United Kingdom VAT & Duties Tribunals Decisions

BUYCO & Anor v Revenue & Customs [2006] UKVAT V19752 (12 September 2006)

19752

HARDSHIP – Appellants with no borrowing facilities – Customs contending that appellant should borrow on the security of properties or dispose of properties – not required – hardship found

LONDON TRIBUNAL CENTRE

BUYCO LIMITED AND SELLCO LIMITED Appellants

- and -

THE COMMISSIONERS FOR HER MAJESTY'S

REVENUE AND CUSTOMS Respondents

Tribunal: DR JOHN F AVERY JONES CBE (Chairman)

Sitting in private in London on 17 and 18 July 2006

Michael Sherry, counsel, instructed by Deloitte & Touche LLP, for the Appellant

Mario Angiolini, counsel, instructed by the Acting Solicitor for HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2006


 


ANONYMISED DECISION

1. Buyco Limited ("Buyco") and Sellco Limited ("Sellco") (together "the Appellants") apply for their appeals to be entertained notwithstanding that they have not paid the VAT in dispute on the ground that they would suffer hardship if required to pay it. The Appellants were represented by Mr Michael Sherry and Customs by Mr Mario Angiolini.
2. I had six ring binders of documents and heard evidence from Financial Consultant, Fellow of the Chartered Association of Certified Accountants, financial consultant to the Appellants until 31 January 2006 and returning a few weeks ago to perform some additional work part-time, and Strategic Financial Consultant, Fellow of the Chartered Institute of Management Accountants, strategic financial consultant to the Appellants from 15 June 2006 but doing some work on a part-time basis before then. I find the following facts:

(1) The current appeal concerns about £8m, comprising £3.4m assessed on Buyco, £0.906m assessed on Sellco (together being the amounts in issue in these hardship proceedings), and Customs have retained £3.5m due to Sellco. The dispute relates to insurance provided to customers on which the Appellants had not charged VAT.

(2) The Appellants taken together carry on business as [nature of business withheld]. Buyco, which is owned by a trust for Mr F, buys the goods, selling them on exclusively to Sellco, which is owned by Mr V, which sells them to the public. In addition an associated company Buyco 2, which is owned by a funded unapproved retirement benefit scheme ("FURBS") for the benefit of Mr F, purchases some goods which are also sold exclusively to Sellco.

(3) At the peak of its trading in 2002 Sellco had a turnover of £144.7m, and Buyco (the retail selling company until January 2002) a turnover of £217.5m (in recording figures in this decision I shall round them considerably to give an idea of their magnitude). In 2003 sales were down 28 per cent to £143.2m (Sellco, then the retail selling company) and £120.9m (Buyco). In 2004 there was a further fall of 37 per cent in turnover from the previous year to £88.9m (Sellco) and £66.7m (Buyco). The drop in turnover has resulted in redundancies, so that the Appellants employ 50 staff compared to 150 in 2002.

(4) During the period of rapid expansion in 2002, the accounting system could not cope. The auditors resigned and the report of the new auditors on the accounts to 31 July 2002 stated that they were unable to form an opinion whether the accounts gave a true and fair view. Since then, audited accounts to July 2003 and 2004 have been finalised in July 2005. These show losses in Buyco of £1.6m and £0.8m respectively, and for Sellco a loss of £29K and a profit of £58K respectively. The audit reports are qualified for 2003 as to opening balances at 1 August 2002 and VAT balances at the end of the period; and for 2004 as to opening stock and VAT balances and closing VAT balances.

(5) I had management accounts for Buyco and Sellco, which Financial Consultant considered were robust, with bank accounts being reconciled monthly. As this is the most up-to-date information available I shall rely primarily on this source. For Buyco the management accounts for the 10 months (strictly the Appellants account on the basis of a 52 week year but I shall refer to months for simplicity) ended 24 May 2006 show a loss of £164K. At 24 May 2006 Buyco had debtors of £3.0m (excluding inter-company accounts on which it owed a net £6.5m, including £28m to Sellco), cash of £1.0m (including £992K in an account of Mr F's, see paragraph 2(13) below), stock of £5.2m, and current liabilities of £7.2m. Net current assets were therefore £2.0m, excluding the amounts owed to associated entities. To put the stock figure into perspective if sales are £1m per week (roughly the rate at that time) the stock figure represents about 5 weeks turnover and so Buyco was financing substantial stock. The highest month-end stock figure in the 10 months was £5.9m and the lowest £4.6m.

(6) The management accounts for Sellco for the 10 months ended 24 May 2006 show a pre-tax profit of £637K. At 24 May 2006 Sellco had £1.729m cash, trade debtors of minus £248K^[1] (this was not explained but consistently over the 10 months of the management accounts "[goods] debtors" is a negative amount), it was owed a net figure of £1.7m by associated entities, the largest amount (£27m net^[2]) being owed by Buyco, stock of £253K, had a liability to trade creditors in respect of advances of goods or services of £1.2m, and current liabilities of £723K. Net current liabilities were therefore £189K, including the liability to trade creditors but ignoring amounts owed by associated entities. To put the stock figure into perspective if sales are £1.3m per week (roughly the rate at that time) the stock figure represents 20 per cent of a week's sales and so Sellco is not financing stock to a great extent. The highest month-end stock figure in the 10 months was £309K and the lowest £208K. Sellco does not hold any land.

(7) Sellco trades from a split site. The site is owned by Propco Limited ("Propco") (see paragraph 2(10)) and is leased to Buyco with Sellco paying a cross-charge. At the height of trading in 2002 the number of members of the public visiting the site particularly at weekends was causing serious problems to which the planning authority was objecting. Following an appeal, temporary planning permission for four years from 24 September 2001 was granted for the continued use of the site. Although this period has expired Strategic Financial Consultant said (and I accept) that discussions were in progress with the planning authority and any problems were likely to be resolved in the light of the current reduced trading volume.

(8) Buyco purchased a site in J Lane in July 2003 for £10m with a long-term view of moving from the split site when the temporary planning permission there expired in September 2005. The current proposal is not to move there but to obtain planning permission which is expected to take two or three years and to involve expenditure of £2m, and then sell it or develop it as a joint venture. Meanwhile the property would be let on short leases. Strategic Financial Consultant considered (and I accept) that it would not be economic to sell the site now, but it should be possible to obtain rent of £800K by leasing half of it plus a further £90K from leasing an office block on the property. Currently there are two leases with a total rent of £510K pa but one of the tenants (rent £300K pa) has given notice to quit after planning problems. Negotiations are currently pending with three tenants. If the property were producing a rent of £800K it should be possible to borrow £5m on its security.

(9) Earlier, Buyco had a lease of a property in A Street, from which goods were collected by customers. Its lease was terminated unexpectedly, which Buyco opposed unsuccessfully. It purchased a site at X Road as a substitute, but it is not currently being used. This it transferred into the FURBS, on which it obtained a corporation tax deduction. The FURBS lets the site to Buyco for £10K per month under an oral lease. I heard no evidence about this lease and find that on the balance of probabilities Buyco would be in a position to terminate it. If this is excluded as an expense Buyco would still currently be making a loss.

(10) Propco Limited is an associated (not group) company which holds properties previously owned by Mr F, mainly the split site, with a cost of £5.3m that are leased to Buyco. Its profits were £250K in 2004. It has given a cross-guarantee to Buyco's bankers in respect of its overdraft for which it receives a guarantee fee. The 2004 balance sheet shows cash of £1K only; rent must have accrued or been lent back (the amount of accrued income owing by Buyco increases from £260K to £473K over the 10 month period of the management accounts). Financial Consultant considered (and I accept) that a lender would not lend to Propco for the purpose of lending to another company, and Strategic Financial Consultant considered (and I accept) that the temporary planning permission for the split site made it unattractive as a security to a lender. Another associated company is Buyco 2 Limited, which also purchased goods that are sold on to Sellco and made profits of £145K and £42K in the years ended July 2003 and 2004. Buyco 3 Limited acts as an agent of Buyco in purchasing goods.

(11) Sellco received advances of goods or services due from trade creditors that as a result of the fall in turnover were in excess of goods or services sold. There is accordingly an outstanding liability to the trade creditors that is being reduced by goods or services sold. The management accounts for the 10 months to 24 May 2006 show negative debtor balances that vary from month to month for trade creditors P and Q, which indicate that business is still being done with these companies, and constant balances for trade creditor R (but with a negative creditor figure of £2.6K—effectively a reduction in the liability—appearing in November 2005 and continuing thereafter; no reference to this was made at the hearing, Strategic Financial Consultant not knowing the current position), S and T, which suggests that no further business is being done with these companies, although some agreement must recently have been made with R for this reduction (it should be mentioned that the management accounts for Buyco also show a negative debtor to R of £4.7K). In addition, there is an amount of £1.4m owing by Sellco to U (in liquidation) that is disputed and is not included in he management accounts. The 2004 audited accounts show this as a contingent liability and state that the directors consider that any claim will be successfully defended. I accept the directors' judgment on this and therefore ignore this item. I find on the balance of probabilities that R, S and T, who are owed a total of £822K, will be seeking repayment of the balance, but since the excess must have arisen through advances in 2003 which were not repaid out of goods or services sold because of the drop in business compared to the previous year the are taking their time to do so, probably realising that their best way of obtaining repayment is to allow Sellco to continue to trade until it is in a position to repay them, which is strange when Sellco holds cash balances surplus to its current trading requirements (see paragraph 2(14)). Both witnesses said that the trade creditors were seeking payment; Financial Consultant accepted that this was exaggerated. However, they are apparently immediately due otherwise they would not be shown in he management accounts as negative debtors but as liabilities falling due after one year.

(12) The corporation tax liabilities of the Appellants is open back to 2002. the management accounts show liabilities of £762K for Buyco and £9K for Sellco. Strategic Financial Consultant put the figure at £2m in his witness statement, correcting this to £1m at the hearing.

(13) In the management accounts for Buyco for the 10 months to 24 May 2006 there is a constant figure of £992K for a bank account in Mr F's name that is held for Buyco. It was explained that this represented sales of scrap metal from the J Lane site and was used as working capital for the site. Strategic Financial Consultant suggested that the constant figure might be because the accounts department did not have access to the statements, but as the burden of proof is on the Appellants I find that this figure is cash available to Buyco. Taking into account its overdraft, which is authorised only to the extent that there are funds in linked accounts, on current account and its deposit account this represents substantially all the cash available to Buyco; at the end of each of the 10 months to 24 May 2006 the total cash balance varied between £820K and £1.224m.

(14) Sellco had cash on deposit varying between £898K to £1.8m every month in the 10 month period ended 24 May 2006. Strategic Financial Consultant said (and I accept) that the lower figure represents about half a week's sales. The current account had balances varying between £1.5m and £6.9K with the latest balance being £9K. In addition there are funds in "Barclays PDQ control account" of between £194K and £375K with the latest balance of £302K which I understand is cash in transit and not available to draw on.

(15) The accounting problems caused problems with the Appellants' bank, Barclays. Earlier, Buyco had a £4m overdraft facility but currently there are no overdraft facilities for either of the Appellants although Buyco is permitted to offset linked accounts. There were charges over the assets of Buyco in respect of guarantees given to Barclays Bank for a rent guarantee and a bond for vehicle licensing fees, both of which were in process of being released. Because of the lateness of the accounts and the qualified audit reports Strategic Financial Consultant considered that it would not be possible to obtain overdraft facilities currently, but the position should improve if the 2005 accounts were ready within a reasonable time (although it seems that because of Financial Consultant's absence they have only just been sent to the auditors) and unqualified, when it would be possible to approach banks for this purpose. Currently Strategic Financial Consultant's involvement with Barclays was mainly on operational matters; other matters were dealt with by Mr F or Mr V. Both Financial Consultant and Strategic Financial Consultant said (and I accept) that a lender would expect interest cover of three-times before lending. Financial Consultant considered (and I accept) that a lender would look at each company separately in deciding whether to lend. Strategic Financial Consultant said (and I accept) that a sale and leaseback would not be possible giving the financial position of the Appellants. Strategic Financial Consultant considered (and I accept) that the best option for finance was on the security of the stock, but there were problems with the lack of profits and the existing debts to trade creditors.

3. Section 83(3) of the VAT Act 1994 provides:

"(3) Where the appeal is against a decision with respect to any of the matters mentioned in section 83(b), (n), (p), (q), (ra) or (zb) it shall not be entertained unless—

(a)   the amount which the Commissioners have determined to be payable as VAT has been paid or deposited with them; or

(b)   on being satisfied that the appellant would otherwise suffer hardship the Commissioners agree or the tribunal decides that it should be entertained notwithstanding that that amount has not been so paid or deposited."

The appeal is against an assessment to which paragraph (p) applies.

4. Mr Sherry contends:

(1) Neither of the Appellants is in a position to pay the VAT without hardship.

(2) Requiring borrowing by either the Appellants to pay the VAT would cause hardship. There was no need for the Appellants to make hopeless applications to banks to borrow.

(3) Requiring sale of J Lane would cause the loss of a potential future profit on the site, which would cause hardship.

(4) The fact that Customs were withholding a £3.5m repayment from Sellco was already causing hardship even before considering whether it could pay the assessed VAT.

(5) While Mr F was holding £992K of Buyco's money, that company owed £1.4m to the FURBS that it had borrowed back after paying the rent to the FURBS.

(6) If Sellco had to pay the VAT it would have to de-stock, which would reduce profits by £0.5m, and it would be trading with nothing in its account.

5. Mr Angiolini contends:

(1) Buyco could sell the J Lane property which is not being used for the business. While it would lose the potential profit in the future it would not involve hardship to forego this.

(2) Buyco had £998K which Mr F was holding for it that was not used in the business. It could also borrow on the security of J Lane. If half the site were let at a rent of £880K pa, Strategic Financial Consultant considered that it should be possible to borrow £5m. There was no direct evidence that it could not borrow at all, and no evidence that Buyco had ever tried to borrow on the security of J Lane. There was no direct evidence that the qualification to the accounts was preventing the bank from lending.

(3) There was no evidence that Propco could not borrow and lend to Buyco.

(4) The FURBS held assets worth £14.6m and had already lent £1.4m to Buyco. There was no evidence that it could not lend further sums to Buyco. Mr F was obviously a man of means and there was no evidence that he had been asked to lend funds to Buyco.

(5) Sellco consistently had about £1m on deposit that was not required for trading.

(6) The Appellants had not acted speedily in preparing accounts; for example because of Financial Consultant's leaving at the end of January 2006 and only returning to do some part-time work in June 2006, the 2005 accounts had only just been sent to the auditors. The Appellant had been less than forthcoming in answer to Customs' requests for information; for example no statements for Mr F's account holding funds on behalf of Buyco had been produced.

Reasons for my decision

6. The issue in this application is whether I am satisfied that each of the Appellants would suffer hardship if they were required to pay the VAT in dispute. It is common ground that I am considering the position as it is today or within a reasonable time from today, which I should specify if I considered that the VAT could be paid without hardship. It is also common ground that the burden of proof is on the Appellants. Also that the test is an "all of nothing" one; whether each of the Appellants would suffer hardship if it paid the full amount of the VAT in dispute. In determining whether there is hardship I consider that I must take each of the Appellants as they are today. Mr Angiolini may voice objections to the purchases of the J Lane and X Road sites and the putting of the latter into a FURBS after the present appeal arose, pointing out that the Appellants can find funds when they need it for business but not for payment of the VAT in dispute, but unless it can be shown that the transactions were outside the ordinary course of its business (in the widest sense to include the acquisition of capital assets for the business) with the purpose of enabling it to avoid paying the tax in dispute, about which there is no evidence, I consider that I must take these transactions as having occurred and look at the situation as it is today.
7. Because hardship applications are heard in private there is little guidance available to me. However, in Tricell v Customs and Excise Commissioners, (2003) VAT Decision 18,127 the Chairman, Mr Bishopp, said:

"55. In case I am found elsewhere to have been wrong in that conclusion, I turn to examine the evidence of hardship which was available to me. It consisted of a statement made by the appellant's managing director, Nick Greer. Mr MacNab did not challenge the statement, and merely commented that the evidence of hardship was "thin". Mr Greer explains in his statement that the appellant had a factoring arrangement with its bankers, which allowed it to access, by means of a variable loan, 85% of the amount due to it by way of VAT repayment. There was an additional condition that each month's repayment claim must be met before the appellant was permitted to begin drawing against the next month's accumulating entitlement; it was correspondingly in its interests to claim its repayments as quickly as possible.

56. The effect of the Commissioners' refusal to meet these claims in full is that the bank has withdrawn the facility altogether. The appellant has not ceased trading, but, as Mr Greer explains, the need to wait until each repayment has been received has had an adverse effect on the appellant's cash flow and its ability to trade; its level of business has reduced substantially. I do not consider it realistic to argue that the appellant should simply look elsewhere for funding; if its bankers will not provide funds, they are unlikely to be readily available from other sources, at least on acceptable terms. I am satisfied from Mr Greer's evidence that the appellant is experiencing significant trading difficulties, that they are a direct consequence of the Commissioners' refusal to meet its repayment claims in full, and that hardship is established."

8. The issue is whether each of the Appellants would suffer hardship if required to pay the tax in dispute. I interpret hardship to mean that the business will be harmed if the tax, which is by definition in dispute and may not ultimately be payable, has to be paid. The real issue is if they do not have the cash available, and so would clearly suffer hardship if the tax were required to be paid, what further steps should the Appellants be expected to take to raise cash in order to avoid suffering hardship. The legislation is silent on this but might have been expected to spell out if steps outside the normal course of trading, such as selling assets for the purpose of raising funds to pay the tax, were required. The legislation merely poses the question whether the tax can be paid without suffering hardship, which suggests that one looks at the existing situation and implies that taking such steps is not expected. So far as borrowing is concerned I accept that a business may need to borrow in order to pay VAT in dispute if the business had existing unused borrowing facilities (or could obtain such facilities or an increase in them merely by asking the bank). Like Mr Bishopp in Tricell I do not consider that, if a business's normal bankers will not lend, it should be expected to pursue other sources of finance purely for the purpose of paying the tax in dispute. I consider that I should rely on the fact that a business that needs finance for the business will already have taken reasonable steps to obtain it, and if a business knows that a bank is unlikely to lend in the circumstances I can understand its being reluctant to make a definite request and risk receiving a refusal which might make borrowing more difficult in the future. I also bear in mind that investigating new sources of borrowing may require the incurring of significant expenses, such as valuations of land and legal fees, which might not ultimately achieve any results. In relation to disposals outside the ordinary course of business of assets that were properly purchased for the business, I consider that it would involve hardship for the business to take the irrevocable step of selling them in order to pay VAT in dispute, whether or not the assets are currently used in the business. The hardship would also include the expenses incurred in selling.
9. Applying this approach to Buyco I consider that it would suffer hardship if it had to sell J Lane, and in any case I do not consider that this can be done in a reasonable time that I could specify. Selling a £10m site would take an unknown time. Commercially, Buyco has plans which involve a two or three year wait for suitable planning permission which in my view should be allowed to take their course. The costs of any such sale would also be significant.
10. I do not consider that Buyco should be expected to try to borrow on the security of J Lane, which would involve significant expense in the form of valuations and legal fees (I saw a letter from Barclays dated 5 May 2005 setting out its requirements in this respect). In any case I find it would not be possible to do so. I am considering the matter as it is today when one of the tenants has given notice and so the only continuing rent is £210K pa and that tenant can quit on three months notice. While there may be a prospect of other tenants I do not believe that a lender would lend on the hope of rent under leases not yet granted. I have no difficulty in accepting Financial Consultant's and Strategic Financial Consultant's evidence that a bank would not lend to a company unless the interest were covered three times; indeed that is an indicator applied by the former Inland Revenue part of the Respondents when considering whether thin capitalisation cases between related entities (which now apply when the lender is UK resident) are at arm's length (ITH para.1223). Here Buyco made a loss of £988,522 in each of the last three years and the management accounts show a loss of £164,847 in the 10 months to May 2006 (and the results for all of these periods would still be losses even if, as I have found, it was possible to terminate the lease from the FURBS on X Road), and so it could not offer a lender any evidence that it could pay the interest or repay the loan. I assume that having lost its £4m overdraft facility Buyco will already have done everything it reasonably can in order to obtain some replacement facility.
11. I do not consider that the Appellants should be required to attempt to borrow from related persons, such as Mr F, Propco or the FURBS, as Mr Angiolini has suggested. They are not in the business of lending. They must primarily consider their own shareholders, or beneficiaries in the case of the FURBS. Apart from Propco, which has no cash, I have no information about their financial position and I do not consider that any entity should itself be required to borrow in order to lend to the Appellants in order for the Appellants to avoid hardship.
12. I accept that there are funds of £992K in Mr F's account held for Buyco which in the last 10 months have not been used in the business. However, Buyco is the company financing the stock and this figure represents only half a week's stock. Even if I were to decide that this sum was surplus to Buyco's business requirements, in view of my decision on selling J Lane or borrowing on its security, this would be the only source of funds available to Buyco and so it would still be unable to pay the whole of the VAT in dispute without suffering hardship.
13. So far as Sellco is concerned it has had a minimum of £898K on deposit every month-end for the 10 months ended 24 May 2006 and a cash figure on that date of £1.729m (with a minimum cash figure during the 10 months of £1.1m), and so this seems to be surplus to trading requirements. If it had paid the VAT assessment of £906K on 24 May 2006 (the latest date for which I have management accounts) it would have £823K in the bank, trade debtors of minus £248K, stock of £253K and current liabilities of £723K, resulting in net current assets of £105K before the liability of £1.2m to trade creditors, or net current liabilities of £1.095m taking these into account (ignoring amounts owed by associated entities, mainly Buyco which is not in a position to pay even that amount without reducing stock). Sellco is not financing any substantial stock and is not likely to have to do so, the highest month-end stock figure in the previous 10 months being £309K; the stock is essentially being financed by Buyco. I do not therefore accept that the cash is required for purchase of stock. The evidence about the imminence of payment of the liability to trade creditors was agreed to be exaggerated but I have found that £822K is owed to three trade creditors with which Sellco is not currently doing business and so it is more likely that they will enforce payment even though they have delayed doing so in the past. If I were to assume that the trade creditors would not be likely to demand their money in the near future I do not consider that it would cause hardship to Sellco to pay the VAT in dispute. But I do not consider that I can ignore these liabilities just because they have not enforced payment in the past. They represent genuine liabilities and if Sellco paid the VAT and then the trade creditors demanded payment it would have no means of paying them other than calling on Buyco to reduce its stock level. While the evidence about the likelihood of such a demand being made was missing I cannot ignore the existence of such a liability.
14. Accordingly I find that each of the Appellants would suffer hardship if they were required to pay the VAT assessed. The parties reserved their position on costs and I direct that any application for an award of costs in principle should be made within 21 days of the date of release of this decision.
15. I should like to add some general points:

(1) A constant objection by Customs was about the lack of up-to-date information, for example statements for all bank accounts. One of the problems is that some bundles were prepared for a hearing in December 2004, which was adjourned after hearing argument, and Customs have not made unambiguous updated requests for information as it is today; for example, there was a request in May 2004 for bank statements for the previous six months, but requests for more recent statements have been less specific. In future, in contested hardship cases what is required is up-to-date information on all aspects of the business and I suggest that Customs should apply for a direction for disclosure if they are not satisfied with what the appellant has provided. Although the burden of proof is on the Appellants they may be content, for example, to rely on the liability to trade creditors being shown as current liabilities without informing the Tribunal what has been agreed with the trade creditors.

(2) I was surprised by out-of-date information being contained in witness statements and only corrected at the hearing. For example Financial Consultant's witness statement dated 13 July 2006 stated that Sellco had cash balances of £200K when the true figure was £898K to £1.8m every month-end in the 10 month period ended 24 May 2006, and Strategic Financial Consultant's, dated 12 July 2006, stated that outstanding corporation tax was estimated at £2m, which he changed to £1m at the hearing (and even that seems to be in excess of that shown in the management accounts). The Tribunal expects professionally-qualified witnesses giving financial information to take care that it is fully up-to-date.

(3) For quite understandable reasons the only witnesses were on the financial side. However in considering wider issues, such as the future of properties, the current position over negotiations with trade creditors, or the approaches to banks, it would have been helpful to have had evidence from people engaged in that side of the business.

JOHN F. AVERY JONES

CHAIRMAN

RELEASE DATE: 12 September 12006

LON/02/0790

Note 1   The figure in the balance sheet in the management accounts is a positive £250K but this does not appear to include the inter-company balances, which have been allocated to the previous period, though apparently not consistently over the 10 month period. I have taken the figure of minus £248K from the summary of debtors.    [Back]

Note 2   In the management accounts this figure is different from the amount in paragraph 2(5).    [Back]