[2009] UKFTT 136 (TC)

TC00104

Appeal number:  LON/08/1362

VAT – Default surcharge – assessment not valid if based on incorrect specified percentage- assessment incapable of amendment if wrong from the start – Dow Chemical Company Ltd (1995) considered.

FIRST-TIER TRIBUNAL

TAX 

	IDEAL SHOPPING DIRECT PLC	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS (VAT)	Respondents

				TRIBUNAL: 	Barbara Mosedale (Chairman)
						Lynneth Salisbury (Member)

Sitting in public in London on 1 April 2009

Mr E King, Counsel, instructed by AGM Partners LLP for the Appellant 

Mr Holl, Senior Officer HM Revenue and Customs for the Respondent

© CROWN COPYRIGHT 2009

DECISION
Introduction
1.	This appeal was lodged before the VAT & Duties Tribunal but heard on 1st April 2009 by the First-tier Tribunal (Tax Chamber).  This case appears to have the distinction of being the first case heard in the new tax chamber.  We directed, as we have power to do under Schedule 3 paragraph 7(3) of the Transfer of Tribunal Functions and Revenue & Customs Appeals Order 2009/56, that the costs rule contained in r29 of the VAT Tribunals Rules 1986/590 would apply in this case rather than the costs rule contained in r10 of the Tribunal Procedure (First-tier Tribunal)(Tax Chamber) Rules 2009/273.  
2.	After Mr King, counsel for the Appellant had made his submissions, Mr Holl, the representative for HMRC, asked the case to be adjourned.  He wished to take instructions to deal fully with the Appellant’s submission that this tribunal should apply the reasoning from Dow Chemical Company Ltd (1995) VAT Decision 13954 to the facts of this case and allow the appeal.  Mr Holl also pointed out that the Tribunal Service had mistakenly categorised this case as a Category 2 appeal rather than a Category 3 appeal with the result that no statement of case had been filed.   The Appellant did not wish the case to be adjourned.
3.	HMRC had requested Further & Better Particulars of the Appellant’s case on 6 October 2008:  they chose not to pursue this application because as they had the 6 page letter dated 28 August 2008 on behalf of the Appellant from Mr Mendham of AGM Partners LLP which set out the case for the Appellant in detail, and in particular its reliance on the Dow Chemical case.  HMRC cannot claim that they were ambushed having known the Appellant’s case since receipt of that letter.  Further, HMRC’s  recent letter of 26 March 2009 specifically referred to the matter stating that “the point of law raised in your [ie the Appellant’s] submission may be addressed” at today’s hearing.  Therefore, although it seems Mr Holl was not properly briefed, HMRC have had 7 months to prepare their case and were not ambushed.  We refused the adjournment.  
The facts
4.	Ideal Shopping Direct Plc appealed against  a default surcharge penalty imposed under the Value Added Tax Act 1994 s59A in respect of period 12/07.  The Appellant was not appealing on the grounds under VATA 94 s59A(8) that the VAT was despatched on time or that it had a reasonable excuse for not so despatching it. Its advisers accept that it was in default in period 12/07 within the meaning of VATA 94 s59A(1). The sole ground of its appeal is that in their view the notice of assessment of the penalty was not valid. 
5.	The facts were not in dispute and we find them to be as follows. The Appellant was in the payments on account scheme.  The Appellant was issued with a Surcharge Liability Notice (“SLN”) for prescribed accounting period 9/06: the Appellant has not challenged this SLN.  For period 12/06, the Appellant was issued with a 2% penalty and a Surcharge Liability Notice Extension (“SLNE”).  The amount of the penalty was assessed at £14,919.  This was reduced to £14,274 in June 2008 to reflect a revised calculation of the amount of the default and again revised on 26 March 2009 to £13,629 following another recalculation of the sum of the default.  The Appellant has not appealed the imposition of this penalty or the SLNE.
6.	For period 3/07 the Appellant was issued on 5 June 2007 with a 2% penalty assessment (in the sum of £644) and a SLNE.  The penalty was incorrect as the specified percentage should have been 5% in accordance with VATA 94 s59A(5)(b) as this was the second default in the surcharge liability period.  It seems HMRC realised this and issued a new assessment at 5% (for £1612) on 23 August 2007 but then on 1 May 2008 they withdrew this assessment because of their original error.   The Appellant has admitted that they were in default for this period.
7.	For period 6/07, the Appellant made a late payment and was assessed to a 10% penalty (£2,527) and issued with a SLNE.  The assessment was reduced by HMRC on 1 May 2008 because the specified percentage was reduced to 5%.  This was because the earlier assessment for 3/07 was withdrawn (see above) and HMRC re-aligned the percentages under s59A(5).  On 8 May 2008 HMRC reduced the penalty further to £966 to reflect a lower calculation of the amount of the Appellant’s default.  Then on 26 March 2009 this penalty was withdrawn altogether as a further review of the Appellant’s default position showed that the errors made by the Appellant were not all one way and the Appellant had overpaid £32,244 in the previous period.  This meant that the Appellant was actually in credit with HMRC in period 6/07 and there was no default.
8.	For period 9/07 only the Appellant’s return was late and a SLNE only was issued.  
9.	The assessment under appeal was issued on 4 March 2008 and related to period 12/07.  It showed a default of £1,301,732 and assessed a surcharge at 15% giving a penalty of £195,259.  The Appellant claims that this assessment is erroneous because 15% was not the correct specified percentage.
10.	This penalty was reduced in a letter from HMRC dated 1 May 2008.  It was reduced for two reasons.  Firstly it was reduced to reflect that the default was only £1,142,999 as the Appellant had paid £158,733 early and this had been overlooked.  It was also reduced to a 10% penalty to reflect that the assessment for period 3/07 (see above) had been withdrawn.  
11.	The penalty assessment was amended again by letter of 26 March 2009 when HMRC reduced the specified percentage to 5% (£57,149) to reflect the withdrawal of the 6/07 default surcharge penalty assessment.  The Appellant claims that these attempts to amend the assessment are ineffective to correct the error in the original assessment.
The issue
12.	Default surcharge penalties are assessed by multiplying the amount of VAT paid late by the “specified percentage”.  The specified percentage is determined by the number of earlier defaults in the same surcharge period.  The provisions are set out in the Value Added Tax Act 1984 s59A (for a payments on account trader as in this case) and we set them out in full as they are fundamental to the Appellant’s argument in this case:
“(4) Subject to subsections (7) to (11) below, if—
(a) a taxable person on whom a surcharge liability notice has been served is in default in respect of a prescribed accounting period,
(b) that prescribed accounting period is one ending within the surcharge period specified in (or extended by) that notice, and
(c) the aggregate value of his defaults in respect of that prescribed accounting period is more than nil,
that person shall be liable to a surcharge equal to whichever is the greater of £30 and the specified percentage of the aggregate value of his defaults in respect of that prescribed accounting period.
(5) Subject to subsections (7) to (11) 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 during the surcharge period which are periods in respect of which the taxable person is in default and in respect of which the value of his defaults is more than nil, 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.”
13.	In asserting that the assessment was wrong and could not be rectified, the Appellant asked this Tribunal to apply the reasoning used by the VAT &  Duties Tribunal in Ground 2 of its decision in the case of Dow Chemical Company Ltd (1995) VAT Decision 13954 and dismiss the appeal.  At the hearing HMRC’s representative both attempted to distinguish this case from that in Dow Chemical  and also challenged the reasoning in Dow Chemical and it is therefore for this Tribunal to decide whether it thinks that reasoning  should apply in this case.
14.	Before setting out the reasoning in Dow Chemcial, we include a short summary of the facts in that case without which it would be difficult to understand the decision.  In Dow Chemical, the Appellant appealed two default surcharge assessments.  It was decided (for reasons not relevant to this appeal) that a valid SLN had been issued to the Appellant for the period 05/94.  This was followed by three default surcharge assessments, the first at 2% (period 10/94), the next at 5% (period 11/94) and the last at 10% (period 3/95).  Later HM Customs & Excise withdrew the 2% penalty (presumably in recognition that they had specified the wrong accounting periods in the notice of assessment).  At the same time HMRC purported to amend by letter the two later assessments by reducing the percentages to 2% (period 11/94) and 5% (period 3/95).  The second ground of appeal and the decision in respect of which the Appellant in this case is asking us to adopt was that the original assessments were wrong because they used the wrong specified percentages (5% instead of 2% for period 11/94 and 10% instead of 5% for period 3/95) and that Customs & Excise’s later attempt to amend them by substituting lower percentages was ineffective.  The taxpayer won its appeal on this ground.
15.	The decision on the law on this point in Dow Chemical is divided into three propositions as follows:
“Ground 2: Decision
We think that the argument for Dow Chemicals is correct on this point. The Commissioners are wrong because Dow Chemicals was not in law liable to a 5 per cent surcharge in relation to the 11/94 period or to a 10 per cent surcharge in relation to the 03/95 period. The assessments purporting to make Dow Chemicals so liable were both wholly invalid and so could not be reduced either in pursuance of section 76(9) or, more accurately we think, in exercise of the Commissioners' inherent power to reduce assessments. Our conclusion is based on three propositions.
The first of these propositions is that each liability occasioned by each default is separate. A liability resulting from a second default in a surcharge period is distinct from a liability resulting from a third default. To use the words of Macpherson of Cluny J in Commissioners of Customs and Excise v Medway Draughting and Technical Services Limited [1989] STC 346 at p 351j, each "penalty" imposed by section 59, is "quite separate". Subsection (4) read in conjunction with subsection (5) contains a set of graduated liabilities each of which depends on a different set of circumstances. For example, a separate and distinct liability arises on account of the second default for a prescribed accounting period falling within a surcharge period. In that situation the liability is "to a surcharge equal to the greater of the specified percentage of his outstanding VAT for that prescribed accounting period and £30"; the specified percentage is found in subsection (5) and depends on the number of other defaults during the surcharge period. If the assessment is based on the wrong liability, for example because the number of other defaults is wrong, it will be ineffective.
The second proposition is that only properly notified defaults for a prescribed accounting period count; (and they drop out of account if a reasonable excuse defence is sustained). For purposes of the liability to surcharge imposed by subsection (4) a default in question must have satisfied the two requirements set out in subsection (2). There must have been a default in respect of a prescribed accounting period (see paragraph (a)) and the Commissioners must have served a notice specifying a surcharge period or an extended surcharge period being "the period ending with the first anniversary of the last day of the period referred to in paragraph (a) above" (paragraph (b)). In other words it is not enough for the Commissioners simply to point to a default, whether admitted by the taxpayer or not; there has to be a valid SLN or SLNE that specifically relates to that default. Without the notice, the taxpayer would have no opportunity to appeal on grounds for reasonable excuse or otherwise.
The third proposition is that while the Commissioners and the tribunal have power to reduce an assessment, this power exists where the assessment is excessive because, for example, it is based on an overstatement of the outstanding VAT; but the power does not exist where the assessment is ineffective because the liability is of the wrong type, for example it assesses a third default liability where it ought to have assessed a second default liability. The Commissioners have an inherent power to reduce an assessment; this is recognised by section 76(9) which reads as follows:
"(9) If an amount is an assessed and notified to any person under this section, then unless, or except to the extent that, the assessment is withdrawn or reduced, that amount should be recoverable as if it were VAT due from him."
The tribunal has power to reduce a surcharge assessment on appeal (and so reduce it to the amount that is appropriate under section 59); this is recognised by section 84(6) which reads as follows:-
"(6) Without prejudice to section 70, nothing in section 83(q) shall be taken to confer on a tribunal any power to vary an amount assessed by way of penalty, interest or surcharge except in so far as it is necessary to reduce it to the amount which is appropriate ."
But in neither instance can the power be exercised where the assessment itself is ineffective and so void ab initio. (This is different from the position that obtains where a taxable person establishes the defence of reasonable excuse under section 59(7); the subsection itself appears to contemplate that the specified percentages for subsequent defaults will be adjusted accordingly.)”
16.	Our summary of the three principles set out above in  that decision is as follows:
(1)	To be valid, an assessment to a surcharge liability under s59 (or in this case s59A) must be based on the correct specified percentage.  This we will refer to as first proposition  from Ground 2 of the Dow Chemical judgment;
(2)	The defaults which ‘count’ towards calculating the correct specified percentage for a later default are only those which are properly notified.  This is the second proposition referred to in  Ground 2 of Dow Chemical judgment.
(3)	HMRC do have power to amend an assessment to a default surcharge but this power cannot be exercised to make an invalid or void assessment effective:  in other words only an assessment valid at the time it was issued can be later reduced.  This it seems to us is a summary of the third proposition.
17.	Since the Appellant wishes us to apply this reasoning to their case and HMRC do not, we need to consider whether our interpretation of s59A would be the same as that Tribunal’s interpretation of s59 (s59 and s59A appear to us to be materially the same as far as the Dow Chemical point is concerned).
18.	Proposition one:  this seems plainly right.  The power of HMRC to assess is under VATA 1994 s76(1) and it is a power to “assess the amount due by way of penalty…” The amount due is set out in s59A(4) and it is the “specified percentage of the aggregate value of his defaults” in that period.  So there is no right to issue an assessment where the specified percentage used to calculate the penalty is greater than the one to which the taxpayer is liable under S59A(5). 
19.	Proposition two:  the second proposition raises two issues.  Does a default have to be “properly notified” in order to count towards the specified percentage and, if so, what does “properly notified” mean?  Perhaps fortunately in the view of the fact that we did not hear full argument on Dow Chemical, it seems to us that we do not need to decide our view of proposition two in order to decide this appeal.  It does seem to us that the point is not self-evident:  S59A(5) gives the count of defaults in a surcharge period as being “periods in respect of which the taxable person is in default and in respect of which the value of his defaults is more than nil”.  There is nothing about notification. S59A(2), which does require the surcharge liability notice to be properly notified, does not on the face of it apply to defaults which are merely counted towards the specified percentage.  
20.	Further, to require the previous defaults to have been properly assessed leads to the anomaly that a mistake in assessing the first default in a surcharge period is (unless the mistake is spotted and corrected by a new assessment) going to mean that not only does the taxpayer have no liability for that first default but has no liability for any later default in the same surcharge period (because the wrong specified percentage was used).  Contrast this to a taxpayer who is properly assessed but can show a reasonable excuse for his first default:  as will be seen from the discussion on Proposition 3 below he escapes liability for that first default but not for subsequent defaults even if the wrong specified percentage was used.  Yet his position should surely be better than the taxpayer who had no reasonable excuse for either default.  
21.	A counter-argument to this might be that unless the earlier default was notified, the taxpayer is unlikely to challenge it even at the hearing for the later default and yet might have had grounds, such as a reasonable excuse, on which to do so.  And the Appellant’s view was that the default surcharge regime is a harsh one and it must therefore be interpreted strictly in favour of the taxpayer.  But, as we have said,  we didn’t have the benefit of full argument on this point nor, as will be seen from below, is it necessary to decide our view of Proposition Two to decide this appeal.
22.	Proposition three:  Proposition three was that assessments which were void ab initio -  wrong from the start - cannot be amended.  The implications are that some assessments can be amended – such as where the assessment was excessive because it was based on an overstatement of the outstanding VAT.   But  - with an exception discussed below - assessments which use the wrong specified percentage are wrong from the start and can not be amended.  The only way to correct the position would be to issue a new assessment (assuming time limits permit).  The exception which Dow Chemical envisaged (see the words in parenthesis at the end of the quotation from the judgment above) was where subsequent to the assessment the taxpayer was able to show a reasonable excuse for one of the defaults on which the specified percentage was based:  in such a case the assessment could be adjusted to reflect the new lower percentage and was not void.  This exception was not actually part of the decision in Dow Chemical as it was not relevant on the facts.  In that case it was decided that the reason the earlier default should not have been counted towards the specified percentage was that its assessment was bad from the start as it mis-described the period to which it purported to relate.
23.	We looked at the VAT & Duties Tribunal decision in the case of S S R Group Services Limited (1999) VAT Tribunal 16033, as this seems to be one of the few  cases in which Dow Chemical has been considered.  However, we would note that it was not cited to us at the hearing, is not binding on us, nor, as the Tribunal in that case records, it did it have the benefit of full argument as the Dow Chemical point was raised as a new issue by the taxpayer on the morning of the hearing. 
24.	In S S R Group case that taxpayer won on other grounds (the defence of due despatch) but the Tribunal indicated that they did not consider Dow Chemical would have helped the taxpayer had they not won on due despatch.  This was because the Tribunal in S S R Group thought the exception noted above in Dow Chemical and suggested to it by the representative for Customs & Excise (Mr Holl in that case as in this case) would apply in S S R Group. 
25.	The Tribunal in Dow Chemical itself suggested that there was a right to amend a later assessment where reasonable excuse for an earlier assessment was shown:  the Tribunal in S S R Group Services Limited extended that right to amend to a case where the due despatch defence was established for an earlier default, as that defence is also contained in s59(7).  
26.	It must be right that assessments can be amended when information not known to HMRC at the time of they made the assessment comes to light such as a taxpayer later establishing a defence of reasonable excuse to a default which counted towards the specified percentage.  But assessments which were always wrong cannot be so amended and HMRC’s only course would be to issue a new assessment if timelimits permitted.  Therefore we agree with Proposition 3.
Decision
27.	The Appellant has accepted that they were in default in period 12/07 and that they  were in a properly notified surcharge liability period (the relevant SLN related to period 9/06 and the relevant SLNE was issued 12/06 and no challenge to these was suggested).  But the assessment of 4 March 2008 was based on 15% of the default under  s59A(5)(d).  To be right this requires there to have been three previous defaults in the same surcharge liability period.  In fact there were only two:  the one in period 12/06 and the one in period 3/07.  Although the taxpayer had been assessed for a default in period 6/07, it was later accepted by all parties that the taxpayer had been unintentionally in credit in this period due to an earlier overpayment and this exceeded the amount which they paid late.  There was no default in 6/07.
28.	Applying proposition 1, the assessment must be based on the right specified percentage.  It wasn’t.  It is not necessary to decide whether it is correct to count defaults which were not properly notified as per Proposition 2.  Such a distinction would be critical if we only had to consider the default in period 3/07 because it is accepted that the taxpayer was in default for that period but that this was not properly notified to them.  There was an incorrect assessment which was withdrawn followed by (apparently) a correct assessment which was also withdrawn (we are not sure why).  We do not need to decide whether it has to be a properly notified default for the purposes of calculating the specified percentage:  the 15% was wrong because it included the “default” for period 6/07 which wasn’t a default.
29.	The only remaining question is whether the wrong assessment can be validly amended as HMRC purported to do by their letters of 1 May 2008 and 26 March 2009.  It seems that HMRC did not attempt to issue a new assessment.  Proposition 3, with which we agreed, was that assessments can be amended when information not known to HMRC at the time they made the assessment comes to light such as a taxpayer later establishing a defence of reasonable excuse to a default which counted towards the specified percentage.  But assessments which were always wrong cannot be so amended.  
30.	It seems to us that that this is a case where the assessment must always have been wrong.  The taxpayer was in credit with HMRC:  this is not a case where it is for the taxpayer to come forward and establish a defence of reasonable excuse or due despatch to a prima facie default and where such a defence depends giving evidence which HMRC would not have known at the time of the assessment.  In such cases there is a default unless and until the taxpayer can establish the defences in S59A(8).
31.	In the case of period 6/07 there was no prima facie default.  VAT was not paid late.  It was not for the taxpayer to come forward and establish a defence:  he simply wasn’t in default.  It seems irrelevant to us that it appears the officers making the assessments for the 6/07 and 12/07 periods did not know that the Appellant was in credit for period 6/07 –although no doubt they could have established this from HMRC’s records.  This seems to be a case where the specified percentage used in the 4 March 2008 assessment was wrong from the start.  This meant that that assessment was wrong from the start and cannot be amended.  The appeal is therefore allowed.

Barbara Mosedale

TRIBUNAL JUDGE
RELEASE DATE: 6 May 2009

LON/08/1362