First-tier Tribunal (Tax)

[2009] UKFTT 302 (TC)

TC00246

 Appeal number TRANS/09/92

Sub-contractors in the construction industry; Construction Industry Scheme; removal of Gross Payments Status; appeal under section 67 Finance Act 2004; “compliance test”; “reasonable excuse” for failure of the compliance test; “exceptional” business conditions.

FIRST-TIER TRIBUNAL

TAX

                                      PRIOR ROOFING LIMITED                     Appellant

                                                                      - and -

                                 THE COMMISSIONERS FOR HER MAJESTY’S

                                                   REVENUE AND CUSTOMS               Respondents

TRIBUNAL JUDGE: C. S. Hacking LL.M  FCIArb

Sitting in public in Liverpool on 11 June 2009

Mr B. Potts and Mr H. Toher for the Appellant

Mr B. Morgan on behalf of HM Revenue and Customs for the Respondents

© CROWN COPYRIGHT 2009

DECISION

1.     The issue before the tribunal concerned the withdrawal by HMRC of the Appellant company’s Gross Payments Status under the Construction Industry Scheme (“the Scheme”).

2.     On behalf of the Appellant it was contended that it was able to establish a reasonable excuse under paragraph 12 (3)(a) Schedule 11 Finance Act 2004 for admitted failures to comply with the Scheme conditions concerning payments to the Respondents and that accordingly withdrawal of Gross Payments Status under the Scheme was unjustified.

3.     For the Respondents it was said that the Appellant’s failures could not reasonably be excused so that removal of Gross Payments Status was required.

4.     The Scheme regulates the way in which payments between contractors and subcontractors engaged generally within the construction industry are made. An important, and, to the subcontractor, valuable, aspect of the Scheme is the right to receive payments from the main contractor gross, that is to say, payments  received which are not subject to a deduction in respect of tax.. A subcontractor who wishes to avail itself of this undoubted benefit must apply to HMRC for registration under s 63 Finance Act 2004 (implementing regulation 25 Income Tax (Construction Industry Scheme) Regulations 2005) to establish entitlement to Gross Payments Status under the Scheme and, if granted, must continue to comply with the Scheme regulations.

5.     An important element of the granting and subsequent maintenance of entitlement to Gross Payments Status is the obligation on the subcontractor to make timely payments of tax to HMRC. Failure to meet these compliance conditions concerning such payments to HMRC will usually result in withdrawal of Gross Payments Status unless the party concerned (in this case a subcontractor) can establish that it falls within one of the few exceptions set out in regulation 32 Income Tax (Construction Industry Scheme) Regulations 2005. It is not contended by the Appellant in this case that any of the circumstances set out in the table appearing at regulation 32 applies.

6.      Paragraph 12 Part 3 Schedule 11 of the Act sets out the compliance test for companies (as opposed to individuals or firms which are dealt with respectively under Parts 1 and 2 of Schedule 11) which together with the business and turnover tests constitute the basis on which determination of eligibility for registration under the Scheme is to be judged. It is appropriate to set out the text of this test in full:

“The compliance test

12 (1) The company must, subject to sub-paragraphs (2) and (3), have complied with—

(a) all obligations imposed on it in the qualifying period (see paragraph 14) by or under the Tax Acts or the Taxes Management Act 1970 (c. 9); and

(b) all requests made in the qualifying period to supply to the Inland Revenue accounts of, or other information about, its business.

(2) A company that has failed to comply with such an obligation or request as—

(a) is referred to in sub-paragraph (1), and

(b) is of a kind prescribed by regulations made by the Board of Inland Revenue,

is, in such circumstances as may be prescribed by the regulations, to be treated as satisfying the condition in that sub-paragraph as regards that obligation or request.

(3) A company that has failed to comply with such an obligation or request as is referred to in sub-paragraph (1) is to be treated as satisfying the condition in that sub-paragraph as regards that obligation or request if the Board of Inland Revenue are of the opinion that—

(a) the company had a reasonable excuse for the failure to comply, and

(b) if the excuse ceased, it complied with the obligation or request without unreasonable delay after the excuse had ceased. “

7.     The Appellant in this case contends that there is a reasonable excuse under sub paragraph (3)(1)(a) above for its failure to comply with its payment obligations to the Respondent and that such excuse continued throughout the period of non-compliance.

8.     The legislation does not state what constitutes a “reasonable excuse”. Until April 2007 the test for relief from strict compliance was a different one. It was then required that the Appellant establish that its failure to comply was of a “minor and technical” nature. It seems reasonable to conclude that in changing this test to one of “reasonable excuse” the intention was to enable a less restrictive view to be taken as to the circumstances which might be considered as excusing the non compliance. In its submission to the tribunal the Respondent states that in its publicly available leaflets and internet pages it interprets these words as meaning something which has happened which is “wholly exceptional” and which “has led directly to the failure (for example, a serious illness of the director) or something which is out of the appellant’s direct control which has brought about the failure (for example a cheque lost in the post)” Whilst the examples cited may well fall within the ambit of the new provisions so too may many other circumstances. The tribunal accepts and endorses HMRC’s view that the excuse must be such as can be described as “exceptional” and equally that it should have led directly to the failure as well as being something out of the control of the appellant.  

9.     The Appellant’s directors, Mr Potts and Mr Toher, gave evidence to the tribunal as to the circumstances in which the Appellant company failed to make a number of payments of tax to the Respondent on time. It was accepted by the Appellant that there were in all, during the relevant qualifying period, 8 instances of non-compliance although only one of these payments was more than 14 days late. Details of the dates on which the payments fell due and when, in each case they were actually paid are set out in a letter from HMRC to the Appellant dated 1September 2008 and are as follows:

Due  Date                                  Effective Date of Payment                 Days late

22 May 2007                             6 June 2007                                             15

22 June 2007                             3 July 2007                                              11

22 July 2007                              28 July 2007                                             6

22 August 2007                         29 August 2007                                        7

22 September 2007                    4 October 2007                                        12

22 October 2007                        31 October 2007                                        9

22 November 2007                    29 November 2007                                    7

22 December 2007                      5 January 2008                                        14

Consequently the provisions of regulation 32 referred to above and which in their effect affords a limited “de minimis” exception to the compliance test were of no assistance to the Appellant. It was common ground between the parties that the only question which it fell to the tribunal to decide was whether the Appellant’s failure to meet the requirements of the compliance test could reasonably be excused.

10.   On behalf of the Appellant, Mr Potts told the tribunal that Prior Roofing Limited had been in business since 2003. It was a specialist roofing contractor working exclusively for major house building companies. It was a characteristic of these companies that payments to their sub contractors were invariably late. It was conceded by HMRC however that the company’s history of payments under the “old” scheme was “relatively up-to-date”. It was also accepted that the most recent payment due on 19^th May 2009 had been paid on time. The non compliances leading to withdrawal of Gross Payments Status had occurred during a period following the introduction of changes to the scheme in April 2007 when there had been a particularly sharp down-turn in the fortunes of the house building industry. It was not suggested that the changes to the Scheme were themselves causative of the failures to any extent.

11.  The more general reduction in activity in the construction industry had begun some 2 years ago in early 2007 but had become increasingly vicious in the North West of England over the following months. It was, Mr Potts told the tribunal, as if someone “had turned the lights off”. The Appellant’s monthly turnover had declined from £400,000 to around £100,000 within a matter of a few months only. An example of this was seen in the complete halt to all work being carried out by Persimmons, a prominent house builder, on the £30 million of housing stock then in construction. The effect of this and other similar situations on the Appellant’s business was disastrous. It had become a major challenge to the company’s management simply to survive throughout this period.

12.  The Appellant turned to its bankers, Lloyds TSB, with which it had a £1.3 million overdraft, to explore the possibility of an extension to its facility but was told that the bank “had no appetite for [your] industry at the moment”. The company was using the full extent of this facility managing its cash on a daily basis. It approached its debtors with a view to expediting payments and thus improving cash flow but its customers were encountering similar problems and this proved not to have any significant effect on the company’s cash position. The Directors sacrificed some £50,000 of the salaries due to them. They also injected additional capital of £160,000 into the company, money raised through personal borrowings. The company’s suppliers were approached in the hope that they would be prepared to exercise patience in receiving payments due. It was the hope of the company that with such patience on the part both of its suppliers and HMRC it would be able to weather the financial storm.

13.  The tribunal was told by Mr Potts and Mr Toher that they had, as directors of the company, done everything they felt that they could do to ensure compliance with the requirements of the Scheme. Withdrawal of Gross Payments Status would mean that the Appellant’s business could not be sustained resulting in the failure of the company and the loss of employment to 7 permanent staff and some 50 sub-contractors. The tribunal notes that these consequences, grave as they might be, are not matters which it was able to take into account in coming to its decision.

14.  The position taken by HMRC in relation to the issue of non-compliance by the Appellant and the decision to withdraw its certificate (permitting the receipt of gross payments ) under the Scheme was set out in a written submission to the tribunal as is the history of  relevant correspondence between the parties.

15.  It is the principal contention of HMRC that whilst the decision to withdraw Gross Payments Status from the company may seem harsh “for such apparently minor failures…” there is, it is said, a fundamental need for all contractors and sub-contractors to be treated equally and fairly. The rules were very clear and the company had contravened them. The company had, it is said, not been singled out from other contractors and had been treated fairly and equally with other contractors. The consequences for any contractor in a similar position would be the same.

16.  The tribunal does not take issue with the above position as a broad statement of policy. However it does not consider it possible to treat companies “equally and fairly” without looking very closely at the particular circumstances leading up to the compliance failures. For example it may well not be the case that all contractors and subcontractors were as a matter of fact in precisely the same position as the Appellant company in terms of the impact of the twin effects of a radical downturn in business volume affecting, in particular, the roofing business and the refusal of banks to assist customers which in more normal times might reasonably expect to be supported. Neither the construction industry nor the banking sector was working normally at the time the failures occurred. Equality of treatment would also dictate that consideration be given to the steps taken by a company’s management to cope with such difficulties. It could not be right in terms of achieving “equality and fairness” that a company whose directors took no or few steps to try and meet its obligations to HMRC should be treated exactly the same as a company whose directors had taken every reasonable step available to it to try and meet such obligations. In the view of the tribunal equality and fairness can only be achieved by looking with great care at the particular circumstances of each individual company and making a considered decision after having done so. This it seems to the tribunal would particularly be the case where the breaches of which complaint is made had been described as “apparently minor failures”. In this respect the fact that the Appellant had declined the offer by the Respondent of a review by an independent reviewer was perhaps unfortunate as this would have provided an opportunity to explain how the exceptional market conditions were affecting the company and the steps it had taken to try and ensure compliance with the scheme.

17.  The Appellant had, in correspondence with HMRC, argued that removal of Gross Payments Status would mean that it would suffer a 20% reduction in its receipts from customers. This could not in the view of the tribunal be advanced as a reason for non compliance. This deduction was, as HMRC quite correctly notes, the inevitable consequence of the Appellant’s failure to meet the requirements of the compliance test. It had also argued that its non-compliance was the result of the cash flow difficulties it faced at a particularly difficult time.

18.   HMRC’s view concerning these cash flow difficulties is expressed in its written submission. It states that it “considers cash flow problems to be a normal part of the commercial issues which businesses face on a day-to-day basis” and that whilst sympathising “where those problems arise, they cannot in this instance be accepted as exceptional and appear to be within the company’s control”. They cannot, HMRC argues, be accepted as constituting a reasonable excuse in this instance. Difficult trading conditions are also, it is stated, part and parcel of business and again cannot be accepted as a reasonable excuse for late payment. The regulations relating to Gross Payment Status do not, HMRC points out, require there to be a consideration of the consequences of removal of that status. Delaying payments under the Scheme can place a company at a competitive advantage to other companies which do observe their obligations. Finally it is made clear by HMRC that its review of compliance does not embrace periods before or after the period under review.

19.  The tribunal having duly considered the submissions detailed above finds as a fact that the circumstances described by the Appellant as giving rise to the failures by it in meeting its compliance obligations under the Scheme were wholly exceptional and led directly to the failures in compliance. It is also satisfied that in light of the efforts made by the directors of the Appellant these exceptional circumstances created a situation which became one which took it out of the control of the directors. A reduction in trading volume of 75% coupled with an almost overnight change in the banking environment could hardly be described as other than exceptional. The submission from HMRC does not suggest what, if any, actions within the control of the directors could or should have been taken which would have enabled them to make the payments due on the dates required in the circumstances prevailing. It is clear to the tribunal that the directors were managing an exceptional situation on a day-to-day basis controlling cash as best they could to ensure that they met, to the best of their ability, their obligations to HMRC under the Scheme.

20.   The tribunal has duly noted the references by HMRC in its submission to the tribunal to the cases of Barnes v Hilton Main Construction (77 TC 255) and Arnold v G-Con Ltd (STC 1516) relating respectively to the future effect of the removal of Gross Payments status on the cash flow of a business and the fact that the extent of a subcontractors compliance with its other tax obligations is irrelevant. It does not take issue with either of these propositions. To the extent to which the Appellant has sought to advance arguments contrary to these decisions those arguments are not accepted by the tribunal as having any substance. Neither of these cases however is helpful in determining the question concerning what constitutes a “reasonable excuse” for non-compliance as both were decided on the previous “minor and technical” test. It is perhaps worth noting however that the Barnes case addressed delays in payment over a three year term of between 1 day and 165 days with yearly average delays of 100 days, 36 days and 33 days. In G-Con PAYE and NIC payments were delayed for periods considerably in excess of those now being considered. It was accepted by HMRC that the Appellant had met its obligations with respect to PAYE and NIC payments. The tribunal also takes note of the statement made by Mr Potts on behalf of the Appellant that the directors of the Appellant take very seriously the company’s obligations to HMRC under the Scheme in respect of the maintenance of its Gross Payments Status. These are matters he said, which it does not take lightly. The company had more recently taken steps in the gradually improving business environment to ensure strict compliance in the future.

21.  The tribunal finds that the circumstances relating to the exceptional and extraordinary trading conditions it experienced coupled with the unhelpful banking environment which prevailed during the review period and which the Appellant company faced taken together constitute a reasonable excuse for its failure to make the payments due within the review period by their respective due dates and that that excuse continued throughout the review period. In coming to this conclusion the tribunal’s decision is not to be considered as in any way providing a “blanket excuse” for companies adversely affected by the problems which have beset British industry over the past 18 months. Many sectors of industry did not experience the drastic downturn seen in the construction industry. Other suppliers to the construction industry were not as critically affected as the Appellant’s business in the roofing sector. Companies which were also engaged in the roofing manufacture and supply sector may not have exhausted the opportunities to ameliorate the position explored by the Appellant’s directors in this case. It should also be stressed that the decision of the tribunal is not simply predicated on the fact of the Appellant’s cash flow problems but rather on the reasons giving rise to those problems. The tribunal’s decision is quite particular to the circumstances of this case and to this Appellant and cannot be seen as having any wider application.

22.  Appeal allowed.

23.    The Appellant has a right to apply for permission to appeal against this decision pursuant to Rule 39 of the Rules.   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.

C.S.Hacking  LL.M  FCI.Arb

TRIBUNAL JUDGE

              RELEASE DATE:  11 November 2009