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Cite as: [2008] UKVAT V20869

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Central Cleaning Contractors Ltd v Revenue & Customs [2008] UKVAT V20869 (14 November 2008)

20869

VAT – Default surcharge – Unprofitable contract with customer representing 90% of turnover – Cashflow problems arising as a result – Whether any excuse arising because of losses exhausted by time of later default

LONDON TRIBUNAL CENTRE

CENTRAL CLEANING CONTRACTORS LTD Appellant

and –

THE COMMISSIONERS FOR HER MAJESTY'S REVENUE & CUSTOMS Respondents

Tribunal: CHARLES HELLIER (Chairman)

DR M JAMES

Sitting in public in Plymouth on 25 September 2008

Paul Dollins, company secretary of the Appellant, for the Appellant

Simon Chambers for the Respondents

© CROWN COPYRIGHT 2008

DECISION

The Appellant appeals against a default surcharge assessed under section 59 VATA 1994 in respect of the period ending 31 January 2008 (the "01/07" period).

Section 59 provides so far as is relevant to this appeal:

The default surcharge

"(1) … if, by the last day on which a taxable person is required in accordance with regulations under this Act to furnish a return for a prescribed accounting period –

(a) the Commissioners have not received that return, or

(b) the Commissioners have received that return but have not received the amount of Vat shown on the return as payable by him in respect of that period,

then that person shall be regarded for the purposes of this section as being in default in respect of that period …

(2) Subject to subsections (9) and (10) below, subsection (4) below applies in any case where –

(a) a taxable person is in default in respect of a prescribed accounting period; and

(b) the Commissioners serve notice on the taxable person (a "surcharge liability notice") specifying as a surcharge period for the purposes of this section a period ending on the first anniversary of the last day of the period referred to in paragraph (a) above and beginning, subject to subsection (3) below, on the date of the notice.

(3) If a surcharge liability notice is served by reason of a default in respect of a prescribed accounting period and that period ends at or before the expiry of an existing surcharge period already notified to the taxable person concerned, the surcharge period specified in that notice shall be expressed as a continuation of the existing surcharge period and, accordingly, for the purposes of this section, that existing period and its extension shall be regarded as a single surcharge period.

(4) Subject to subsections (7) to (10) below, if a taxable person on whom a surcharge liability notice has been served –

(a) is in default in respect of a prescribed accounting period ending within the surcharge period specified in (or extended by) that notice, and

(b) has outstanding VAT for that prescribed accounting period,

he shall be liable to a surcharge equal to whichever is the greater of the following, namely, the specified percentage of his outstanding VAT for that prescribed accounting period and £30.

(5) Subject to subsections (7) to (10) below, the specified percentage referred to in subsection (4) above shall be determined in relation to a prescribed accounting period by reference to the number of such periods in respect of which the taxable person is in default during the surcharge period and for which he has outstanding VAT, so that –

(a) in relation to the first such prescribed accounting period, the specified percentage is 2 per cent,

(b) in relation to the second such period, the specified percentage is 5 per cent,

(c) in relation to the third such period, the specified percentage is 10 per cent, and

(d) in relation to each such period after the third, the specified percentage is 15 per cent …

(7) 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 despatched 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 despatched,

he shall not be liable to the surcharge and for the purposes of the preceding provisions of the 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).

(8) For the purposes of subsection (7) above, a default is material to a surcharge if –

(a) it is the default which, by virtue of subsection (4) above, gives rise to the surcharge, or

(b) it is a default which was taken into account in the service of the surcharge liability notice upon which the surcharge depends and the person concerned has not previously been liable to a surcharge in respect of a prescribed accounting period ending within the surcharge period specified in or extended by that notice …"

Section 71 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.

(2) In relation to a prescribed accounting period, any reference in sections 59 to 69 to credit for input tax includes a reference to any sum which, in a return for that period, is claimed as a deduction from VAT due."

There is no dispute as to the circumstances giving rise to the surcharge assessment. The Appellant was late in paying its VAT for each of the periods 10/05, 07/06 and 01/07, HMRC served a surcharge liability notice in respect of the 10/05 period and an extension notice in respect of the 07/06 periods. The default in 01/07 fell within the extended surcharge period and was the third default. The rate of surcharge was thus 5% of the outstanding VAT i.e. 5% of £192,803.12 or £9,640.00. (The papers before us suggested that there had also been a default in respect of the 10/06 period but that HMRC had not made any assessment for that period – or had withdrawn the assessment it had originally made. Mr Chambers did not seek to argue before us that there had been any relevant default in respect of the 10/06 period and we proceeded on the basis that there was none.)

The Appellant argued that it had a reasonable excuse for the default. It said that its particular circumstances caused it to be short of funds to pay its VAT. It did not assert that that shortage was a reasonable excuse but says that those circumstances afford a reasonable excuse for its failure to pay in time.

In Customs and Excise Commissioners v Steptoe [1992] STC 757, the Court of Appeal held that the legislative intention of the precursor of section 71 (which was in the same terms as section 71) was "that insufficiency of funds can never of itself constitute a reasonable excuse, but that the cause of the insufficiency, i.e. the underlying cause of the default, might do so." – see Lord Donaldson at page 770.

As Lord Donaldson later noted that left the difficulty of determining what underlying causes of an insufficiency which leads to a default are to be regarded as reasonable excuses. He said however that there must be limits to what could be regarded as a reasonable excuse: "if the exercise of reasonable foresight and of due diligence, and a proper regard for the fact that the tax would become due on a particular date would not have avoided the insufficiency of funds which led to the default, then the taxpayer may well have a reasonable excuse for non-payment, but that excuse will be exhausted by the date on which such foresight, diligence and regard would have overcome the insufficiency of funds."

Mr Dollins told us, and we accept, that the Appellant's cashflow problems had arisen in the following way:-

(i) Over 90% of the Appellant's business consists of cleaning premises of Co-op shops. It cleans some 900 shops. It had (and its unincorporated predecessors had been) one of the Co-op's main contractors for 17 years. This is a low margin business. Prior to 2005 the Appellant had made modest annual profits.

(ii) In 2005 the Appellant entered into a new 3-year contract with the Co-op. It came into force in relation to the relevant Co-op premises in stages but was fully in force by April 2005. The contract had been carefully negotiated over 3 months and many meetings. When it was concluded the Appellant's management had thought it would be modestly profitable in operation.

(iii) The contract contained certain provisions which in their application to larger Co-op shops caused no problems, but which in their application to smaller premises were particularly disadvantageous. The contract specified the hours to be spent in any week cleaning a store. A fixed rate – about £10 per hour – was paid to the Appellant. If fewer hours than specified were spent cleaning a particular store then the amount paid was reduced at the rate of £10 per hour; and if less than 95% of the specified time was spent cleaning a penalty of £25 would be deducted from the amount paid. In a large store, where say 100 hours per week or more would be spent cleaning, the £10 per unspent hour reduction and the £35 penalty were both unlikely to result in a significant proportion of income being lost, but for a smaller store with 9 hours or less specified cleaning time, the £35 penalty represented more than 35% of the Appellant's income, and the £10 per hour reduction provided no recognition of the fact that the Appellant's overhead cost – its management costs in relation to that store were unaltered.

(iv) When the 2005 contract was negotiated those difficulties in relation to smaller stores were not thought to be particularly significant, but in late 2004 the Co-op had purchased a number of smaller stores and their cleaning became part of the responsibility of the Appellant under the contract. The additional shops to be cleaned caused the Appellant some problems –

(i) it had to employ new employees to do the work

(ii) cleaners frequently left on short notice, and did not always work the expected hours

(iii) for smaller stores this meant a greater burden of penalties and income reduction.

(v) In July 2005 the Appellant realised that it was in difficulties with the contract. It approached the Co-op and a modest increase in hourly rate was agreed together with an acceleration of payment times. By 31 January 2006 the Co-op had paid all the monies owed to the Appellant, and after that date it paid 75% of any invoice within 7 days and the balance when the amount of the invoice was agreed

(vi) But the Co-op contract remained unprofitable. The Appellant made losses on it through 2005 and 2006. The losses on the contract were reflected in reduction in available cash. It delayed payment to its suppliers. It factored its debts. But it still had insufficient cash.

(vii) Throughout 2006 the company ploughed on. It's officers believed it had no chance of amending the Co-op contract tax.

(viii) At the end of 2006 the company became concerned about its solvency. It investigated the possibilities (including further cost control) and concluded that its choices were either to seek liquidation or to change the terms of the Co-op contract. It approached the Co-op in early 2007 and explained its problems with the smaller stores and more generally. The Co-op agreed to a change in the contract terms which was formalised in May 2007. Since then the company has been trading at a modest profit.

(ix) In 2006 and early 2007 the company used its bank facilities to the full. It managed its cash flow to ensure that its wages were paid on time and (with one exception) that its PAYE was paid on time. It delayed VAT payments where that was necessary to ensure wages and PAYE were paid timeously. For some VAT periods the dates on which the Co-op paid were such the VAT could and was paid on time (the 01/06, and 04/06 periods were such); in others it was paid late.

Mr Dollins says that the problem with the Co-op contract caused the cash flow shortages which gave rise to the defaults. He says that this was an unforeseen problem from which it took the Appellant almost 2 years to recover and that it is a reasonable excuse for the Appellant's default.

Mr Chambers says that the company realised it had problems in late 2005 and that it had sufficient time to arrange its affairs so as to ensure that VAT in later quarters was paid on time. The company had been warned by the Surcharge Liability Notices of the effect of default. Whilst its circumstances might have afforded a reasonable excuse in the early period of that contract, that excuse would have been exhausted once due diligence and reasonable foresight could have been prevented the insufficiency. The company took two years before it approached the Co-op. It received the cash representing its VAT liability. It was reasonable to expect it to have made arrangements by January 2007 to enable it to pay the 01/07 VAT on time.

Discussion

We have some sympathy for the Appellant. It operated in a business area with small margins and with a large client it could not easily afford to upset, but the question for us is whether the circumstances afford a reasonable excuse.

We asked ourselves whether reasonable foresight and due diligence would have resulted in an earlier resolution of its difficulties with the Co-op contract.

It seemed to us that the company appeared to stumble through 2006 without taking any remedial action. It knew that it was not breaking even and it knew the causes of its problems, but it appeared to be paralysed. Mr Dollins described it as being overwhelmed. It is reasonable to expect a company to remain paralysed for so long?

We thought that it was not. In our view a reasonable businessman in the company's position would have done something definite sooner. The knowledge that VAT was not being paid on time and that penalties were being incurred would have prompted more urgent action even in the face of a large and powerful customer. Whilst it may well have been reasonable for the company to do nothing until mid 2006: for it had to recognise that it was making losses, realise the source of its losses, and to see if it could address them in some other way before it could reasonably be expected to adopt a robust approach with the Co-op, it was in our view no longer reasonable to delay after mid 2006.

It therefore seems to us that the Appellant does not have a reasonable excuse for its 01/07 default.

However, it does seem to use that it had a reasonable excuse for its default in 10/05. This was a default in relation to a period in which the effects of the new contract and the number of small shops were being recognised. The difficulty had not been reasonably anticipated because the number of small shops had not been reasonably anticipated. Indeed at about that time it first approached the Co-op (although the result of that approach did not in the end solve its difficulties).

Section 59 (7) provides that if a person satisfies the Commissioners, or an appeal a tribunal, in the case of a default which is material to an appeal, that there is a reasonable excuse for a default then he shall not be treated as having been in default in respect of the period to which that default related.

For the reason given by the Tribunal in Aardvaak Excavations Ltd (VAT D 20468) it seems to us that the effect of section 59 (7) in this case is that the 10/05 default is therefore to be ignored in computing the 01/07 surcharge. The 01/07 default is therefore the first default in the surcharge period created by the Surcharge Liability Notice served in respect of the 07/06 default and the rate of surcharge applicable is thus 2% (although that notice is entitled "Surcharge Liability Extension Notice" that notice also acts expressly as a Surcharge Liability Notice).

Accordingly we feel that the surcharge for in respect of the 01/07 period is 2% x £192,803, or £3,856.06 and find that the assessment should therefore be reduced to that amount.

Our decision was unanimous. We make no order as to costs.

CHARLES HELLIER

CHAIRMAN

RELEASED: 14 November 2008

LON 2008/0436