United Kingdom VAT & Duties Tribunals Decisions

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Cite as: [2004] UKVAT V18563

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Zen Internet Ltd v Customs and Excise [2004] UKVAT V18563 (05 April 2004)

VALUE ADDED TAX — dishonest evasion — VATA s 60 — appellant paying six successive centrally-issued assessments for less than the true liability — inadequate attempts to put accounting records in order — whether "dishonest" — yes — appeal dismissed but reduction for mitigation increased

MANCHESTER TRIBUNAL CENTRE

ZEN INTERNET LTD Appellant

- and -

THE COMMISSIONERS OF CUSTOMS AND EXCISE Respondents

Tribunal: Colin Bishopp (Chairman)

Mr J T B Strangward

Miss C A Roberts

Sitting in public in Manchester on 3 March 2004

Noel Tyler, VAT Consultant, for the Appellant

Nigel Poole of counsel, instructed by the Solicitor for the Customs and Excise, for the Respondents

DECISION

This is an appeal by Zen Internet Limited against the imposition on it pursuant to sections 60 and 76 of the Value Added Tax Act 1994 of a penalty for dishonest evasion. The amount of the penalty was originally £22,785, being 45% of the tax of £50,640 which had been calculated by the Commissioners as the sum evaded. That figure was later revised downwards, when the appellant submitted returns which were agreed by the Commissioners, and the amount of the penalty was correspondingly reduced. The penalty now under appeal is £16,295. It remains 45% of the tax contended to be evaded. The appellant maintains that there has been no dishonesty but if, contrary to that contention, it should be found that there has been dishonesty, it argues that the amount of the penalty should be reduced to 25% of the tax. There is now no dispute about the correct amount of the tax upon which the penalty, if any is appropriate, should be based.

The appellant is an internet service provider ("ISP"). It came into existence in October 1996, when it took over an ISP business which had previously been carried on by another company, Zen Microsystems Ltd. The two companies have in common that their sole beneficial shareholder and principal director is Richard Tang. It was quite clear to us that Mr Tang dominated the management of the appellant and that, for all practical purposes, he and the appellant are one and the same. Mr Tang's evidence before us was that he had been engaged for some years in the computer business, latterly undertaking hardware and software projects for other companies through the medium of Zen Microsystems Ltd, a company which had no employees other than himself.

Although, in 2004, the internet is largely taken for granted, in 1995 it was still very much in its infancy and it was by no means clear that it would become the phenomenon into which it has, in fact, developed. In that year Mr Tang decided to begin offering an ISP service, as part of the business of Zen Microsystems, while he continued with his other activities. In the space of a year the ISP business had expanded to such an extent that Mr Tang decided, he told us, to form the appellant in order to carry it on. For a short time he continued with the other activities of Zen Microsystems, although he has since wound them down. The transfer of the business from one company to the other was effected on 1 October 1996. It was common ground that Zen Microsystems Ltd had submitted its VAT returns correctly and on time throughout its existence, including the period when it was carrying on the ISP business.

The appellant's application for registration was submitted in November 1996, but it sought registration from October 1996. In his covering letter, sending in the application for registration, Mr Tang predicted a turnover of £10,000 per month, which did not make the company immediately registrable for VAT, but he explained that it would be most inconvenient if, once it had passed the threshold, it had to revise its pricing structure, to include VAT on its fees, and the Commissioners agreed to register the appellant from the date requested, that is 1 October 1996. Mr Tang also requested that its VAT quarters should be arranged so as to coincide with its year end of 30 September. We deduce that, because of that request and because by the time of his letter almost two months had gone by since the effective date of registration, the appellant was directed to send in a first return for the six months to 31 March 1997 and to send in subsequent returns at the conventional three-monthly intervals thereafter.

The appellant did not, however, send in its first return, nor its next five returns. In the absence of its returns, it received estimated assessments generated by the Commissioners' computer, which it paid. Eventually the appellant's failure to send in its returns led to a control visit, undertaken by Ronald Grace on 25 September 1998. Mr Grace, from whom we also heard evidence, told us that he saw Mr Tang when he arrived at the appellant's premises, and that he was entirely cooperative. He showed Mr Grace the records he requested, though they were in some disorder and, to some extent, incomplete. Nevertheless Mr Grace was able to calculate the difference between the tax due and the tax which had been included in the assessments which the appellant had paid, amounting to the £50,640 which we have already mentioned. That calculation, as it later emerged, was inaccurate although it appears that a good deal, though not all, of the inaccuracy was attributable to Mr Tang's failure to produce all of the appellant's purchase invoices, which resulted in Mr Grace's allowing too little input tax. Mr Grace told us that Mr Tang did not challenge his calculations, when they were presented to him, but indicated that the appellant would need time to pay. Mr Grace suggested he contacted the Commissioners' debt management unit and told him he did not think he would receive a sympathetic hearing since it was in the nature of the appellant's business that the sums received from its customers were paid in advance and, consequently, the appellant had already received the VAT for which it was required to account. There was, moreover, a suggestion which (in the absence of returns) Mr Grace could not verify, that the appellant was using cash accounting.

Mr Grace explained that he had played no part in the decision to impose a penalty. He had made no recommendation that one should be considered, but the amount of the assessment which he issued, following his visit, automatically led to an investigation by the Commissioners' penalty team.

As part of the penalty team's investigation, Mr Tang was interviewed on 14 December 1998 by two officers, Michaela Thorpe and Marc Smith. We did not hear evidence from those two officers, though we did have a transcript of the interview, on which, in our view, very little turns. We should mention that Mr Tang explained the appellant's history, as he was to do in his evidence before us, and acknowledged that it was wrong to have paid the centrally-issued assessments and not to have sent in the appellant's returns, but he denied that he, or the appellant, had been dishonest in adopting that course.

His explanation, in his evidence, was that the appellant's business had expanded much more rapidly than he had expected. Although some of its customers were businesses, the majority were private individuals paying modest amounts each month. By the end of 1997 the appellant had about 3,000 subscribers, most of whom made a payment each month. The sheer volume of small transactions had overwhelmed Mr Tang who, in addition to dealing with the appellant's administration, had himself been extensively involved in its operations, to the extent that he was working seven days a week and was often manning the appellant's telephone helpdesk. He had not found the time to put in place an accounting system which could keep track properly of all the appellant's receipts and payments. When the first VAT return (for the six month period ending on 31 March 1997) arrived he realised that he did not have the information with which he could fill it in properly. He made a start on assembling that information but he had not succeeded in doing so by the time the centrally-issued assessment arrived and he decided to pay that assessment while continuing with his efforts. Mr Tang told us he had no real expertise in bookkeeping, although he had been on a government-sponsored course, and he relied mainly on somewhat rudimentary manual records. At this time, the appellant had another director, a Mr McWilliam, but he dealt entirely with the appellant's operations and made no contribution to the bookkeeping.

During the course of 1997 – Mr Tang could not be more specific – he made an arrangement with an accountant (the level of whose qualification we did not learn) that the accountant would deal with the preparation of its accounts in exchange for which the appellant would design and maintain the accountant's website. This arrangement, according to Mr Tang, was not a happy one since the accountant's work turned out to be of very poor quality and Mr Tang was forced, at a later stage, to have the accountant's work done again. In the later part of 1997, Mr Tang said he received some advice from an organisation known as Business Link from which he realised for the first time, he said, the importance of maintaining proper accounting records. He learned also how such accounts should be kept. Unfortunately, by that time the records the appellant had were in such disarray, and so far behind, that putting them in proper order became a formidable task. Even so, he did not seek help but decided to continue to deal with the matter himself.

Mr Tang accepted that the appellant ought to have employed a bookkeeper but said that he had not realised at the time that it should do so and it was for that reason he had tried to deal with the appellant's accounting records himself while at the same time running the business. He severed the appellant's relationship with the first accountant, whose efforts had been so unsatisfactory, and appointed others though it appears that he did not do so until the latter part of 1998, shortly before Mr Grace's visit, and that by the time of that visit they had not had the opportunity of making much impact.

Mr Tang told us that the receipt of each return and, later, each centrally-issued assessment acted as an impetus to him to put the appellant's accounts in order but in fact, it appears, they were falling further and further behind. He told us that he had no real idea of the amount of the appellant's liability and thought the best course, while he continued to sort out the accounts, was to pay the central assessments as an interim measure. As time went by he began to suspect that the amounts assessed were too little but at the outset he did not know whether they understated or overstated the appellant's liability. It did not cross his mind, he said, to telephone the Commissioners to ask for their assistance; he thought there would be little benefit in his doing so since he did not expect the Commissioners to work out the appellant's liability for him. When the appellant was appraised of Mr Grace's impending visit he did make an additional effort to bring matters up to date, but he had not succeeded by the time Mr Grace arrived. It did, however, become clear to him as he was preparing for the visit that the central assessments understated the appellant's liability.

Mr Tang said that he was under the impression that Mr Grace realised that he was doing his best to bring matters up to date, and there was no suggestion to him during the course of the meeting that there might have been any dishonesty. (We should perhaps add that, although Mr Grace was not asked about his own views, there is no suggestion in his visit report, of which a copy was before us, that he thought Mr Tang had been dishonest). He was therefore quite surprised when he received a copy of the Commissioners' notice 730 shortly before the interview in December 1998 (and reminded of it when the interview began) and he was taken aback by the implicit accusation of dishonesty. He told us that he had at no time had any dishonest intention, fully intending throughout to put matters in order. However, as he conceded, he did not in fact send in any returns at all until August 1999, shortly after he received Mr Grace's original assessment, when he rendered the returns for the appellant's first three accounting periods, 3/97, 6/97 and 9/97. The returns for the four succeeding periods were rendered in October 1999 by which time even the last of them (relating to 9/98, the period during which Mr Grace had visited) was almost a year late. As we understand it, the Commissioners accept that those returns were accurate (the tax due was adjusted on the strength of them) and no complaint is made about the appellant's subsequent compliance record.

The Commissioners do not contend that the appellant, through Mr Tang, misrepresented the appellant's liability by concealing sales or overstating purchases and they do not contend that Mr Tang concealed material from Mr Grace, told untruths at his interview in December or has at any time admitted dishonesty. Their argument, as it was put by Nigel Poole, of counsel, representing them, was that its repeated failure to render its returns while instead paying centrally-issued assessments for sums much less than the true liability could be regarded only as the dishonest evasion of tax within the meaning of section 60 of the 1994 Act. This was not a case, Mr Poole argued, in which the controlling director of the appellant was ignorant of VAT; Mr Tang had run a VAT-registered business before the appellant began trading and, as he himself accepted, he knew of the appellant's obligations yet chose not to comply with them. Noel Tyler, the VAT consultant representing for appellant, did not attempt to excuse the appellant's failure to send in its returns – nor of course could he – but he argued that its failure to do so was attributable to the rapid expansion of its business and, as he accepted, Mr Tang's failure to delegate the maintenance of the appellant's accounts when it became, or should have become, obvious to him that he was not coping.

In his visit report Mr Grace had described Mr Tang as "a control freak". Though Mr Tang evidently did not recognise himself in that description, it does not seem to us to be too far from the mark. Certainly it was obvious to us, and should have been obvious to Mr Tang, that he needed help with the appellant's accounts from a very early stage. His reluctance to take on help, or to delegate, is difficult, if not impossible, to understand. Mr Tyler emphasised that when, even if belatedly, it did become obvious to Mr Tang that he needed help, he sought it and he emphasised the fact that, even though they were late, the returns when eventually rendered were accurate, a factor which, he said, pointed to honesty rather than dishonesty – and particularly so when it was borne in mind that two of the returns showed that the appellant's liability was higher than that calculated by Mr Grace for the same period.

Section 60(1) of the 1994 Act, so far as material, reads as follows:

"(1) In any case where —

(a) for the purpose of evading VAT, a person does any act or omits to take any action, and

(b) his conduct involved dishonesty (whether or not it is such as to give rise to criminal liability),

he shall be liable … to a penalty equal to the amount of VAT evaded or, as the case may be, sought to be evaded by his conduct."

What is meant by "dishonesty" was perhaps most succinctly defined by Lord Lane CJ in R v Ghosh [1982] 1 QB 1053 at 1064 where he said that the test is "whether according to the ordinary standards of reasonable and honest people what was done was dishonest." However, as the tribunal indicated in Gandhi Tandoori Restaurant v Customs and Excise Commissioners [1989] VATTR 39 that definition of dishonesty, taken alone, is not sufficient for the purposes of applying section 60. In that case, the tribunal was required to consider the terms of section 13(1) of the Value Added Tax Act 1983 which was in all material respects identical to section 60 of the 1994 Act. At page 46 it said this:

"It is to be observed that in section 13(1) the first requirement for liability to a penalty is that the taxpayer shall have done, or refrained from doing, something 'for the purpose of evading tax'. But that alone is not sufficient to impose liability, something else is necessary, namely, his conduct must involve 'dishonesty'. It seems to us clear that in such a context, where a person has, ex hypothesi, done, or omitted to do, something with the intention of evading tax, then by adding that that conduct must involve dishonesty before the penalty is to attach, Parliament must have intended to add a further mental element in addition to the mental element of intending to evade tax. We think that that element can only be that when he did, or omitted to do, the act with the intention of evading tax, he knew that according to the ordinary standards of reasonable and honest people that what he was doing would be regarded as dishonest. In other words we think that it is evident from the wording of section 13(1) taken as a whole that the word 'dishonesty' is to bear the meaning that was given to it, where it appears in the Theft Act 1968, by the Court of Appeal (see R v Ghosh). In the majority of cases brought under this section the course of conduct adopted by the taxpayer will be such that the necessary mental element of dishonesty can be readily inferred."

Mr Tyler's argument requires us to accept that the appellant, through Mr Tang, was doing its honest, even if inadequate, best to comply with its obligations. He recognised, as he is forced to do by the decision of the Court of Appeal in R v Dealy [1995] STC 217 that "evasion" can consist in a deferment, rather than permanent evasion, of a liability. His point, as we understand it, is that this case is to be distinguished from Dealy's case and from cases such as Hodgson & Hodgson v Customs and Excise Commissioners (1997, decision 15165), Johnson v Customs and Excise Commissioners (1998, decision 15868) and Storey v Customs and Excise Commissioners (2002, decision 17793) in all of which it was shown that the unsuccessful appellant had paid centrally-generated assessments, knowing that those assessments understated the true amount of tax due. No such knowledge could be shown here, he said, and the Commissioners had not correspondingly established dishonesty. Mere suspicion, such as that conceded by Mr Tang, was not enough; the intention to evade was absent.

We accept that Mr Tang did not set out with the intention of evading the appellant's tax liabilities. So much is apparent from the satisfactory compliance record of Zen Microsystems Ltd and from his request that the appellant be registered for VAT before it became liable to register. We are willing to accept, too, that he intended at all times to put the appellant's affairs in order, and we recognise that, even if very belatedly, he did so. Nevertheless, we think there are substantial obstacles in the way of Mr Tyler's argument.

By his own account Mr Tang is educated to degree level. He has spent his working life in the computer industry and must be taken to be well aware of the capabilities of computers. In his letter seeking registration, he indicated that the appellant was already using a proprietary brand of accounting software. In his evidence he told us that the software it had was somewhat out of date but it seems to us that it would have been a matter of great simplicity to purchase and install a more recent version. We can understand that, as the due date for the sending in of the appellant's first return neared, Mr Tang might have realised that he had made inadequate provision for the keeping of the appellant's records even though we found his explanation a little difficult to believe. He told us that not only the records of the appellant's receipts and payments but also the records of its subscribers were in disarray, to the extent that a subscriber who ceased to pay his monthly subscriptions would not have the appellant's service withdrawn for quite some time (and even then it was not explained how it would eventually be realised that a subscriber was no longer paying). At the same time, it was obvious that the appellant's business was increasing substantially; even if the rate of increase was considerably greater than Mr Tang had expected it was evident that the appellant was able to keep up with that growth by expanding the capacity of its service. Given the nature of the business, expansion plainly involved the acquisition and implementation of computer equipment. It is in our view difficult to accept that a trader which was able to expand its computer business successfully was incapable of expanding its accounting system to match.

Had the appellant's failings been confined to one or, conceivably, two accounting periods its failings might have been excusable. However in our view an honest trader, realising it had defaulted twice, would recognise that it needed professional help. Mr Tang did, we recognise, seek some help, but he did so very belatedly and in a somewhat casual fashion; and it was evident that the help he sought was in the preparation of the appellant's annual accounts, rather than in the preparation of its VAT returns. It may have been a difficult task to bring the historical records up to date but it does not seem to us that it would have been impossible for the appellant to draw an imaginary line and thereafter keep good records, and send in its returns on time, while attempting to put right its past failings. Instead, Mr Tang closed his eyes to the obvious and, rather than putting matters right, allowed them to deteriorate. Though we cannot go so far as to say that we are satisfied he would have allowed the situation to carry on indefinitely had it not been for Mr Grace's visit and subsequent events we cannot, we think, leave out of account altogether the fact that little real, or effective, effort had been put into the task before the visit.

We turn therefore to ask ourselves whether the appellant's conduct was dishonest, within the test laid down in R v Ghosh and Gandhi Tandoori, bearing in mind that the burden is on the Commissioners but that they need do no more than establish an intention to defer payment, as the Court of Appeal held in Dealy. Mr Tyler, as we have mentioned, urged us to the view that this case was to be distinguished from Hodgson, Johnson and Storey because in those cases the appellants knew, and in this it did not, that its liability was in fact higher than the amounts centrally assessed. We are willing to accept that Mr Tang did not know, even approximately, what the appellant's true liability was but we are unable to accept that he did not realise that it was considerably higher than the amounts centrally assessed. Saving one period, when the appellant's purchases had been unusually high, the true liability was far in excess of the amount centrally assessed and, again, saving that one period, there was a steady increase. In the last of the relevant periods, for example, the true amount of tax was well over 20 times the amount centrally assessed. We do not accept that a man of Mr Tang's intelligence had no more than a vague suspicion that this might be so, even if he did not know the precise amount of the true liability. If he did not realise it, his failure to do so could be attributable only to his wilfully closing his eyes to the obvious. The business was expanding and the number of customers paying subscriptions, including VAT, was increasing rapidly. While there would be – and the figures ultimately produced showed that there were – corresponding increases in purchases, it was almost certain that the gap between income and expenditure would widen and that the net liability for VAT would rise with it. We take the view that by the standards of ordinary people, Mr Tang's conduct would and should be regarded as an attempt to avoid, if only by deferment, the appellant's VAT liability, and that, within the test as it is laid down in the cases, his conduct must be regarded as dishonest. The appeal against the imposition of the penalty must, therefore, fail.

We turn now to consider mitigation. The Commissioners have arrived at 55%, by the application of their usual tariff. They allowed 25% of a maximum 40% for an "early and truthful explanation as to why the arrears arose and the extent of them"; they did not allow the full amount because, they say, Mr Tang did not complete the appellant's VAT returns (at least promptly) and he made no admission of dishonesty. They allowed 25%, the maximum in accordance with their tariff, for his cooperation in substantiating the full amount of the arrears and they allowed half of the maximum of 10% for attending interviews and producing records – they withheld half because Mr Tang did not produce his annual accounts.

We, of course, are not bound by the tariff but may instead take into account all those factors which it appears to us appropriate to take into account, save those three identified by section 70 of the 1994 Act, that is insufficiency of funds, that overall there has been no loss of VAT and that the person concerned has acted in good faith. None of those factors is relevant here. We should pay regard to the tariff in the interest of consistency of treatment of different tax payers, even if we are not bound by it. Mr Tang's failure to produce annual accounts is a consequence of the same problem, namely the inadequate accounting records, and to deprive him of any mitigation on that account is, we think, double counting. For that reason, we think that application of the tariff should lead to mitigation of 60%.

This is not dishonesty of the worst kind, where a deliberate attempt has been made to defraud the Commissioners. On the other hand, the appellant's failings are considerably worse than those of a trader who, for good reason or bad, sends in his return and pays the tax due late, and who may be subject to default surcharges of up to 15% of the tax. Mr Tyler accepted that, had default surcharges been imposed, the appellant would have no conceivable reasonable excuse. We must, we think, reflect some distinction from the default surcharge in our conclusion. In our view, if we approach the matter at large and without applying the tariff, we come to much the same conclusion, that the appropriate penalty in all the circumstances of this case is 40% of the tax. We reduce the penalty accordingly.

The appeal therefore succeeds to that extent. Each party applied for payment of its costs by the other should it succeed. Although we have reduced the penalty, it is in reality the Commissioners who have succeeded. We think it appropriate that the appellant should pay their costs and we so direct. If the amount cannot be agreed, either party may apply to have it assessed by a tribunal chairman sitting alone.

COLIN BISHOPP
CHAIRMAN

Release date:

MAN/00/178