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Welshback Exercise Ltd v Revenue & Customs [2007] UKVAT V20310 (16 August 2007)

20310

VAT – FLAT RATE SCHEME – Retrospective withdrawal of authorisation – associated with another company – whether Appellant and another company closely bound to one another by financial, economic and organisational links – satisfied that Respondents' decision reasonable – assessment reasonable – Appeal dismissed

LONDON TRIBUNAL CENTRE

WELSHBACK EXERCISE LIMITED Appellant

- and -

HER MAJESTY'S REVENUE and CUSTOMS Respondents

Tribunal: MICHAEL TILDESLEY OBE (Chairman)

GEORGE MILES (Member)

Sitting in public in Bristol on 5 July 2007

John R Wells, director, for the Appellant

Johnathan Holl , advocate for HM Revenue & Customs, for the Respondents

© CROWN COPYRIGHT 2007

DECISION

The Appeal

The Appellant was appealing against the Respondents' decision dated 4 August 2006 withdrawing authorisation to use the flat rate scheme for the VAT periods from 1 January 2005 to 30 June 2006. As a result of this decision on 11 December 2006 the Respondents issued an assessment for unpaid VAT in the sum of £21,489 and a misdeclaration penalty dated 19 January 2007 in the sum of £2,462.

The Appellant's Notice of Appeal of 1 November 2006 predated the issuing of the assessment and the penalty. The statement of case, however, treated the Notice as an appeal against the three decisions. The Tribunal did likewise particularly as the assessment and the penalty were the consequences from the Respondents' decision withdrawing the Appellant from the flat rate scheme. It also avoided the problem of the Appellant being out of time in respect of any new Notice of Appeal against the assessment and penalty.

The Appellant's ground of appeal was that

"I disagree with the interpretation made by the officer with regard to the close financial and economic links. I was not given an opportunity to give more information. WB Clubs Ltd as a supplier has treated an independent company in an identical manner".

The Issue in Dispute

The Appellant traded as "The Downs Club" carrying on business as an exercise club. The Respondents contended that the Appellant was associated with WB Clubs Limited, and, therefore, ineligible to join the flat rate scheme. The Respondents backdated their decision to withdraw the Appellant from the scheme to the date of its admission, which was on 1 January 2005. The Appellant submitted that it was an independent and separate company from WB Clubs Limited. Further the companies were not closely bound to one another by financial, economic and organisational links. The Appellant challenged whether the Respondents had lawful authority to backdate their decision to the date of its admission to the scheme.

Under section 84(4ZA) of VATA 1994 our powers on Appeal are limited to considering the reasonableness of the Respondents' decision to withdraw the Appellant from the flat rate scheme backdated to the date of admission. We are not permitted to substitute our own judgment for that of the Respondents. The issue for the Tribunal was whether the Respondents' decisions to withdraw and backdate were decisions which no reasonable body of Commissioners could have arrived at. In order for the decisions to be reasonable the decision maker must have considered all relevant matters and must not have taken into consideration irrelevant matters.

The Law

The flat rate scheme was introduced with effect from 25 April 2002. The scheme is a simplification measure, allowing taxpayers within specific turnover limits to pay VAT as a percentage of turnover instead of working out the VAT on sales and purchases (normal accounting). The taxpayer applied to join the scheme.

The legislative authority for the scheme is section 26B of VATA 1994 which enables the Respondents to make regulations dealing with the operation of the scheme. The relevant regulations are 55A to 55V of the VAT Regulations 1995. The Respondents have issued VAT Notice 733 which gives practical guidance on the workings of the scheme but carries no force in law.

The relevant regulations or parts of them for this Appeal are:

Regulation 55A(2) provides

For the purposes of this Part of the regulations (our italics), a person is associated with another person at any time if that other person makes supplies in the course or furtherance of a business carried on by him, and

(a) the business of one is under the dominant influence of the other, or

(b) the persons are closely bound to one another by financial, economic and organisational links.

Regulation 55L (Admission to Scheme) provides

(1) A taxable person shall be eligible to be authorised to account for VAT in accordance with the scheme at any time if –

(d) he is not, and has not been within the past 24 months -

(iii) associated with another person

Regulation 55M (Withdrawal from the scheme) provides

(1) Subject to paragraph (2) below, a flat rate trader ceases to be eligible to be authorised to account for VAT in accordance with the scheme where -

(f) he becomes –

(iii) associated with another person

(h) his authorisation is terminated in accordance with regulation 55P below.

Regulation 55P (Termination by the Commissioners) provides

The Commissioners may terminate the authorisation of a flat rate trader at any time if

(a) they consider it necessary to do so for the protection of the revenue

(b) a false statement was made by, or on behalf of, him in relation to his application for authorisation.

Regulation 55Q (Date of withdrawal from the scheme) provides

(1) The date on which a flat rate trader ceases to be authorised to account for VAT in accordance with the scheme shall be

(c) where regulation 55M (1)(c), (d) or (f) applies, the date the event occurred.

(f) where regulation 55M(1)(h) applies, the date of issue of a notice of termination by the Commissioners or such earlier or later date as may be directed in the notification.

Section 83(fza) of VATA 1994 gives the taxpayer a right of appeal to the Tribunal in respect of a decision of the Commissioners refusing or withdrawing authorisation to use the flat rate scheme. Under Section 84(4ZA) of VATA 1994 the Tribunal's jurisdiction on such appeals is limited to examining the reasonableness of the Commissioners' decision. Section 84(4ZA) provides

"Where an appeal is brought –

(a) against such a decision as is mentioned in section 83(fza), or

(b) to the extent that is based on such a decision, against an assessment,

the tribunal shall not allow the appeal unless it considers that the Commissioners could not reasonably have been satisfied that there were grounds for the decision."

The Evidence

We heard evidence from Mr John Wells, a director, for the Appellant. Mr Nicholas Hart, the assessing officer, and Mr Les Bingham, the review officer, gave evidence for the Respondents. A bundle of documents was supplied at the hearing.

Background

The Appellant carried on business as an exercise club from premises in Bristol under the trading name of "The Downs Club". The Appellant was registered for VAT with effect from 1 September 2003.

The directors of the Appellant were Mr and Mrs Wells and their daughter, Mrs Katherine Murphy. Mr and Mrs Wells were the shareholders, holding one share each with equal voting rights. Mrs Wells also acted as company secretary.

The shareholders of WB Clubs Limited were Mr and Mrs Wells, holding one share each with equal voting rights. Mr Wells was the sole director with Mrs Wells as company secretary. The principal source of income for WB Clubs Limited was rent from premises and the leasing of gym equipment. WB Clubs Limited owned three premises. WB Clubs Limited leased one of its premises and gym equipment to the Appellant. A member owned and managed company operating as the "Welsh Back Squash and Health Club" rented another of the Appellant's premises.

The Appellant's VAT 1 dated 27 October 2003 declared that one of its directors was involved in the running of WB Clubs Limited.

On 12 July 2004 the Appellant applied to use the flat rate scheme. On 19 July 2004 the Respondents sought clarification of the Appellant's relationship with WB Clubs Limited. The Appellant did not respond with the result that the Respondents refused the Application on 17 August 2004.

On 10 March 2005 Mr Wells responded on behalf of the Appellant to the query about its relationship with WB Clubs Limited. Mr Wells stated that he was employed by WB Clubs Limited. He was the sole director of WB Clubs Limited, which he controlled. Further the Appellant and WB Clubs Limited did not trade together or form part of a trading group and neither was a subsidiary of the other. Mr Wells also disclosed that he was one of the three directors of the Appellant which he did not control. Mr Wells requested reconsideration of the decision refusing authorisation of the Appellant's application to join the flat rate scheme.

On 16 March 2005 the Respondents permitted the Appellant to use the flat rate scheme with a flat rate percentage of 5.5 per cent.

On 10 July 2006 Mr Hart carried out a routine inspection of the Appellant's business records and accounts. He discovered some accounting errors which were not disputed by the Appellant. Mr Hart was also concerned about the Appellant's relationship with WB Clubs Limited but delayed judgment on this issue until after his inspection of the business records for WB Clubs Limited.

On 4 August 2006 Mr Hart informed the Appellant that he was withdrawing the Appellant's authorisation to use the flat rate scheme. Further he ruled that the Appellant was never eligible to use the scheme, and was, therefore, backdating his decision to the 1 January 2005. As a result of his ruling the Appellant was required to account for VAT under normal accounting rather than under the flat rate scheme from 1 January 2005. Mr Hart requested the Appellant to supply a schedule of output and input tax for the periods 03/05 to 06/06.

On 31 August 2006 the Appellant requested a review of Mr Hart's decision. Mr Bingham carried out the review and confirmed Mr Hart's decision in a letter dated 13 October 2006.

On 7 November 2006 Mr Hart repeated his request for the schedule of output and input tax. As no schedule was forthcoming Mr Hart wrote to the Appellant explaining how he would calculate the VAT under declared for the periods 03/05 to 06/06. On 11 December 2006 Mr Hart issued an assessment in the sum of £21,489. On 19 January 2007 a misdeclaration penalty was also issued in the sum of £2,462. Mr Hart mitigated the penalty by 25 per cent to reflect the amount of co-operation provided by the Appellant.

Mr Hart's decision of 4 August 2006

Mr Hart decided that the Appellant was not eligible to use the flat rate scheme because of its association with WB Clubs Limited. He, therefore, withdrew the Appellant's authorisation to use the flat rate scheme. Mr Hart considered that the Appellant had close financial and economic links with WB Clubs Limited which included loans and the waiver of lease and rental charges by WB Clubs Limited.

Mr Hart relied on the following facts in reaching his decision to withdraw authorisation:

(1) The Appellant was the management company for the gym. WB Clubs Limited owned the assets and the equipment.

(2) WB Clubs Limited leased the gym equipment and the property to the Appellant. WB Clubs Limited had collected no rent and no charges for the property and the equipment from the Appellant. WB Clubs Limited would recoup this income once the Appellant became commercially viable.

(3) WB Clubs Limited collected direct debit membership fees on the Appellant's behalf, which was then repaid to the Appellant, either weekly or monthly, plus a bit extra to help the Appellant with its cash flow and bank balance. The Appellant was unable to set up a direct debit arrangement with its bank, and, therefore, reliant on WB Clubs Limited for this facility.

(4) WB Clubs Limited often bought goods and consumables for the Appellant, posting the expenditure to a loan account with no expectation of repayment.

(5) The entry described as "Downs Running Costs" in the accounts of WB Clubs Ltd for year ending 31 December 2004.

Mr Hart insisted that he applied the correct test of close organisational, financial and economic links despite using the word or instead of and in his decision letter dated 4 August 2006. Mr Bingham repeated the same mistake in his review letter dated 13 October 2006. According to Mr Bingham the Respondents' procedural guidance contained the word or which was the reason for the error in the letters.

Mr Hart concluded that the Appellant had close organisational links with WB Clubs Limited following his initial visit to the Appellant because they had the same shareholders with Mr Wells holding directorships in each company. He also considered that it was Mr Wells' vision of small neighbourhood fitness clubs which defined the way the Appellant ran its business. Mr Hart formed the view that the close organisational link between the two companies operated at the strategic level with Mr Wells setting the strategic direction for both companies.

After the visit to the Appellant Mr Hart did not have enough information about the close financial and economic links between the two companies, which was one of the reasons for conducting an inspection of WB Clubs Limited accounts and VAT records. He was satisfied from the accounts that WB Clubs Limited made loans to the Appellant. Also WB Clubs Limited paid a global sum to the Appellant in respect of the direct debit membership fees which were debited to WB Clubs Limited bank account. The global sum generally exceeded the amount collected by direct debit, with the excess being used to ease the Appellant's cash flow. Based on this extra information Mr Hart was satisfied of the existence of close financial and economic links between the two companies as well as the close organisational links. He decided that the Appellant could not function without the assistance from WB Clubs Limited.

Mr Hart considered that the association between the two companies existed on 1 January 2005 when the Appellant was first authorised to use the flat rate scheme. He noted that an entry described as the Downs running costs appeared in the accounts for WB Clubs Limited year ending 31 December 2004. Mr Hart decided that the Appellant was never eligible to operate the flat rate scheme. In those circumstances Mr Hart applied the Respondents' policy as set out in paragraph 8.4 of Public Notice 733 Flat Rate Scheme for Small Businesses which was to backdate the withdrawal of the Appellant's authorisation to the date when it first used the flat rate scheme, namely 1 January 2005.

Mr Hart cited regulation 55P of VAT Regulations 1995 as the authority enabling the Respondents to withdraw authorisation to use the flat rate scheme. Later in his decision letter Mr Hart referred to regulation 55M(1)(f) which provides a separate ground for the withdrawal of authorisation.

Regulation 55P gives two grounds for terminating authorisation, protection of revenue or making a false statement. Mr Hart and Mr Bingham considered that Mr Wells' letter dated 10 March 2005 which persuaded the Respondents to authorise the Appellant's use of the scheme did not supply a full account of the association between the two companies, and in that respect amounted to a false statement.

Mr Hart calculated the assessment for unpaid VAT from the Appellant's VAT records. He assessed the output tax from the gross figures previously declared on the Appellant's VAT returns from 03/05 to 09/06. The figure for input tax was arrived at by examining the Appellant's input tax claims in the period before admission to the flat rate scheme (01/09/03 to 31/12/05) which produced an average of £556 per quarter for input tax. Mr Hart was then able to assess the quarterly VAT by deducting £556 from the output tax computed from the quarterly gross figures. Mr Hart gave Mr Wells several opportunities to supply the actual figures for the periods in question, which were not taken up by Mr Wells.

The Appellant's Evidence

Mr Wells explained that the Appellant provided a small neighbourhood exercise club, which was friendly and service driven. As a neighbourhood club most of its members would be expected to live or work within walking distance of the club. The focus of the club was getting members to exercise for health benefits. The regime for the club was based on the programme advocated by Arthur Jones Nautilus which was widely used in the USA.

Mr Wells described the current state of the fitness industry in the United Kingdom. He stated that it was following the pattern established in the USA of being dominated by a few multi-sited operators which required large premises with a focus on sales. Mr Wells viewed the Appellant as a break from the current set up for fitness clubs. He wanted to test whether the model of neighbourhood service driven fitness clubs would become profitable by finding a niche in the market.

When the Appellant was established Mr Wells anticipated that it would take one year for the Appellant to break even with good profitability in the second year. The reality was that after four years of trading the Appellant had not broke even. The Appellant survived by not paying the rent and leasing charges due to WB Clubs Limited.

Mr Wells explained that WB Clubs Limited took a business decision not to collect the rent and leasing charges from the Appellant. The option of evicting the Appellant from the property would result in considerable additional costs for WB Clubs Limited because it would take over responsibility from the Appellant for the upkeep of the premises and the maintenance of the equipment. Mr Wells explored alternative uses for the building which were rejected on the grounds of extra cost for alterations and the time required to supervise the alterations. According to Mr Wells WB Clubs Limited had also discounted the rent and leasing charges due from Welsh Back Squash and Health Club which occupied another premises owned by WB Clubs Limited which enabled the Squash and Health Club to continue in business.

Mr Wells ran WB Clubs Limited. He took the decision to waive the rent and the leasing charges due from the Appellant. There were no board minutes of WB Clubs Limited recording his decision releasing the Appellant from its obligations. Mr Wells did not know the existence of any documents which set out the terms of the Appellant's occupation of WB Clubs Limited premises and the charges paid by the Appellant for the leasing of the gym equipment.

Mr Wells stated that the Appellant relied upon WB Clubs Limited to provide it with direct debit and credit card facilities because its bank did not consider the Appellant suitable to have access to these facilities. Under this arrangement WB Clubs Limited was the recipient of the Appellant's membership subscriptions, which were then transferred as a global sum to the Appellant's bank account. The direct debit mandate completed by the members of the Appellant's club did not state that WB Clubs Limited was collecting the subscriptions as the Appellant's agent.

Mr Wells denied that WB Clubs Limited was subsidising the Appellant's activities. He disagreed with Mr Hart about the existence of loans made by WB Clubs Limited to the Appellant. Mr Wells considered that Mr Hart misinterpreted the entry of operating costs (Downs) in the management accounts of WB Clubs Limited as a loan. Mr Wells, however, stated that the operating costs (Downs) formed part of WB Clubs Limited operating costs in its accounts.

Mr Wells stated that he was not involved in the day-to-day running of the Appellant's club which was undertaken by a club manager who was supervised part-time by Mrs Murphy in her capacity as director. Mr Wells did not keep the Appellant's accounts, although he signed the Appellant's return for Companies House and its VAT return. Mr Wells had considerable experience in the leisure industry which meant that the Appellant's managers used him as a sounding board about the strategic direction for the business. The managers could reject his advice. Mr Wells described his role for the Appellant as a consultant and a non-executive director. Mr Wells asserted that if he got involved with the day-to-day management of the Appellant club, it would skew the model of a neighbourhood service driven leisure facility which would defeat the rationale for the Appellant's business. Mr Wells, however, acknowledged that only his wife and he held the voting rights as shareholders of the Appellant.

Mr Wells considered his letter of 10 March 2005 to be factually correct and did not amount to a false statement. He acknowledged that the letter did not spell out his directorship of the Appellant.

Mr Wells believed that the Respondents' action in withdrawing their authorisation for the Appellant to use the flat rate scheme was not in the public interest. The VAT assessment would push the Appellant into liquidation with the loss of ten jobs. The local community would be deprived of a neighbourhood service driven leisure facility. The Respondents would be denied revenue from the Appellant's future tax receipts. Mr Wells considered the Respondents' action to be highly prescriptive which did not take into account the bigger picture of the effect on the Appellant and the public.

Reasons for Our Decision

Our jurisdiction in this Appeal is limited to considering the reasonableness of the Respondents' decision to withdraw the Appellant from the flat rate scheme backdated to the date of admission. We are not permitted to substitute our own judgment for that of the Respondents. Mr Hart's decision of 4 August 2006 comprised four elements which were sequentially dependent upon each other, namely:

(1) Whether the Appellant was associated with WB Clubs Limited in that they were closely bound to one another by financial, economic and organisational links?

(2) Whether Mr Hart's decision to withdraw the Appellant from the flat rate scheme with effect from date of admission was reasonable in the sense that he had regard to relevant matters and disregarded irrelevant matters?

(3) Whether there were reasonable grounds for raising an assessment for unpaid VAT against the Appellant, and if so the correctness of the assessment?

(4) Whether the legal requirements for issuing a misdeclaration penalty were met, and if so whether there were grounds for finding a reasonable excuse or mitigating the penalty?

Whether the Appellant was associated with WB Clubs Limited?

Mr Wells contended that the Appellant was a separate legal entity and operated at arms length from WB Clubs Limited. In Mr Wells' view the Appellant was not closely bound to WB Clubs Limited by financial, economic and organisational links. The Respondents, on the other hand, submitted that Mr Hart gave clear cogent evidence of the close links between the two companies. His finding that the Appellant was associated with WB Clubs Limited was reasonably arrived at.

Under our limited jurisdiction of section 84(4ZA) of VATA 1994 we are required to examine anew the relevant facts and circumstances of the Appeal in order to decide the reasonableness of the Respondent's decision about the weight given to relevant and irrelevant considerations. We make the following findings of fact:

(1) The Appellant and WB Clubs Limited had the same shareholders.

(2) Mr Wells effectively ran WB Clubs Limited. He was the sole decision maker for the company. Mr Wells took the decision to waive payment of the rent and leasing charges by the Appellant, which was not recorded in board minutes of WB Clubs Limited.

(3) Although Mr Wells sought to distance himself from the management of the Appellant company, we are satisfied that Mr Wells exerted considerable influence on the strategic direction and the finances of the Appellant. The evidence demonstrated that Mr Wells' vision of a neighbourhood service driven fitness club based on a specific exercise regime defined the way that the Appellant operated its business. The financial survival of the Appellant was dependent upon Mr Wells waiving the rent and leasing charges due to WB Clubs Limited.

(4) WB Clubs Limited supplied the Appellant with the premises and gym equipment to carry out its business of a fitness club. WB Clubs Limited has never collected from the Appellant the rent for occupation of the property and the leasing charges for use of the equipment.

(5) Although WB Clubs Limited received no rent and leasing charges, it derived an economic benefit from the Appellant's occupation of the premises and use of the equipment. WB Clubs Limited avoided considerable additional costs by the Appellant assuming responsibility for the upkeep of the premises and maintenance of the equipment.

(6) The Appellant relied upon the direct debit and credit card facilities of WB Clubs Limited to collect membership subscriptions from its members which formed at least 90 per cent of the Appellant's income.

(7) The direct debit mandate for membership subscriptions required payment to be made to WB Clubs Limited. The mandate did not state that WB Clubs Limited was acting as the Appellant's agent. Thus as far as the members were concerned they were paying the subscriptions to WB Clubs Limited not the Appellant.

(8) WB Clubs Limited transferred the membership subscriptions to the Appellant's bank account by means of a global sum which did not correspond exactly with the value of the subscriptions.

(9) The Appellant's relationship with WB Clubs was not documented in respect of its occupation of the premises and the leasing of equipment.

(10) WB Clubs Limited subsidised the Appellant's business activities which was demonstrated by the entry of operating costs (Downs) in the management accounts of WB Clubs Limited and Mr Wells' admission that these costs were merged with the operating costs for WB Clubs Limited.

Our findings of fact confirm Mr Hart's conclusion that the Appellant was associated with WB Clubs Limited. The findings establish that there were close organisational links between the companies in that they had the same shareholders with Mr Wells playing a significant strategic role in both companies. The close financial links were evidenced by the financial dependency of the Appellant upon WB Clubs Limited which subsidised the Appellant's activities directly and indirectly by not collecting the rent and leasing charges. WB Clubs Limited also supplied the means (direct debit and credit card facilities) by which the Appellant collected its income. The Appellant had been denied these facilities by its bank. The companies shared close economic links, securing mutual benefits from their association. The financial support of WB Clubs Limited enabled the Appellant to continue in business. The Appellant's assumption of responsibility for the upkeep of the premises and gym equipment preserved the value of assets of WB Clubs Limited and in turn WB Clubs Limited avoided significant maintenance costs. The absence of documentation evidencing the relationship between the two companies, and the lack of transparency in their dealings, no board minutes, undermined Mr Well's assertion that the companies operated at arms length and enjoyed a normal business relationship.

We hold that the Appellant and WB Clubs Limited were closely bound by financial, economic and organisational links. Based on our findings we are satisfied that Mr Hart took account of relevant matters in arriving at his decision that the Appellant was associated with WB Clubs Limited and disregarded irrelevant matters. We, therefore, find that his decision regarding the Appellant's association with WB Clubs Limited was reasonable.

Decision to withdraw authorisation with effect from date of admission

Mr Hart formed the view that the Appellant was never entitled to use the flat rate scheme. The Appellant's association with WB Clubs Limited existed on 1 January 2005, the date of its admission to the scheme. In those circumstances Mr Hart was obliged to withdraw the authorisation from the Appellant to use the scheme since "association with another person" was a legal bar to joining the scheme. Mr Hart then applied his discretion to backdate the withdrawal to the date of the Appellant's admission to the scheme, namely 1 January 2005. The act of backdating gave rise to the assessment for VAT. Mr Hart justified the backdating by reference to the Respondents' policy set out in paragraph 8.4 of VAT Notice 733 (February 2004 version) which stated:

"Additionally, if we withdraw the scheme because you were never eligible to use it we will backdate the withdrawal to the time when you started to use the scheme and you will have to account normally for VAT from then".