be regarded as a normal hazard of trade.”  Lord Justice Scott’s view was that this had been a misdirection since the findings of fact had made it clear that late payments were a normal incidence of the taxpayer’s business with his customer.  The Tribunal decision had commented that “it was conduct of the sort that a small trader was entitled to expect would not happen”, but Scott LJ’s view was that the findings of fact showed that the customer’s conduct was both consistent and persistent.

10.  Lord Justice Nolan, with whom Lord Donaldson MR agreed, took a different approach, accepting the Chairman’s finding of fact that as a result of the conduct of the customer the taxpayer was without sufficient funds to pay the tax due and his further finding that “if the taxpayer had brought pressure to bear on the [customer] he would probably have received no further orders and the bulk of his livelihood would have disappeared”.  On the basis of these findings Nolan LJ, though regarding the Chairman’s first finding as being on the “borderline of sustainability” as a matter of law, dismissed the Commissioners’ appeal and found for the taxpayer.

11.  The test to be applied is summarised in the judgment of Lord Donaldson at p 770:

“… save in so far as Parliament has given guidance, it is initially for the commissioners to decide whether the underlying cause constitutes a reasonable excuse and for the tribunal to decide this on an appeal. That said, there must be limits to what could be regarded as a reasonable cause. Nolan LJ, as I read his judgment explaining and expanding on his judgment in Customs and Excise Comrs v Salevon Ltd [1989] STC 907, is saying that if the exercise of reasonable foresight and of due diligence and a proper regard for the fact that the tax would become due on a particular date would not have avoided the insufficiency of funds which led to the default, then the taxpayer may well have a reasonable excuse for non-payment, but that excuse will be exhausted by the date on which such foresight, diligence and regard would have overcome the insufficiency of funds.”

Having set out the test, Lord Donaldson went on to find that its application should be left, so far as possible, to the discretion of the expert tribunal.  On this basis, although also expressing surprise at the Tribunal’s finding in that case, he too dismissed the Commissioners’ appeal.

12.  There are certain similarities between the facts of this case and those of Steptoe, but we are concerned not with trying to match the instant facts with those of another decision, but with applying the principle of law set out by the majority in the Court Of Appeal in Steptoe.  In this case, although R Ltd is virtually the only customer of the Appellant and pays its invoices late as a matter of course, this was something known to the Appellant from the very early stages of the Appellant’s business and was something that the Appellant, with reasonable foresight and due diligence, could have dealt with through proper cash flow management.

13.  In any event, we are not satisfied that in this case there was an insufficiency of funds.  For only one of the months in question (06/08) was the credit balance in the Appellant’s bank account on the due date lower than the amount of VAT due.  For that period, in common with the other periods, we find that the Appellant could have exercised reasonable foresight and due diligence to cover the shortfall, either by arranging a modest temporary overdraft with its bank or by creating a sinking fund out of previous account surpluses, to deal with such an eventuality, which we consider a reasonable businessman in the Appellant’s circumstances would have foreseen occurring from time to time in the normal course of business.

14.  In relation to its credit balances on the relevant date the Appellant argued that it needed to pay its staff and suppliers, and that transfers to personal account out of its bank account were necessary in order to pay staff in cash.  We do not accept that these factors could found proper reasons for an insufficiency of funds to pay the VAT on the due date, and they cannot therefore represent a reasonable excuse.

15.  The Appellant’s claim that it had insufficient funds to pay the VAT on the due dates was, in our view, unfortunately based on a fundamental – though genuine - misconception of the nature of the liability to VAT.  Underlying the Appellant’s arguments was the assumption that the VAT charged on invoices delivered to its customers needed to be collected before it could be paid to HMRC.  This is of course generally not the case, absent cash accounting, to which we return below.  Subject also to bad debt relief, which might be applicable in a particular case, VAT is due on an invoiced amount whether or not the customer has remitted funds to the supplier that include the particular VAT charged on an invoice.  This misconception, it seems to us, led the Appellant to fail to pay VAT on time even when, as the bank statements show, there were generally sufficient funds in the account to satisfy the VAT liability on the due date.

16.  The Appellant’s misconception also underpinned what we consider to be its misguided assumption that a move to quarterly accounting would be a solution to its difficulty in collecting the VAT in time to pay on the due date.  In our view the fact that the Appellant had not, in view of its poor compliance record, been permitted to use quarterly accounting does not provide any basis for a reasonable excuse for its defaults.

17.  The Appellant was advised by HMRC in January 2007 to make use of the cash accounting scheme.  It is helpful here to refer again to the judgment of Nolan LJ in Steptoe where he says (at p 769):

“I would repeat that as a general rule a small trader dealing with larger organisations and having difficulty in securing the prompt payment of his bills should elect to account for his value added tax on the cash basis and would have no reasonable excuse for failing to do so. I recognise that, as the taxpayer told us, much additional trouble and expense may be involved in the keeping of cash accounts for the Commissioners of Customs and Excise in addition to the 'earnings basis' accounts which are normally required by the Inland Revenue, but that is one of the painful necessities which the tax system involves. His omission to elect for the cash accounting system (of which he said he was unaware) does not, however, appear to have been relied on by the commissioners before the tribunal, nor did Mr Pleming press it in his submissions before us, concentrating as he did on the broader questions of principle.”

In this case, unlike in that of Steptoe, the Appellant must have been aware of the cash accounting scheme having been advised by HMRC to use it.  And contrary to the position in Steptoe, here Mr Chambers relied upon this fact in his submissions to us.  We find that this is an additional reason why in this case the Appellant has no reasonable excuse based on the insufficiency of funds.

18.  Separate considerations apply to the periods 02/08 and 03/08.  Having heard the Appellant’s evidence in relation to these periods Mr Chambers said that he would accept that the Appellant’s had a reasonable excuse for 02/08, but not for 03/08.

19.  For each of those periods the Appellant argued that it had a reasonable excuse due to the unexpected closure of its accounting adviser’s business and the difficulties it had encountered in obtaining relevant information from its advisers to enable it to calculate the VAT position for 02/08 and 03/08.  To this there may be added Mr Olajide’s own unplanned absence from the UK at around the same time on account of the ill-health of his mother in Nigeria.  Mr Chambers argued that, as the due date for 03/08 was not until 30 April 2008, there had been sufficient time for the Appellant to have made at least an estimated return and payment.  We agree with Mr Chambers’ concession in relation to the 02/08 period, and we accept that the position as regards 03/08 is arguably more marginal, bound up as it is with the more general insufficiency of funds argument.  However, on balance, we accept that the disruption to the Appellant’s accounting caused by the unexpected closure of CDUK and the lack of available information, did prevent the Appellant from making the return and payment for 03/08 by its due date, as well as for 02/08, and that accordingly the Appellant had a reasonable excuse for both periods.

Decision

20.  For these reasons we allow the appeal as regards the periods 02/08 and 03/08, and we dismiss the appeal for the periods 04/08 to 08/08 inclusive.  We make no order for costs.

Each of the Appellant and the Respondents have a right to apply for permission to appeal against this decision pursuant to Rule 39 of The Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.  The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.

ROGER BERNER

TRIBUNAL JUDGE

RELEASE DATE: 5 August 2009