[2010] UKFTT 85 (TC)

TC00396

Appeal number TRANS/09/11001

Construction Industry Scheme – removal of gross payments status – reasonable excuse – proportionality.

FIRST-TIER TRIBUNAL

TAX 

	ENDERBEY PROPERTIES LIMITED
	
Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS 	
Respondents

				TRIBUNAL: 	P PETHERBRIDGE (Chairman)
						S AKHTAR

Sitting in public in Birmingham on 13th October 2009

Mr Jones, for the Appellant

Mr Sensier, Officer of HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2009

DECISION

Introduction
1.	The Appellant company appeals against the decision of HMRC made after an internal review and notified to its accountant on 14 April 2008 to withdraw its gross payment status for the construction industry scheme.  We did not have a copy of this decision in front of us but the Appellant accepted that he had received it.
2.	HMRC periodically check compliance by taxpayers registered for gross payments.  They run the check looking at compliance in the twelve months prior to the test to decide whether the taxpayer is eligible for registration at that time – it is as if the taxpayer is having to make a fresh application and HMRC deciding afresh whether to register him.
3.	Under the new rules introduced in 2007 HMRC ran a compliance check on the Appellant company and they considered that it had failed – that is if it had made an application at that time to be registered for gross payment status they would have refused it.  
4.	The Appellant company notified HMRC of their appeal on 13 May 2008, HMRC were asked to review the decision which they did by 06 October 2008, upholding the decision.  This was too late for the appeal to be listed in front of the General Commissioners and it came before the new tax tribunal in October 2009, nearly 18 months after the original decision to remove gross payment status.
Law
5.	The current construction industry scheme (“CIS”) came into force on 6 April 2007.  It is contained in the Finance Act 2004 and the Income Tax (Construction Industry Scheme) Regulations 2005 SI no 2045 (“the Regulations”).
6.	HMRC’s decision to de-register the Appellant from gross payment status was taken under s66(1)(a)  Finance Act 2004.  This provides:
“The Board of Inland Revenue may at any time make a determination cancelling a person’s registration for gross payment if it appears to them that-
(a) if an application to register the person for gross payment were to be made at that time, the Board would refuse so to register him,”
7.	In other words, HMRC considered that had the Appellant not been registered but applying for registration, they would not have registered it.  So to determine whether this is correct, the Tribunal needs to look at the test for registration for gross payments.
8.	This is contained in Schedule 11 of the Finance Act 2004.  There are three tests and all must be passed:  the business test, the turnover test and the compliance test.  HMRC did not suggest that the Appellant had not met the business and turnover tests and we did not consider them.  HMRC deregistered the Appellant company because they considered it failed the compliance test.
9.	The compliance test for companies is set out in paragraph 12 of Schedule 11.  This provides that:
“(1) The company must, subject to sub-paragraphs (2) & (3) have complied with – 
(a)	all obligations imposed on it in the qualifying period (see paragraph 14) by or under the Tax Acts or the Taxes Management Act 1970,…
(b)	….”

10.	Paragraph 14 gives the qualifying period as “the period of 12 months ending with the date of the application in question”.  The test period for the CIS Compliance Testwas from 28 October 2006 to 28 October 2007.
11.	The compliance test, paragraph 12(2), to which sub-paragraph (1) above is expressed to be subject, brings certain tolerances into the rules:
“A company that has failed to comply with such an obligation or request as-
(a)	is referred to in sub-paragraph (1) and
(b)	is of a kind prescribed by regulations made by the Board of Inland Revenue, 
is, in such circumstances as may be prescribed by the regulations, to be treated as satisfying the condition in that sub-paragraph as regards that obligation or request.”
12.	The effect of sub-paragraph 12(2) above is that failures to comply with tax obligations within the permitted tolerances will not amount to breaches of the compliance test.  The tolerances are set out in the Regulations.  The Regulations are the Income Tax (CIS) Regulations 2005 SI No 2045 at Regulation 32.  This provides the following relaxation in so far as relevant:
“32 (2) The circumstances prescribed in which the …company is to be treated as satisfying the conditions in paragraphs  … 12(1) of Schedule 11 to the Act as regards each of the prescribed obligations are given in column 2 of Table 3.

Table 3	
Obligation to pay – 
(a)….
(b) tax liable to be deducted under the PAYE regulations	(1) Payment is made not later than 14 days after the due date, and
(2) the applicant or company – 
(a) has not otherwise failed to comply with this obligation within the previous 12 months, or (b) has failed to comply with this obligation on not more than two occasions within the previous 12 months.

13.	Going back to sub-paragraph (3) of paragraph 12 of Schedule 11 to the Finance Act 2004, this provides:
“A company that has failed to comply with such an obligation or request as is referred to in sub-paragraph (1) is to be treated as satisfying the condition in that sub-paragraph as regards that obligation or request if the Board of the Inland Revenue are of the opinion that – 
(a)	the company had a reasonable excuse for the failure to comply, and
(b)	if the excuse ceased, it complied with the obligation or request without unreasonable delay after the excuse had ceased.”

14.	The effect of this is that a failure to comply with tax obligations outside the tolerances permitted by the Regulations will not lead to the application for registration being refused (or, as in this case, the gross payment status registration being removed) if the taxpayer can demonstrate a reasonable excuse.
15.	In this case HMRC were not satisfied that the Appellant had a reasonable excuse.  The appeal is under s67 Finance Act 2004, which provides that:
“(4) the jurisdiction of the commissioners on such an appeal shall include jurisdiction to review any relevant decision taken by the Board of Inland Revenue in the exercise of their functions under section 63, 64, 65 or 66.”
16.	Therefore we have jurisdiction to decide whether or not the Appellant failed the compliance test including whether or not he had a reasonable excuse for paying tax late.  We therefore move on to consider the facts in this case.
Defaults
17.	The decision to remove the Appellant’s gross payment status taken by HMRC was based on the following late payment and in some cases non-payment of PAYE in the year to 28 October 2007 as tabulated below, which were not disputed by Mr Jones.  Mr Jones did not dispute the defaults in the hearing.  They were as follows:
Due date	Date paid	Days late	
22/05/06	26/4/7	1	
22/06/06	16/5/7	8	
22/07/06	12/6/7	6	
22/08/06	Not paid		
22/09/06	Not paid		
22/10/06	Not paid		
22/11/06	Not paid		
22/12/06	Not paid		
22/01/07	Not paid		
22/02/07	Not paid		
22/03/07	Not paid		
22/04/07	16/04/07	238	
22/05/07	Not paid		
22/06/07	Not paid		
22/07/07	27/07/07	67	
22/08/07	Not paid		
22/09/07	Not paid		
22/10/07	Not paid		
22/11/07	29/11/07	7	

18.	These defaults are clearly beyond the tolerances allowed for by the Regulation cited above (as only a maximum of 3 defaults are permitted and then only if less then 15 days late).  The question for the tribunal was therefore whether the Appellant had a reasonable excuse for the late PAYE payments.
Reasonable excuse?
19.	The reasons given by Mr Jones were as follows:
•	In a letter of the 11th September 2008, Mr Jones on behalf of the Appellant set out what he considered to be the extenuating circumstances as to why the Appellant Company was in the situation that they found themselves to be in.  He said this:
	“Historically, my clients have had two limited companies; one company was an electrical contractor, CK Electrical Installations Limited, the other a property maintenance company, Enderbey Properties Limited.  As with many companies under common control, they had an overall bank overdraft facility of £200,000, covered under a cross guarantee on both companies and secured by personal guarantees of the Directors.
This has never caused a problem until late 2005 when CK Electrical Installations Limited had cash flow problems, caused by two major customers refusing to pay a total of £500,000 as it fell due.  Over the next 18 months, the company tried to resolve matters, with the full knowledge of the creditors.  Within the industry there are mechanisms for disputes, whereby claims can be heard at arbitration.  However, these matters do take time and eventually, before matters could be resolved, CK Electrical Installations Limited, were served with a company winding-up order and the company went into liquidation in March 2007.
During the period that CK Electrical Installations Limited were in cash flow difficulty, the bank would periodically, without warning, move monies across from Enderbey Properties Limited to CK Electrical Installations Limited, under the cross guarantees on the overdraft.  These monies had been earmarked for creditors. When the company went into liquidation, the overdraft amounted to £180,000.  To secure their position, the bank converted the overdraft into a loan on Enderbey Properties Limited and transferred £150,000 out of the current account into a deposit for security, which my clients would access.  The £150,000 had been received in advance of work to be done and as you can imagine the loss had a massive effect on the cash flow of Enderbey Properties Limited.  Over the past year, my clients have struggled to pay the company’s debts as they fall due and only now are they getting the company back on track.  So much so that they have managed to pay current liabilities to the Revenue on time and they are working to paying off arrears.
One other major factor that my clients wish to bring to your attention is that the majority of the company’s work is with the NHS in Birmingham.  They have been a long standing customer of the company, but the NHS only deal with companies who have a gross amounts certificate.  Therefore, if Enderbey Properties Limited were to lose their gross status, the company will be unable to continue to trade and they will be forced into liquidation.
My clients accept that they have fallen down on the strict requirements of the gross payment scheme but the problems have been caused by events outside their control.  They have said that they will give assurances that they will continue to pay current year liabilities on time and bring the arrears up to date as soon as possible.
I trust that you are able to take these reasons into account, when making your decision on the gross status.”
20.	The Respondent’s response to that following an internal review of its decision to remove the gross payment status for the company, as set out in its letter to the Appellant’s accountant of the 6th October 2008 was as follows:
“In correspondence with HMRC you have highlighted a reason and the underlying circumstances surrounding the company’s late payments.  I have considered your comments, but I do not consider that reasonable excuse can be attributed.
You state that the late payments were due to an error by the bank when the company’s bank account was frozen following with liquidation of an associated company.  Whilst I can appreciate that this situation would cause a measure of financial difficulty, it does not meet the Department’s interpretation of a reasonable excuse.  The sums paid late relate to PAYE deducted from employee’s wages, which the company collects on behalf of HMRC.   The company has no authority to withhold payment of PAYE and the sums collected must be passed to HMRC at the correct time.
I would add that the aim of the new Construction Industry Scheme is to improve the level of compliance across all construction businesses, including those which are largely but not completely compliant.  The new scheme seeks to ensure that not only is every payment made, but that each payment is made by the due and payable date.
Trading after Cancellation of Gross Status
You also suggest that CIS denial may force the closure of the business and lead to unemployment; whilst this is certainly not the aim of the scheme, the consequences of refusing a gross payment application is not something that can be taken into consideration.  The decision can only be made in accordance with the legislation without reference to proportionality.  In this regard I would draw your attention to the following tax case:-
Barnes v Hilton Main Construction (77TC255)
Here Judge Lewison stated “I consider that the General Commissioners application of a test of proportionality was not a test that the legislation allowed them to apply.”
It should be noted, however, that since April 2002 subcontractor companies are allowed to offset their CIS deductions against their monthly PAYE, NIC and other liabilities to help to alleviate any resulting cash flow issues.
In summary, I must uphold the decision taken.  However, you should note that you are not prevented from making a further application at such time as the company satisfies the requirements of the Compliance 
Test...”
The Evidence 
21.	For the Respondents, Mr Sensier said that the Appellant had never discussed with HMRC its cash flow problems.  It had never sought to make an arrangement for payment and the failure of the two companies to pay CK Electrical Installations Limited had arisen in 2005.   No details of the “major customer’s refusing to pay a total of £500,000 as it fell due” had been provided.
22.	In response, Mr Jones for the Appellant said that no contact had been made with the HMRC because no money was available to make any arrangement at the time.
23.	Mr Carroll, a Director of the Appellant Company added that at the time of the cash flow problems, CK Electrical Installations Limited was causing stress insofar as the operation of the Appellant Company was concerned.  Mr Carroll said that the Appellant’s bank, the Royal Bank of Scotland, had reneged on its bank loan.
24.	The Tribunal were referred to the correspondence from the Royal Bank of Scotland to Mr Carroll of the 22nd March 2007 and the Royal Bank of Scotland’s letter of the 20th April 2007 and the e-mails of the 17th August 2007 and the 20th August 2007 passing between the Royal Bank of Scotland and Mr Jones, the accountant.
25.	The term loan facility of £180,000 was reflected in the letter of the Royal Bank of Scotland of the 20th April 2007.   That letter noted that CK Electrical Installations Limited, a guarantor of Enderbey Properties Limited, had had a liquidator appointed and that the loan had crystallised and become payable on account of the liquidation of CK Electrical Installations Limited.
26.	The Tribunal accepted that as a result of this default of CK Electrical Installations Limited the Appellant’s bank had resort to such funds as were available to the Appellants.  This was not an unusual incident of cross guarantees given by associated companies.
27.	The Tribunal did not consider that the manner in which the bank had operated its term loan facility in the light of the cross guarantees given by CK Electrical Installations Limited could be construed as providing the Appellants with reasonable excuse for the late payment of the PAYE, as tabulated above.
28.	The Tribunal also heard evidence from Mr Kibble a Director of the Appellants who said that there had been problems with the company’s book keeper who had left in March 2007 and there had also been trouble by the company with its software.
29.	The Tribunal did not consider that either of these two reasons amounted to the Appellants being able to show that they had reasonable excuse for the late payments.
30.	The Tribunal noted that the Appellants had been able to make arrangements with its suppliers and creditors to carry on in business, notwithstanding the liquidation of CK Electrical Installations Limited, but it did so without reference to HMRC, which it may well have been able to negotiate some form of time to pay arrangement had it been open with the HMRC as to its difficulties.
Proportionality
31.	The Appellants are pleading that the loss of their status might put the company out of business.  However, our understanding of the law is that we have no discretion to take such a factor into account.  The High Court has ruled in a decision, which is binding upon us, that neither HMRC nor we the Tribunal can consider proportionality: Barnsley v Hilton Main Construction [2005] EWHC 1355 (CH).  In that case, the judge considered the Human Rights Act and concluded that it did not require the UK courts to read in a test of proportionality in the gross payments status rules.   The Court also thought that in any event, the Rules were not disproportionate as there was (then) the “minor and technical” exemption (replaced by the “reasonable excuse” exemption, which must be even more likely to be seen as proportionate) and because in the last resort the tax payer could also seek to recover gross payment status 12 months after it was removed if it could demonstrate compliance.
32.	The Tribunal were, therefore, of the opinion that had the Appellant Company applied for registration on the 28th October 2007 they would have refused it and the Tribunal agrees that they would have been right to do so.
33.	The Appellant has a right to apply for permission to appeal against this decision pursuant to Rule 39 of the Rules.   The parties are referred to “Guidance to a Company Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this Decision Notice.

TRIBUNAL JUDGE
RELEASE DATE: 27 January 2010