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Weed Control Ltd v Revenue & Customs [2007] UKVAT V20101 (12 April 2007)

20101

VAT Default surcharge - section 59 VATA - Reasonable excuse - section 71 VATA

LONDON TRIBUNAL CENTRE

WEED CONTROL LIMITED Appellant

- and -

THE COMMISSIONERS FOR HER MAJESTY'S

REVENUE AND CUSTOMS Respondents

Tribunal: Charles Hellier (Chairman)

Sheila Wong Chong FRICS

Sitting in public in Bristol on 16 January 2007

Tim Cordell, Director of the Appellant for the Appellant

Pauline Crinnion instructed by the Acting Solicitor for HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2007

DECISION

Weed Control Ltd appeals against a default surcharge in respect of the period ending 30 April 2006 (the 04/06 period) of £9,751.86 being 15% of the VAT due in respect of that period.

We heard oral evidence from Mr Cordell and from Karen Cordell (who is another director of the Appellant and Mr Cordell's wife). We also had before us copies of the Appellant's and Mr Cordell's bank statements, letters from his bank and copies of correspondence between the Appellant and the Respondents.

From the evidence before us we find the following facts:

(1) Weed Control Ltd carries out ground maintenance contract work for electricity supply companies, local authorities and other large companies. Over the last 5 years the majority of its work has been done for Central Networks in the midlands and another electricity supply company in the South East.

(2) In 1992 Karen Cordell and David Singer formed a partnership which commenced the business now undertaken by the Appellant. At that time they were married to each other.

(3) Karen Cordell and David Singer separated in 2003 and were later divorced. There was some acrimony in their separation and divorce, although more recently they have found a way of getting along together without significant dispute.

(4) Following their separation and divorce Karen Cordell ceased to be involved in the detail of the running of the business and to attend the business's offices. This continued from 2003 until about May 2005. In that period she retained her financial interest in the business, received occasional news of its progress, signed, various forms relating to it and received income from the business.

(5) On 1 January 2004 the business was transferred to, and thereafter continued by, the Appellant. Karen Cordell and David Singer each held 50 per cent of the share capital of the Appellant and were appointed directors of the Appellant. Karen Cordell signed, on behalf of the Appellant, its VAT registration application.

(6) In the middle of 2004 John Wright was appointed managing director of the Appellant. He remained managing director until October 2006 when he was dismissed.

(7) Between 2003 and 2005 David Singer and a girlfriend acquired and took over the management of a pub. Karen Cordell provided a guarantee of David Singer's borrowings for the pub. The pub venture was not a success. The guarantee was called and Karen Cordell stumped up £30k. It appears to be the case that in this period David Singer borrowed some £65k from the business (initially from the partnership and later from the company).

(8) In September 2004 Central Networks cancelled its contract with the Appellant. The Appellant's contract was however reinstated in March 2005. The Appellant's monthly income from Central Networks was some £50k. In the period from September 2004 to March 2005 it therefore lost some £300k of turnover. 13 men were made redundant.

(9) The Appellant's VAT return for the quarter 01/05 and its VAT payment for that quarter were received 16 days after the due date. The Appellant received a Surcharge Liability Notice from the Respondents in respect of that period (we shall return below to the effect of such notices).

(10) The Appellant's VAT return for the quarter 04/05 and its VAT payment for that quarter were received 17 days late on 17 June 2005. The Appellant was assessed to a 2% surcharge of £407.61 and received a VAT surcharge extension notice from the Respondents.

(11) In the relevant period the company's finance manager was Janet Biss. She had authority to sign cheques on behalf of the company, and would have signed the cheques for the payment of the 04/05, 07/05, and 01/06 default surcharges. She also prepared the VAT returns taking the information from the company's SAGE accounting system, Karen Cordell signed the returns in the relevant period.

(12) In May 2005 Karen Cordell was asked to attend a meeting at the Appellant's offices to discuss its financial situation. Her expertise was in financial matters and cash flow forecasts were needed. Over the following months she became acquainted again with the detail of the financial situation of the business and its conduct prior to May 2005.

(13) Whereas the accounts for the year to July 2004 showed a profit, those for the year to July 2005 showed a £58k loss reflecting in large part the loss of the loss of the Central Networks income for 6 months of that year and set up costs for a new contract in Swindon.

(14) We did not ask when Karen Cordell married Tim Cordell but by 2004 we find that they were together. From that time onwards Mrs Cordell related her knowledge of the business to Mr Cordell. She was aware in September 2004 that the Central Networks contract had been lost and that the Appellant had cash flow difficulties. Her income depended to some extent on the continuation of the business. Between August 2004 and April 2006 Mr Cordell lent some £45k to the Appellant. Since then he has lent a further £25k or thereabouts.

(15) The Appellant held its bank account with Lloyds TSB. Mr Cordell also had an account at Lloyds TSB. Transfers of funds were made from Mr Cordell's account to the Appellant's account when Mr Cordell made loans to the Appellant.

(16) The Appellant's VAT returns and VAT payments were late for the 07/05 and 01/06 quarters. Surcharges of 5% and 10% (respectively £1,812.28 and £6,594.95) were assessed in respect of these periods and further surcharge liability extension notices served.

(17) It appears that John Wright did not disclose these or the earlier default surcharges to the other directors of the company, Karen Cordell and David Sergeant.

(18) In May 2006 Tim Cordell was appointed a director of the Appellant. He and Karen Cordell had at around this time an informal arrangement with the Lloyds bank manager under which if the bank would be about to refuse to pay a direct debit the manager would phone Mrs Cordell and sums could be transferred from Mr Cordell's account with normally his oral authority.

(19) In January 2006 Central Networks became somewhat erratic in their payments. Hitherto they had paid fairly regularly on about the 3^rd of each month but:

(i)	the payment for	January	was made on	31 January 2006
(ii)	"	February	"	19 April 2006
(iii)	"	March	"	3 March
(iv)	"	April	"	3 April
(v)	"	May	"	23 May
(vi)	"	June	"	after 14 June

(20) Thus between 3 February 2006 and 19 April 2006 the Appellant was £48k short and between 3 May 2006 and 23 May 2006 £49k short, of its normally expected cash position. And between 3 June and 14 June short by a similar amount. No explanation was received from Central Networks for the delay despite requests.

(21) The Appellant's bank permitted it a formal overdraft limit of £75,000 in the relevant periods. However, the bank allowed the Appellant to exceed that limit by up to £42k - on one occasion taking the overdraft to £117k - in the first half of, 2006. The overdraft was secured in part by shareholders guarantees.

(22) The Appellant's VAT payment for 04/06, the quarter under appeal, was due to be taken by direct debit from its account on 12 June 2006. The payment was for £65,012.43; the overdraft at the beginning of the day was £51,026.21. If it had been paid the overdraft would have been some £116k. The bank refused to pay the direct debit. Although there was more than £30,000 in Mr Cordell's account with the bank, which, if transferred to the Appellant would have brought the overdraft to £86,000, the bank manager was away for the day and the bank did not contact either Karen Cordell or Tim Cordell.

(23) That VAT payment was eventually made on 23 June 2006.

(24) On 16 June 2006 the Respondents issued an assessment for a VAT surcharge of 15% of £65,012, being £9,751.86. This is the surcharge which is the subject of this appeal. The letter was received by the Appellant on 20 June 2006.

(25) On 6 or 7 July 2006 there was a directors' meeting. Apparently it was the first formal directors' meeting since Tim Cordell's appointment. Janet Biss approached Karen Cordell and showed her the assessment notice asking what she should do about it. It was the first Karen Cordell had heard about the surcharge.

(26) The Appellant's accounts for the year to July 2006 showed a profit of £25k.

(27) We noted above that John Wright was dismissed on 9 October 2006. The stated grounds for his dismissal were that he had been guilty of gross misconduct in the following respects:

(i) that he had failed properly to manage a contract with Scottish & Southern Energy plc;

(ii) that he had bullied employees;

(iii) that he had failed properly to report health and safety issues;

(iv) that he had refused to cooperate with, and carry out instructions of, the Board; and

(v) that he had failed to report the cash flow difficulties of the company to the directors including the VAT surcharges noted above.

Relations with Mr Wright have since deteriorated and there have been allegations made that he stole company documents. These allegations were investigated by the police and, we were told, the investigation involved his arrest.

The Parties' contentions

Mr Cordell argued that the Appellant had a reasonable excuse for the late payment of VAT for 04/06. He said that there was no one circumstance which constituted that excuse but three circumstances which, taken together, were properly to be regarded as a reasonable excuse for the default.

The first circumstance was the delayed and erratic payment by Central Networks. He says that for 8 years Central Networks had been excellent regular payers: that was shown by the bank's acquiescence to the overdraft exceeding the agreed limit by £30k. Until early 2006 Central Networks had regularly paid on the 3^rd - 5^th of each month. Central Network's delay was beyond the Appellant's control: they could not dictate to a multinational enterprise. If Central Networks had made its June payment even just 7 days later, (on 10 June rather than 3 June), the VAT payment would have been made on time. The late payment was beyond the Appellant's control and not within reasonable contemplation.

The second was the John Wright situation. Although the Respondents might say that because John Wright knew about the defaults in VAT payment, the penalties, the notices and the cash position of the company; the company did not have a reasonable excuse; Mr Cordell says that Mr Wright was corrupt, dishonest, threatening to staff, and a man who covered up and hid the facts from the other directors. That he said was something beyond the Appellant's control and which the Appellant and its other directors could not stop until they had found out about it. This was not just reliance on any old employee: this was trust in the top man - misplaced trust in a person whom it was reasonable to trust; but trust in a person who frightened his staff into silence and was dishonest.

The third circumstance was the arrangements which he and the Appellant had with the bank. It was reasonable for the Appellant to have expected the bank to seek a transfer of funds from Mr Cordell's account which, when taken with the latitude allowed over its overdraft limit, would have enabled the VAT to have been paid. The bank manager had been out of the office on that day and a decision had been taken to refuse the direct debit without contacting Mr or Mrs Cordell. That was something outside the company's control which it could not reasonably be expected to guard against. The refusal of the direct debit was not properly to be regarded as being the company's fault.

Lastly, Mr Cordell submits that the 15% surcharge is disproportionate. He notes the common law position that a penalty clause in a contract may be unenforceable if it is not a genuine attempt to quantify the damage caused by a breach. He asks whether £9,751 is a proportionate penalty for being 23 days late in paying £65,000. He says the existence of a warning procedure (the notices and the escalating penalty regime) cannot turn something disproportionate into something proportionate: if someone told you they were about to punch you before doing so it would make it legal.

Mrs Crinnion notes that the company through its managing director, John Wright, and its employees were aware of the company's cash position and of the previous default surcharges. Even if the other directors had not been informed of the surcharges and the cash position, the company knew of these circumstances through the managing director and the other employees. The company could not avoid liability by saying that it had relied on these people to manage the company's affairs so as to avoid the surcharges.

Neither was the insufficiency of funds permitted to constitute a reasonable excuse. Nor could it fairly be said that the bank's actions or inactions afforded a reasonable excuse: the managing director and the finance manager knew of the company's financial state. They must have been aware of the possibility that the direct debit would be refused. They could have contacted the bank. Indeed they should have contacted the bank. It was not simply that the bank had failed to contact Mr or Mrs Cordell: and, because it was reasonable to expect the company's managing director and finance manager to speak to the bank, it could not be said that the bank's inaction afforded a reasonable excuse.

So far as concerns the issue of the proportionality or legality of the default surcharge, Mrs Crinnion referred us to the decision of the tribunal in Greengate Furniture Ltd (Decision 18280). The default surcharge provisions she said were clearly set out in section 59 VATA 94 and the tribunal could not choose to ignore or vary them.

Lastly, Mrs Crinnion noted that the cash flow problems caused by the erratic Central Networks payments had not been raised by the Appellant in correspondence with the Commissioners prior to the hearing. Mr Cordell explained that this was because they had understood that shortage of funds could not constitute a reasonable excuse. It had only been in the days before the hearing that, with some internet research they had realised that the reason for a shortage could constitute a reasonable excuse. We accept that.

The Law

Section 59 VATA 1994 prescribes the default surcharge regime. Where a person fails to deliver a VAT return or to pay the VAT due on time he is regarded as being in default (sub-section (1)). Following a default the Commissioners may service a surcharge liability notice which prescribes a period of 12 months from the end of the period of the default. A subsequent default in that period triggers both an extension of the period (by a surcharge liability extension notice (sub-section (3)), and a default surcharge. The default surcharge is 2%, 5%, 10%, or 15% of the late paid VAT for the period of the relevant subsequent default depending upon whether the default is the first, second, third or subsequent default in the period created by those notices (sub-section (5)).

Section 59(7) 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—

(a) the return or, as the case may be, the VAT shown on the return was dispatched at such a time and in such a manner that it was reasonable to expect that it would be received by the Commissioners within the appropriate time limit, or

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

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)."

But section 71(1) VATA 1994 provides:

"(1) 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."

In C&E Commissioners v Steptoe [1992] STC 757, the Court of Appeal affirmed that the effect of section 71(1) was to prevent lack of funds on its own being a defence to a default, but did not prevent the reasons for the insufficiency of funds constituting a reasonable excuse if properly those reasons could be so regarded.

In C&E Commissioners v Salevon 1989 STC 907, Nolan J considered two tribunal decisions relating to reasonable excuse. In the first case the dishonest concealment by a company secretary of the fact that £24,000 had not been paid led in the circumstances of that case to a shortfall in the available funds of the company. The tribunal had held that the real cause of the later default by the company in paying its VAT on time had been the dishonest conduct of the former company secretary. Nolan J commented that the "initial shortfall of £24,000 was no doubt totally unforeseen and unforeseeable, and thus potentially acceptable without too much difficulty as affording a reasonable excuse for the non-payment of the tax."

In the second case the taxpayer relied upon an accountant to effect the VAT regulation and compliance of their business. The accountant let them down. Nolan J noted that apart from the provisions of what is now section 71, that would have been a perfectly reasonable excuse for the taxpayers' failure, but that section 71 prevented them from invoking it because they had relied on the accountant to advise them and effect their VAT compliance and he had been inaccurate in his advice and dilatory in performing the tasks entrusted to him: "Hard as it seems in the circumstances… Parliament has deprived [the taxpayers] of their defence of a reasonable excuse."

The important difference between the two cases is that it appears that in the first case the taxpayer's excuse was not founded upon having relied upon the company secretary to perform a task, but on the fact that a dishonest concealment from the purchase of the company of its true position had resulted in less funds being available; whereas in the second case the default was a direct consequence of the reliance upon the delusiveness and inaccuracy of the accountant.

In Greengate Furniture Ltd the Tribunal heard full argument on the question of the proportionality under the European Convention on Human Rights and under Community Law of certain default surcharges. The Tribunal concluded that the default surcharge system could not be said to be devoid of reasonable foundation or "not merely harsh but plainly unfair", and thus that the tribunal could not interfere with the imposition of the penalty on the grounds of proportionality.

Discussion

We note that whereas Karen Cordell had only limited knowledge of the operation of the business prior to May 2005, after that date she became progressively further involved. We found her able, and could easily accept that she had financial expertise which could be turned to account in the running of the business.

The Activities of John Wright

In relation to his activities we start from the proposition that this is the appeal of the company, not that of its directors or owners. The company relied upon John Wright to manage its affairs and he managed them badly. In Steptoe Scott LJ noted in relation to paragraph (b) of section 71 that it was plain that a failure by a person relied upon cannot by itself constitute a reasonable excuse, but that it was also plain that, provided the failure was due to something other than dilatoriness or inaccuracy, the reason for the failure could be put forward as a reasonable excuse.

What part did Mr Wright play in the failure to pay the 04/06 VAT payment in time? His failure properly to manage the Scottish & Southern contract may have contributed to the shortage of funds, he failed to take steps to deal with the cash flow problems of the company, he specifically failed to ensure that VAT payments were made on time even after the initial penalties, and he failed to ring the bank in June to check that the VAT direct debit would be paid.

But these were failures of a man the Appellant relied upon. If there was a reason for the failure (because he was ill for example) then we could look behind the reliance. But [we] are not convinced that mere incompetence or awkwardness of the person relied upon is enough. There is a difference between a loss because of a fraud - where the loss is not truly by reason of the reliance upon another person but by reason of his act, and a loss because of a failure of a person to perform a task he was relied upon to perform. Mr Wright's failures seem to us to fall into the latter category and to be barred from supporting a reasonable excuse.

In our view, properly construed, the effect of section 71 is that if two or more reasons are being relied upon together as constituting a reasonable excuse, even if none of them on their own do, then even though literally section 71 might be read as referring to the whole of the circumstance of the suggested excuse, its effect properly construed is to bar any one of those reasons if it falls within section 71 from forming any part of the circumstances which might otherwise suggest a reasonable excuse.

The Central Networks' Payments

The company knew the state of its bank balance. It can reasonably be assumed that it knew that the VAT payment would have breached its overdraft limit. It did nothing to prevent that occurring.

The Central Networks' payments for February and May had been unexpectedly late. The company could reasonably be expected to have worried about and looked out for the arrival of the June payment, and could reasonably have been expected to make contingency arrangements such as contacting its bank in advance in case it was late. It did not.

If the Central Networks' payment had always come in on the 3^rd of the month, but wholly unexpectedly did not in June; if the company had chased Central Networks in early June and had contacted its bank to extend its overdraft facility but had failed to be able to do so in the time available, then this could be a reasonable excuse or at least good grounds for one. But in the circumstances of the Appellant it does not seem to us that the factors surrounding the Central Networks' payments can be, or can support, a reasonable excuse.

The Arrangements with the Bank Manager

The essence of this reason is that the company through Mr and Mrs Cordell relied upon the bank manager to perform a task, namely to telephone them when a direct debit might be returned so that arrangements could be made to put the company in funds. The bank manager failed to perform that task.

It seems to us that those reasons cannot support a reasonable excuse because of section 71(1)(b). What is put forward is merely reliance on the manager to perform a task. It was not being said that he had failed because he had a heart attack that morning but simply that he failed to do something which had been relied upon.

Conclusion - Reasonable Excuse

It seems to us that taking all the circumstances into account the company does not have a reasonable excuse:

(i) the Central Networks delayed payment could, but does not in the circumstances support a reasonable excuse;

(ii) the facts of reliance on Mr Wright and his failures cannot be added to the balance to explain and excuse the inescapable effect of the circumstances in (i) and leave our conclusion in relation to it unaffected; and

(iii) the failure of the bank manager to contact Mr and Mrs Cordell cannot be taken into account to support their excuse.

That leaves the proportionality point raised by Mr Cordell, and the decision in Greengate Furniture. Mr Cordell did not have the opportunity to read that issue to develop his arguments on this issue. It is only fair that he should have an opportunity to argue the issue, and that we should not decide the point without giving that opportunity. Nevertheless, we should say that we find the reasoning in Greengate Furnishing very persuasive.

We therefore DIRECT that if before 30 April 2007 the Appellant gives written notice to the Respondents and the tribunal centre that it wishes to pursue an argument based on proportionality then a date be fixed to give further direction for the hearing of the appeal in relation to that issue.

But if no such notice is given, then we dismiss the appeal.

Charles Hellier

CHAIRMAN

RELEASE DATE: 12 April 2007

LON/2006/124