[2009] UKFTT 341 (TC)

TC00282

Appeal number TC/2009/12565

Construction Industry Scheme – penalties for late filing of returns required by paragraph 4 of the Income Tax (Construction Industry Scheme) Regulations 2005 – Reasonable excuse defence under section 118(2) TMA 1970 – No power to mitigate penalties – Preliminary Decision – proportionality issue not argued but considered by the Tribunal – Tribunal in doubt as to whether the statutory provisions satisfy the requirements of the Human Rights law principle of proportionality – Greengate Furniture Ltd. v Customs & Excise [2003] UKVAT V18280 considered – Directions made to list the appeal for further argument on the proportionality issue and on what interpretation of the statutory provisions in issue should be adopted by the Tribunal if it was to conclude that the statutory provisions (or any of them) did not satisfy the Human Rights law principle of proportionality.

FIRST-TIER TRIBUNAL
TAX CHAMBER

	SKG (LONDON) LIMITED	Appellant

	- and -

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

				TRIBUNAL: 	JOHN WALTERS QC
						MRS. LESLEY STALKER											

Sitting in public in Bexleyheath on 28 October 2009

John R. Culverhouse, Culverhouse & Co., Farnborough, for the Appellant
Hugh O’Leary, Higher Officer, H.M. Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2009

PRELIMINARY DECISION

Introductory and facts
1.	This is an appeal against the decision of HM Revenue and Customs (“HMRC”) to refuse to reduce or waive penalties totalling £2,800 imposed under the Construction Industry Scheme (“CIS”) on SKG (London) Limited (“the Appellant”).
2.	We heard no formal witness evidence, but from the explanations given to us by Mr. Culverhouse, for the Appellant, and Mr. O’Leary, for HMRC, and the documents with which we were provided, we find that the penalties were imposed in the following circumstances.
3.	The Appellant is a company run by a father and son, Brian and Chris Higgins.  It is in the business of supplying conservatories.  The business was a family business until it was transferred to the Appellant company on its incorporation in March 2008.
4.	Brian and Chris Higgins did as much of the bookkeeping as possible themselves, including the VAT.  They got into a muddle and called upon Mr. Culverhouse’s firm to assist in February 2009.  Culverhouse & Co. had handled the payroll and PAYE before that.
5.	In February 2009, Culverhouse & Co. reviewed the Appellant’s VAT accounting and during that review it became apparent to them that they had used the services of a subcontractor, Partridge Home Extensions Limited, in July 2008.
6.	That subcontractor had allowed a deduction for tax against the amount invoiced to the Appellant for its services.  
7.	In February 2009, Culverhouse & Co. advised the Appellant of its obligation to make a CIS return and contacted HMRC by telephone to register the Appellant in the CIS scheme.  The Tribunal was not shown any document recording this.
8.	A monthly return was then submitted to HMRC on behalf of the Appellant for the month ending 5 August 2008.  The return showed the total amount deducted on account of tax by Partridge Home Extensions Ltd. as £1,119.40.  HMRC received the return on 11 March 2009
9.	The declarations made on the return included one indicating that the Appellant “did not anticipate paying subcontractors in the next six months” (Box 8 of the form).
10.	On 28 February 2009, that is, before receipt of the monthly return for the month ending 5 August 2008, HMRC issued penalty notices in respect of late filing. The penalties were charged in two amounts of £700 and £2,100, totalling £2,800.
11.	The £700 penalty was calculated at £100 per month for each of the months between 19 August 2008, the due date of filing, and 19 March 2009.
12.	The £2,100 penalty was calculated as follows.  £100 for each of the six months between 19 September 2008 and 19 March 2009, plus £100 for each of the five months between 19 October 2008 and 19 March 2009, plus £100 for each of the four months between 19 November 2008 and 19 March 2009, plus £100 for each of the three months between 19 December 2008 and 19 March 2009, plus £100 for each of the two months between 19 January 2009 and 19 March 2009, plus £100 for the month 19 February 2009 to 19 March 2009.  These calculations give £600 plus £500 plus £400 plus £300 plus £200 plus £100, totalling £2,100.
13.	Subsequently, in September 2009, when Culverhouse & Co. were preparing the annual accounts of the Appellant, it came to light that there had been additional payments made to subcontractors by the Appellant.  This necessitated the “repairing” of returns for the periods considered above.  We understand that the returns “repaired” were those for the months ending 5 October 2008, 5 November 2008, 5 December 2008 and 5 January 2009.  An extra £2,363.50 in tax was accounted for by the Appellant on 14 September 2009.
The law
14.	The CIS was introduced by Chapter 3 of Part 3 of the Finance Act 2004 (“FA 2004”) and came into effect on 6 April 2007 pursuant to SI 2006/3240. The primary legislation is supplemented by regulations, the Income Tax (Construction Industry Scheme) Regulations 2005, SI 2005/2045 (“the Regulations”).
15.	The CIS is a scheme for certain payments made by a contactor to a subcontractor under construction contract (“contract payments”) to be made under deduction of sums on account of tax. Payments which would otherwise be required to be made under deduction pursuant to the CIS can nevertheless be paid gross (pursuant to section 60(4) FA 2004) if the payee is registered for gross payment when the payment is made.  Registration for gross payment is made by HMRC on their being satisfied in relation to certain matters.  These are for the most part set out in Schedule 11, FA 2004 and Part 6 of the Regulations.  In order to be entitled to be registered for gross payment, a payee must satisfy the business test (that he is carrying on a construction business in the UK), the turnover test (that he has a minimum turnover as specified in the Regulations) and the compliance test (that generally he is compliant with his tax obligations).
16.	 Where the payee is not registered for gross payment, a deduction must be made under section 61 FA 2004 and the contractor paying the net sum must pay the amount deducted on account of tax to HMRC.
17.	Regulation 4 of the Regulations provides for the making of monthly returns.  The paragraph relevant to this case is paragraph (1)(a) which provides that a return must be made to HMRC in an approved form not later than 14 days  after the end of every tax month, by a contractor making contract payments or payments which would be contract payments but for section 60(4) FA 2004 (payments to payees who are registered for gross payment).  The returns require a significant amount of information to be provided about the contractor (payer) and the subcontractor (payee) and must contain certain declarations to be made by the person making the return.
18.	Paragraphs (10) to (12) inclusive of regulation 4 of the Regulations are relevant to the appeal.  They provide as follows:
(10) If a contractor who has made a return, or should have made a return, under this regulation makes no payments under construction contracts in the tax month following that return, the contractor must make a nil return not later than 14 days after the end of that tax month.  This is subject to paragraph (11).
(11) Paragraph (10) does not apply if the contractor has notified the Commissioners of [HMRC] that the contractor will make no further payments under construction contracts within the following six months.
(12) ... section 98A of TMA (special penalties in the case of certain returns) applies to the requirements in–
Paragraph (1) ... [and] ... paragraph (10).
19.	Section 98A of TMA (Taxes Management Act 1970), which is referred to in regulation 4(12) cited above, provides relevantly as follows:
(2) Where this section applies in relation to a provision of regulations, any person who fails to make a return in accordance with the provision shall be liable–
(a) to a penalty or penalties of the relevant monthly amount for each month (or part of a month) during which the failure continues ...
(3) For the purposes of subsection (2)(a) above, the relevant monthly amount in the case of a failure to make a return–
(a) where the number of persons in respect of whom particulars should be included in the return is fifty or less, is £100 ...
20. Section 118(2) of TMA provides as follows:
 (2) For the purposes of this Act, a person shall be deemed not to have failed to do anything required to be done within a limited time if he did it within such further time, if any, as the Board or the tribunal or officer concerned may have allowed; and where a person had a reasonable excuse for not doing anything required to be done he shall be deemed not to have failed to do it unless the excuse ceased and, after the excuse ceased, he shall be deemed not to have failed to do it if he did it without unreasonable delay after the excuse ceased.

The application of the law to the facts
21.	There was, as Mr. Culverhouse accepts, an obligation on the Appellant to make a return under regulation 4(1)(a) of the Regulations of the deduction made on account of tax from the payment made to Partridge Home Extensions Limited in July 2008.  That return was due to be made on or before 19 August 2008.  It was in fact received by HMRC on 11 March 2009.  Subject to any available reasonable excuse defence under section 118(2) TMA, section 98A TMA provides in these circumstances that a penalty of £700 is payable, recognising the six months and a part of a month by which the return was late.
22.	 There was also an obligation on the Appellant to make monthly returns for each tax month after 19 August 2008 (i.e. the months ending on 19 September 2008 and succeeding months) until 19 March 2009, at which point it appears that the obligation had been satisfied.  This is the result of the application of regulation 4(10) of the Regulations.  Regulation 4(11) cannot save the Appellant because his notification that he would make no further payments under construction contracts within six months was made in the return for the month ending 19 August 2008 which, as has been said, was not received by HMRC until 11 March 2009. 
23.	Each of the six returns due respectively on 19 September 2008, 19 October 2008, 19 November 2008, 19 December 2008, 19 January 2009 and 19 February 2009 was also late and, again subject to any available reasonable excuse defence, the application of the formula set out in section 98A TMA gives total penalties due of £2,100 as set out above.
24.	Mr. Culverhouse submitted that penalties of this magnitude (£2,800 in all) were out of all proportion to the tax in issue (originally £1,119.40 but later adjusted to £3,482.90).  He said that the delay – a maximum of 7 months on the original return, which was the longest outstanding – was over a relatively short period of time.  He emphasised that the Appellant had been honest throughout and the delay had been due to Brian and Chris Higgins failing to understand the CIS system, but the problem had been rectified as soon as Culverhouse & Co. had identified it.  He contended that in the circumstances the Appellant had a reasonable excuse.
25.	Mr. O’Leary submitted that no reasonable excuse had been shown.  HMRC take the view that a ‘reasonable excuse’ is confined to one where an exceptional event beyond a person’s control has prevented the person making a return on time.
26.	The Tribunal comments that in relation to ‘reasonable excuse’ as a defence to a default surcharge in a VAT context, the leading case of Customs and Excise Commissioners v Steptoe [1992] STC 757 supports HMRC’s interpretation.
27.	Mr. Culverhouse readily acknowledged that “ignorance of the law” can afford no excuse, and also that on the facts the Appellant ought reasonably to have been on notice that it had an accounting obligation when it received an invoice from Partridge Home Extensions Ltd. allowing a deduction of £1,119.40 representing tax.
28.	Mr. Culverhouse’s main complaint was that the penalty regime operated disproportionately and unfairly in relation to the Appellant and the Tribunal should recognise this, even if HMRC did not.
The proportionality point
29.	At the end of the hearing we reserved our decision, informing the parties that we would consider the point of whether there was any overarching requirement for the penalties in issue to be proportionate to the relevant default and, if appropriate, list the appeal for further argument.  Neither Mr. Culverhouse nor Mr. O’Leary was, perfect understandably, in a position to address argument to us on this point at the hearing.
30.	We have considered the decision of the VAT and Duties Tribunal (Chairman: Theodore Wallace) in Greengate Furniture Ltd. v Customs & Excise [2003] UKVAT V18280 (11 August 2003).  That decision (as the first paragraph states) was concerned with the proportionality under Community Law and under the European Convention on Human Rights of VAT default surcharges totalling £14,855.56, arising from late payments for four accounting periods in 200 and 2001 which were from 12 days to four days late.  In particular, it concerned the absence of a power to mitigate the penalties.
31.	After an initial hearing (Decision No. 17976), the Tribunal had concluded that the appellant, Greengate Furniture Ltd. (“Greengate”), had not established a reasonable excuse for any of the defaults, following Steptoe (see: above).  The Tribunal was however of the view that if it had power to mitigate the surcharges, a reduction would have been appropriate, and Greengate’s representative had complained that the surcharges were excessive and should be set at a more reasonable level.  The Tribunal noted, see paragraph [25], that:
“It is clear from recent decisions in the higher courts that the principle of proportionality both under Community Law and under Article 1 of protocol 1 to the Human Rights Convention does apply to taxation penalties, see in particular Loudakis v Greece (Case C–262/99) [2001] ECR I-5547 and Lindsay v Customs and Excise Commissioners [2002] STC 588 in the Court f Appeal.”
32.	It therefore listed the issue of proportionality for legal submissions, neither party having been legally represented at the initial hearing.  Also, at the request of the Tribunal, the Attorney-General appointed Mr. Hugo Keith of Counsel to act as Advocate to the Tribunal.  The Tribunal had the benefit of his assistance and extensive submissions by Mr. Richard Hill, Counsel for the Commissioners, together with skeleton arguments from each of them, in reaching their decision reported under the reference given above.
33.	With the benefit of these submissions, the Tribunal was able to trace the history of the VAT default surcharge legislation and noted that whilst any power to mitigate was excluded from the default surcharge scheme, such a power had been introduced in the Finance Act 1993 for serious misdeclaration, persistent misdeclaration, late registration and dishonest evasion (ibid. [40]).
34.	The Tribunal noted that under the VAT default surcharge scheme, the surcharges were tax-geared by reference to unpaid VAT liabilities, and traders generally receive a surcharge liability notice after the first default in one year and escape the regime after a year without defaults.  The first default does not however result in a surcharge liability, but only entry into the regime.  It will however result in notification to the trader of his entry into the regime and the consequences. In addition HMRC operate what the Tribunal at ibid. [43] described as “administrative reductions”, whereby no surcharges calculated at the 2% or 5% rates are issued for less than £400.  The regime provides for increasingly severe surcharges as the frequency of defaults increases during a time when a trader is in the regime.  A reasonable excuse defence is, of course, available in appropriate cases against the imposition of a VAT default surcharge.
35.	The Tribunal’s decision contains a wide-ranging survey of Community law and Human Rights law on proportionality in the context of civil penalties.  It noted (ibid.  at [62]) that the Advocate to the Tribunal had said that there was little divergence between Community law and Human Rights law on the point. It also noted (ibid. at [88]) that Lord Phillips MR (as he then was) in Lindsay had observed that it did not seem to him that the doctrine of proportionality in Community law adds significantly to the Strasbourg (Human Rights law) jurisprudence.  This is of significance in this case because the penalty regime under the CIS could only be susceptible to conforming interpretation by reference to Human Rights law principles of proportionality (unlike VAT default surcharges).
36.	 Those principles can be summarised as follows:
37.	Having regard to Article 1 to the First Protocol to the European Convention on Human Rights, which is in the following terms:
“Protection of Property
Every natural or legal person is entitled to the peaceful enjoyment of his possessions.  No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and the general principles of international law.
The preceding provisions shall not, however, in any way impair the right of a State to enforce such laws as it deems necessary to control the use of property in accordance with the general interest or to secure the payment of taxes or other contributions or penalties.”
the European Court of Human Rights has held that an interference with the entitlement to peaceful enjoyment of possessions in the light of the second paragraph of Article 1– 
“must achieve a ‘fair balance’ between the demands of the general interest of the community and the requirements of the protection of the individual’s fundamental rights. ... there must therefore be a reasonable relationship of proportionality between the means employed and the aims pursued.” Gasus Dosier und Fordertechnik v Netherlands (1995) 20 EHHR 403 at [62].
38.	Nevertheless the European Court of Human Rights  has also held that–
“a contracting State, not least when framing implementing policies in the area of taxation, enjoys a wide margin of appreciation and the court will respect the legislature’s assessment in such matters unless it is devoid of reasonable foundation” – National and Provincial Building Society v UK [1997] STC 1466 at [80].
39.	In International Transport Roth GmbH v Home Secretary [2002] 3 WLR 344, which involved a scheme which provided for fixed penalties of £2,000 per clandestine immigrant without any power to mitigate, Simon Brown LJ (as he then was) said–
“It is further implicit in the concept of proportionality, however, that not merely must the impairment of the individual’s rights be no more than necessary for the attainment of the public policy objective sought, but also that it must not impose an excessive burden on the individual concerned ...” (ibid. at [52])
and he formulated the relevant question as follows–
“Is the scheme not merely harsh but plainly unfair so that, however effectively that unfairness may assist in achieving the social goal, it simply cannot be permitted?” (ibid.  at [26])
40.	In this case, as in Greengate Furniture Ltd., the aspect of the penalty regime which most concerns us from the point of view of lack of proportionality is the absence of any power in the Tribunal to mitigate penalties for late returns under the CIS in a proper case.
41.	 We note that, unlike the VAT default surcharge regime, the CIS late filing penalties in issue are not tax-geared and impact on a contractor without prior notice from HMRC.  Thus the penalties impact very harshly on contractors with small liabilities to account under the CIS in comparison with contractors with high liabilities.  Further, contractors who are not advised in relation to the scheme are in practice at a severe disadvantage compared with contractors who are so advised.
42.	In contrast, in Greengate Furniture Ltd., Counsel for the Commissioners had stressed that the fact that the VAT default surcharge was issued after a warning and that it was geared to the tax unpaid were indications of a reasonable relationship of proportionality between the penalty and the public objective sought to be met by it (ibid. at [56]).
43.	Whereas it might be difficult to conclude that a late filing penalty in relation to a return of actual payments made by a contractor within the CIS was “devoid of reasonable foundation”, the position is or may be different in relation to the penalties attaching to successive nil returns which are required to be made under regulation 4(10) of the Regulations.  It is to be noted that the facts of this case (late filing of the original return) effectively nullify in the circumstances of this appeal the safeguard provided by regulation 4(11) of the Regulations.
Conclusion and direction
44.	In the light of the foregoing, the Tribunal is left in doubt as to whether or not the statutory provisions for the penalty for late filing of a return under regulation 4 of the Regulations and the defence of reasonable excuse provided by section 118(2) TMA, without an explicit power in the Tribunal (or HMRC) to mitigate the penalty, satisfy the requirements of the Human Rights law principle of proportionality.
45.	In these circumstances we will direct as follows:
DIRECTIONS
1.	The appeal will be listed for further argument on the proportionality points identified in this Decision and on what interpretation of the statutory provisions in issue should be adopted by the Tribunal if we were to conclude that the statutory provisions (or any of them) did not satisfy the Human Rights law principle of proportionality.
2.	The Tribunal will require a skeleton argument from any party which is legally represented, to be lodged with the Tribunal not less than four days before the date fixed for the further hearing.
3.	The parties are each of them to write to the Tribunal within 21 days after the release of these Directions with their respective wishes on:
o	Where the further hearing will be held, whether at Bexleyheath or 45 Bedford Square London WC1B 3DN;
o	How long the further hearing should be listed for, whether for one day or more than one day; and
o	What dates in the period from March to July 2010 (inclusive) would be inconvenient for the adjourned hearing
46.	The Tribunal will request the Attorney-General to appoint Counsel to act as Advocate to the Tribunal.  If such Counsel is appointed the Tribunal will have regard to his or her dates to avoid in fixing the further hearing and such Counsel should provide the Tribunal with a skeleton argument not less than four days before the date fixed for the further hearing.  

JOHN WALTERS QC

JUDGE OF THE FIRST-TIER TRIBUNAL
RELEASE DATE: 3 December 2009