United Kingdom VAT & Duties Tribunals Decisions

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Cite as: [2007] UKVAT V20465

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Parle Skip Hire Ltd v Revenue & Customs [2007] UKVAT V20465 (23 November 2007)

20465

Value Added Tax - Default Surcharge - Delay occasioned by bad debts constituting 12% of the Appellant's turnover for the relevant VAT period in which there was also a seasonal down-turn in business and a strain on cash-flow through business expansion - Appeal Dismissed

LONDON TRIBUNAL CENTRE

PARLE SKIP HIRE LIMITED Appellant

and –

THE COMMISSIONERS FOR HER MAJESTY'S REVENUE & CUSTOMS Respondents

Tribunal: HOWARD M NOWLAN (Chairman)

MRS NORAH CLARKE

Sitting in public in Cardiff on 8 November 2007

Elwyn Jones and Richard Waggott, Managing Director and Finance Controller respectively of Parle Skip Hire Limited, for the Appellant

Mrs P Crinnion of HMRC's Solicitors' Office, for the Respondents

© CROWN COPYRIGHT 2007

DECISION

Introduction

This was a default surcharge appeal against the imposition of a 5% surcharge on the Appellant, a company conducting a skip hire business, in the amount of £3,275.75 for the 3-month VAT period ending on 31 December 2006.

The factors that the Appellant contended provided a reasonable excuse for the late payment, by approximately one month, of £65,515.07 of the £75,515.07 VAT assessed for the period were that two major debtors, owing in total £56,212.88 had gone into administration in November and December, all at a time when turnover in the run up to the Christmas period was inevitably low. Since the Appellant was investing profits and monies raised on overdraft in considerable expansion, and could not increase its borrowing, the bad debts and decline in turnover left the company unable to pay its VAT on time.

Whilst the evidence given by Mr. Elwyn Jones, the Managing Director and Mr. Richard Waggott, the Finance Controller left us in no doubt that the evidence was totally honest, and that both men were fundamentally efficient in controlling a substantial and fast expanding business, we have nevertheless decided that the facts do not justify a decision in favour of the Appellant, when we must apply the statutory test for determining reasonable excuse and the case law guidance that has been built up in relation to bad debts.

The facts in more detail

The business of the Appellant is that of hiring out skips. The company's substantial and expanding turnover (currently of in excess of £4 million a year) reflects the fact that the company's main customer base is a commercial/industrial one, rather than the individual house-holder with a skip in the road, and the company's business extends to dealing with the appropriate recycling and disposal of commercial and industrial waste.

The company's two main sources of finance, other than retained profits, were a bank overdraft facility of £125,000, fully guaranteed by Mr. Jones with the Bank of Ireland, and a factoring or loan facility geared to the company's debtors. Under this latter facility the company was able to borrow 80% of amounts invoiced to customers on issuing the invoices, with the remaining 20% being paid by the bank when the bank collected the receivables. This facility contained a provision limiting draw-downs against invoices to £500,000, and under it the bank did not assume the credit risk of the customers paying their bills. Thus if a customer defaulted, the company would immediately have to repay the 80% that had been advanced on the invoices that had not been settled.

Whilst the individual monthly figures did not quite tally with the total turnover figure of £1.2 million for the VAT period ending on 31 December (and we do not suggest that anything hinges on this) we were given the monthly figures of turnover for the months from October to December, of £359,000, £401,000 and £250,000 to demonstrate the seasonal factor that customers are unlikely to be hiring skips for use over the Christmas holiday period. Accordingly gross turnover would inevitably be down in December. We were also told that few of the Appellant's expenses were reduced in December with the result that the management accounts for December showed an £80,000 loss for that month.

On 14 November and 18 December 2006 the Appellant was notified by firms of accountants that they had been appointed as Administrators for customers of the Appellant that together owed the figure mentioned in paragraph 2 above. These two debtors appeared to be the Appellant's largest two debtors at the time of the defaults, partially presumably because the debts would have escalated over a period of two or three months, whilst the customers were in difficulties. We attach no particular blame to the fact that the debts escalated since we were satisfied that the Appellant's credit controls were generally good and the customers were long-standing trusted customers.

When the Appellant came to make its VAT return at the end of January, with a liability to pay (if by electronic transfer) by 7 February 2007, the Appellant's overdraft was drawn down to the approximate figure of £80,000, indicating that a further £45,000 could be drawn without exceeding the limit. Whilst we were given no details of the amount and timing of other commitments for which cheques might have been issued or which were about to become due, we were told that the Appellant had various other urgent calls for cash, including those for paying wages, and tip fees to the operator of the Waste Disposal Station, which in turn included an element for Landfill Tax. We were told that if the tip fees were not paid on the due date, the Appellant's ability to dump rubbish would immediately be terminated, and naturally the Appellant could expect considerable trouble if employee wages were not paid on time. We were told that the Appellant sought to increase its overdraft facility but that the bank refused this request. We were also told that as a result of this the Appellant changed its bankers and subsequently negotiated a higher overdraft limit with the new bank, but it was not possible to do this in time to pay the VAT on time on 7 February 2007.

We were shown the figures at around the date 6 and 7 February to demonstrate that the facility for financing debtors by raising 80% of invoiced debtors was also right at the limit, with only an irrelevant amount available to be drawn assuming sufficient invoices.

In response to questions that we put to Mr. Jones to ascertain whether profits from earlier periods had been distributed in the form of dividend or in payment of substantial bonuses, we were told by Mr. Jones that since he had acquired the company in 2004, he had worked virtually full-time in the business but had not taken a penny either in dividend or salary and bonus of any sort.

The Appellant's liability for VAT was calculated on an invoice basis so that the VAT in respect of the debtors who defaulted would have been paid in part in the previous quarter, with those remaining invoices submitted to the two defaulting customers in the final quarter of 2006 being included in the return for that period. The Appellant was under the impression that it would not be able to make bad debt claims in respect of the two debtors for a six month period, albeit that since it had received notification that the two customers had been placed in administration in the period ending 31 December, it could actually have made bad debt claims in that period, and thus reduced the liability for VAT by the appropriate fraction of the £56,212.88. As it was it was unaware of this and failed to make the claim in that period though doubtless has done so subsequently.

We were also told that shortly after the relevant VAT period, the Appellant managed to secure insurance against bad debts in respect of all debtors owing more than £1,000. The cost of this insurance was apparently £10,000 per year, and we were told that the debts covered by the insurance, in other words the debts of more than £1,000, constituted approximately 85% of the total debtors.

The contentions on behalf of the Appellant

It was contended on behalf of the Appellant that:-

the company would have been able to pay the whole of its VAT for the relevant period on time, had the two debtors not failed to pay;

the cumulative effect of the defaults, the losses incurred through seasonal factors in the month of December, the general strain on cash flow occasioned by the company's expansion and the refusal of the bank to increase the company's overdraft made it impossible for the company to pay its VAT on time and pay staff wages and the company's tip bill; and that

it would have been fatal to the continuance of the company's business for the company to fail to pay its charges to the operator of the waste disposal facility on time, and fatal not to pay staff wages on time.

The contentions on behalf of the Respondents

It was contended on behalf of the Respondents that:-

since there was £45,000 that could be drawn under the Appellant's overdraft facility, the company did have adequate resources to pay the bulk of its remaining VAT liability on 7 February, beyond the £10,000 that the company did pay on time;

the company should treat its VAT liability as its first priority, and could not justify late-payment of its VAT liability by claiming that it needed to retain funds to meet other liabilities that were shortly to fall due;

the level of expenditure shown on the company's VAT returns for the various periods before, in and after, the relevant VAT period suggested that most of the company's expansion commitments were incurred in periods other than the relevant one ending 31 December; and

in any event, the defaulting debtors represented only about 12% of the company's turnover for the 3-month period and case law indicated that for bad debts to constitute the reasonable excuse for the late payment of VAT so as to eliminate the liability for default surcharge, the bad debts needed to constitute a far larger percentage of turnover than 12%.

Our decision

We placed no importance on the third contention made by the Respondents that the company's expansion was an irrelevant factor in the relevant period. VAT returns made on an invoicing, rather than cash, basis would be a very misleading indicator of when the cash cost of additional expenditure on plant and machinery would actually fall due. For instance all of the company's additional plant purchases were said to be made on hire purchase which would be reflected in the VAT return when contracts were incurred, so that later returns would all fail to show when the hire purchase instalments actually fell due.

We accepted that the company's cash position made it impossible for the company to pay its VAT on time and simultaneously to retain funds to meet other urgent calls for cash. This raises the question of how we should properly address the issue of whether the Appellant could demonstrate a reasonable excuse for the late payment of VAT. The Appellant contended that for business reasons it had no option but to provide for the other liabilities first. The Respondents contended that "VAT should be paid first", and the Respondents periodically argue that the taxpayer is holding "HMRC's money", having "collected VAT from its customers", so that those monies, even if not allocated to separate accounts, should be accounted for to HMRC and not diverted to meet other claims.

We consider that the approach that we must follow is as follows. We first consider it incorrect to regard the Appellant as holding monies for HMRC collected from customers, or invoiced against customers, as held in any way for HMRC. Regardless of the input deductions that some customers might have on purchasing services from the Appellant, all that the Appellant charges its customers is "price", and not VAT. VAT is the Appellant's own separate liability to HMRC, and is a liability for which only the Appellant is liable, and there is no sense in which any of the Appellant's resources are held in any sort of trust for HMRC.

It is also inappropriate to treat one liability "as being owed first". Whilst there are indeed other important legal implications if a company cannot discharge all of its debts as they become due, there is no remote order of priorities for the payment by a company which is not in administration or liquidation, of the company's various debts if two or more have become due and payable. The simple position is that there are various different implications to the failure to pay different debts on time. Failure to pay salaries on time will not only be a breach of contract but may result in the staff walking out, or possibly being sympathetic and patient. Failure to pay the company's tip fees may mean that the company would immediately be put out of business, or the company might be able to negotiate a slight delay in payment. Failure to pay VAT on time occasions perfectly clear consequences. Beyond liability for interest, a default surcharge liability arises, unless the Appellant can demonstrate reasonable excuse; the statute provides that lack of funds does not constitute a reasonable excuse; and case law demonstrates that while the underlying cause of lack of funds can potentially constitute a reasonable excuse, this is not so in the case of bad debts unless the bad debts were owed by a dominant or core customer, and unless the level of bad debts was of a far higher order than the 12% in this case.

It seems to us that our task is not to balance the various calls for cash against each other. We must simply apply the statutory and case law guidance just summarised. We accept that some extraneous call for cash might be the factor that could constitute the reasonable excuse for the late payment of VAT but that would usually only be so if some very large liability suddenly arose in an unexpected fashion. In the present case all that can be said is that the Appellant suffered bad debt experience at a level clearly held by authority not to constitute a reasonable excuse, and that this factor was aggravated by the downturn in business in December and by the strain on cash occasioned by the company's expansion plans. In our view we must conclude that the company's expansion programme was the result of a policy (albeit a praise-worthy policy) on which the company embarked voluntarily. And the downturn in business in December was a well-known feature in the building industry, and not some unanticipated disaster. Thus the conclusion is that modest bad debt experience, at a far lower level than has been held to constitute a reasonable excuse for late payment of VAT merely coincided with a seasonal and anticipated downturn in business for which the Appellant should provide and with the cash strain occasioned by the company's own chosen business model. Putting the same point in another way, if a company embarks on expansion, it must plainly still provide for meeting all its liabilities as they fall due, and must accept that predictable fluctuations in business will inevitably arise.

While we have felt compelled to decide this case against the Appellant, we would like to record our respect for the presentation of his case by Mr. Jones, and to say that we have reached our decision, in line with the authorities, with some regret.

HOWARD M NOWLAN

CHAIRMAN

RELEASED: 23 November 2007

LON 2007/0906