[2011] UKFTT 57 (TC)

TC00935

Appeal number: TC/10/01722

INCOME TAX/CORPORATION TAX – Taxes Management Act 1970 s.12B(1) – whether requisite records kept – transfer of profit on construction contract from sole trader’s accounts to company partially owned by sole trader – loss of tax.  Appeal dismissed. 

FIRST-TIER TRIBUNAL

TAX 

	JOHN JOHNSTONE	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

TRIBUNAL JUDGE:	W Ruthven Gemmell, WS 

Sitting in public at 126 George Street, Edinburgh on Wednesday 1 December 2010.

Mr George Moore of Montpelier Professional (Galloway) Limited, for the Appellant

Ms Christine Cowen, instructed by the General Counsel and Solicitor to HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2011

DECISION

Introduction
1.	This is an appeal by John Johnstone (“JJ”), a builder who trades as a sole trader, against an assessment for the tax year 2005/2006 in respect of omitted sales of £14,214 in relation to an Imperial Homes (“IH”) contract, relating to work carried out between March 2004 and April 2005, issued by HM Revenue and Customs (“HMRC”) on 2 September 2009.
2.	The Assessment was reviewed and upheld by HMRC on 22 December 2009.
3.	JJ contend that the income belongs to Kinnera Homes Limited (“KH”), a property development company of which JJ personally owned 50% of the shares until 2005 when he purchased the other 50% from Mr Harry Drysdale (“HD”).
Legislation

Taxes Management Act 1970

Section 12B

Records to be kept for purposes of returns -
(1)     Any person who may be required by a notice under section 8, 8A or 12AA of this Act to make and deliver a return for a year of assessment or other period shall—
(a)     keep all such records as may be requisite for the purpose of enabling him to make and deliver a correct and complete return for the year or period; and
[(b)     preserve those records until the end of the relevant day, that is to say, the day mentioned in subsection (2) below or, where a return is required by a notice given on or before that day, whichever of that day and the following is the latest, namely—
(i)     where enquiries into the return are made by an officer of the Board, the day on which, by virtue of section [28A(1) or 28B(1)] of this Act, those enquiries are completed; and
(ii)     where no enquiries into the return are so made, the day on which such an officer no longer has power to make such enquiries.
Cases
The Cape Brandy Syndicate v C. I. R [1921] 1 K.B. 64
T.Haythornwaite and Sons Ltd v Kelly, Court of Appeal [1927]
Nicholson v Morris (Ch.D.) [1976] S.T.C. 269
Hurley v Taylor (Ch.D.) [1998] S.T.C. 202

The Facts
The following facts were found –
4.	JJ is a builder and trades as a sole trader normally involved in civil engineering and building work with particular emphasis on agricultural buildings.  
5.	JJ owned land at Kirkinner in Wigtownshire and in February 2003 he and HD, a joiner, decided to develop a site in the centre of Kirkinner village as a speculative development on a joint venture basis.  In order to obtain the protection of limited liability and simplify the division of profits, JJ and HD formed a company, Kinnera Homes Limited (“KH”), which was registered in Edinburgh on 2 February 2003.  JJ owned 50% of the one hundred shares and HD the other 50%.
6.	Land at the site which was known as Rowantree site was bought by the company from JJ and was developed to build six dwelling houses.  JJ and HD, as sole traders, carried out work for KH at their normal charge out rates and KH contracted other trades as required.
7.	The work on the Rowantree site was completed in May 2004 and whilst this work was in progress Mr L Martin who owned land at 60 Main Street, Kirkinner, impressed by the Rowantree development, asked for a similar type of house to be built.  Work for this commenced in November 2003 and was completed in April 2004.
8.	The accounting treatment for the Martin house was similar to the Rowantree development where JJ charged KH for his time at his usual rates and the profit on the contract was retained by KH and formed part of the taxable profits for the company.  In January 2004, a further enquiry was made by IH who also owned land at Kirkinner.  In relation to the contract for IH the quotation for the work was prepared by JJ as a sole trader, invoices were raised to IH by JJ and payments were made to JJ’s bank account.
9.	JJ was responsible for keeping the books and records of KH and it was important to keep these separate from his own business so that KH could receive an account of the correct level of profits on its business transactions.  
10.	On 5 July 2005, HD sold his shares in KH to JJ and HD resigned as director for personal reasons.  At this time, HD was involved in divorce proceedings.
11.	The accountants for KH, JJ and HD were the same firm, Montpelier Professional (Galloway) Limited (“Montpelier”), based in Newton Stewart.  When Montpelier prepared a draft of the accounts for KH for the year to 28 February 2006 there were no records of any sales for the company.  This was queried with JJ who remembered that a second phase of work was done for KH in the first three months of that year which started in February 2005 and completed in April 2005 which had been included as part of JJ’s sole trading business.  Montpelier adjusted the accounts of KH so that the share of the contract due to KH was debited to JJ’s sole trading business and credited to KH.  HMRC challenged this transaction when carrying out a review of JJ’s trading records.
12.	No written contract for the Rowantree development existed between JJ and HD as to what work would be carried out or allocated but all work was put through KH.  KH had only two employees, JJ and HD.  It was explained that in Wigtownshire, it was not the habit to use written contracts and, instead, there was usually a verbal contract, an estimate and, thereafter, matters largely depended on trust.  No contract between JJ and IH was produced and similarly no contract between IH and KH was produced.
13.	It was stated in evidence that JJ was suffering from chronic fatigue syndrome, also known as ME, and was struggling to run a business and that he was so affected by this illness that he was unable to take a holiday with his family.
14.	Evidence was given by Mrs Maureen McClumpha (“MM”) who is a Higher Officer with HMRC based at their Irvine office in Ayrshire and who was a credible witness.  MM wrote letters on 28 June to Montpelier enclosing a Section 9A Taxes Management Act 1970 notice and wrote to JJ on 28 June, requesting detailed information about JJ’s 2005/2006 tax return, a copy of which was also sent to Montpelier.  
15.	Having received no reply, MM wrote again on 31 August with a list of items requesting that these should be produced within thirty days and on the same date, a letter was sent to Montpelier enclosing a notice under Section 19A of the Taxes Management Act 1970.
16.	Responses were made on behalf of JJ by Montpelier on 24 September and 5 December 2007.
17.	The nominal ledger submitted for the period ended 30 November 2005 showed an entry for IH for £14,214.  On 13 December 2007, MM raised a query concerning this entry and requested documentation in support of the addition made in respect of IH.
18.	Having received no reply, MM wrote again on 6 February 2008 including a request for the reasons why JJ had not included details of his directorship of KH in his return.
19.	On 11 March 2008, a further notice under Section 19A of the Taxes Management Act 1970 was issued and a reply was received from Montpelier dated 17 March stating that KH actually undertook the IH work but that payment was received by JJ and that the full amount £14,214 was included in the accounts of KH for the year to 28 February 2006.
20.	A meeting took place at the offices of Montpelier on 27 August 2008 at which JJ, George Moore, a partner in Montpelier, and MM and another HMRC inspector were present.
21.	A note of this meeting was submitted to the Tribunal together with a letter of 8 September sending it to MM stating that the minutes “represent a general report of the relevant matters discussed and asking if Montpelier would let HMRC have their client’s written agreement to these minutes by having one copy signed, dated and returned within thirty days of the letter and also stating that if these were not received HMRC would assume JJ’s agreement”.
22.	On 11 September 2008, Montpelier wrote in relation to a subsequent telephone enquiry by MM in relation to the interview relating to holidays.  In the letter Montpelier stated that JJ gave “correct, honest information at the interview”.
23.	The minutes of the meeting of 27 August stated that JJ was under no obligation to answer any of HMRC’s questions but that any volunteered information would be taken into account.  JJ stated that “he had adopted a haphazard approach to his record keeping and that he normally wrote up his cash book on a quarterly basis to coincide with completing his VAT returns”.  JJ confirmed that at the end of each year he handed over his records, which JJ appreciated may not be easy to follow, to Montpelier and, at that stage, any errors or mistakes would be picked up and discussed by JJ and Mr Moore.  
24.	JJ had tried to improve his record keeping but found it difficult.  MM explained that JJ had an obligation to maintain his records to an acceptable standard and  referred to rules regarding record keeping and the need to keep a clear audit trail along with full supporting documentation.
25.	An explanation was given as to the operation of KH whose main activity was property development as opposed to the sole trading businesses carried out by JJ and HD.  The arrangement in place was that sub contractors brought all the materials and supplied the labour and at the end of each month invoices were then given to KH although JJ confirmed that he did not know for certain if he actually prepared invoices nor whether he kept them.
26.	The eventual sale of the Rowantree development was carried out by KH.  JJ confirmed that after the Rowantree project, the company was involved with two properties in Main Street, Kirkinner, one with Mr Martin and one with IH which were “new build” rather than property developments and where the land was owned respectively by Mr Martin and IH and the properties were sold by IH and owned by Mr Martin.  As regards IH, JJ stated that the work carried out on this contract was by his sole trading business which paid for all materials and labour and he explained this was then invoiced to KH although when asked to confirm this he stated he was unsure if paperwork ever changed hands between himself and KH.
27.	MM noted that the IH invoices were raised by JJ as a sole trader, the expenses relating to this work had been paid by his sole trading business and that payment from IH had been paid to JJ and deposited in his sole trading business banking account where it had remained.  MM stated at the interview there was no evidence to support the statement that work belonged to KH.  It was confirmed at this meeting that no paperwork had ever been created by KH and KH never received or paid out any monies in respect of this work.
28.	At the meeting JJ accepted that he could not claim the expenses of one business against the profits of another but in JJ’s mind he had not seen this as important as it was still him.  MM reminded JJ that he needed to keep both businesses separate.  MM stated that her view was that the £14,214 would be added back to JJ’s sole trading business.  A summary of the meeting stated that it was agreed that Mr Moore would review the issues regarding the work of IH.
29.	On 22 October 2008, a further Section 19A of the Taxes Management Act 1970 Notice was served on JJ in respect of items not received which had been requested in the letter of 8 September 2008.  Amongst these items was a request for any paperwork relating to the work carried out to/from the businesses being JJ and KH.  This was to include any invoices, receipts, corresponding bank entries, copies of construction industry vouchers issued or received.
30.	A response to this letter was sent to HMRC from Montpelier on 2 December which stated “once again JJ is looking out the paperwork relative to the transactions between his business and KH”.
31.	On 22 December 2008, a telephone conversation took place between MM and JJ.  JJ was advised of the seriousness of failing to supply the required information which JJ acknowledged.  JJ assured MM that he would deal with the enquiries and was given until 5 January 2009 to respond.
32.	A letter dated 5 January 2008, but received by the Scottish West Glasgow HMRC office on 9 January 2009, was sent enclosing a copy of the accounts for KH for the year 28 February 2006.  These contained a debtors item for £14,214.  A letter dated 8 January 2009 included amongst other things “documentation relating to the work done by KH for IH together with a time chart showing the timing of the work and invoices from JJ’s own business together with costings”.  These included “1) quotations to IH dated 16 February 2004 (J Johnstone Billhead), 2) invoices from JJ to IH and 3) spreadsheets from IH.  
33.	A note attached to the 8 January 2009 letter stated that “the monies from IH were paid to JJ’s business account for a number of inter-related reasons and as previously discussed the necessary adjustments were made at a later date, i.e. on submission of the accounts”.  The note went on to say “essentially at a time when IH was being carried out difficulties had arisen between the directors and to avoid further unnecessary complications at that stage discussion with Mr Moore advised on a course of action which meant that monies were not transferred at that time and, accordingly, as now pointed out, the paperwork which would have implemented such transfers did not get created”.  
34.	At the time of the payment JJ, as a sole trader, was operating on a substantial overdraft situation; meanwhile KH was comfortably in credit.  As KH was not requiring funding but still owed JJ from previous directors’ loan, the situation got overlooked during a complete review of how the KH/HD was to be sorted out.  In preparation of the accounts, this matter came to light and the necessary adjustments were made to resolve the situation”.
35.	The note continued “JJ, as a sole trader, was only due costs for this job, analysis which showed that the costs amounted to some £31,870 with the final paid amount from IH of £46,303.  Profit of approximately £14,000 was therefore due to KH and, accordingly, were made to reflect such”.
36.	JJ stated that there was never any attempt to disguise or hide any adjustments and clerical systems had been improved to avoid a repeat of such a situation.
37.	On 16 February 2009, MM wrote again requesting further documentation about the business conducted by KH and JJ.
38.	MM stated that unless evidence could be provided the Revenue’s view would be that the IH transactions were carried out by JJ and they should be returned and assessed by his sole trading business.  MM stated it was not sufficient to simply say that it was the intention of the limited company to deal with this side of the business; it must be proved that the transactions were legally carried out by the company.
39.	Montpelier replied on 30 March 2009 and stated that KH was not a builder or involved in any way in construction and was not registered under the CIS regulations to provide construction industry statements.
40.	By letter dated 13 May 2009, HMRC proposed an addition be made to JJ’s accounts for the year to 30 November 2005 and a corresponding reduction made in the accounts to KH for the year to 28 February 2005.
41.	Montpelier replied on 19 May stating IH had approached KH to ask them to do work on a property in Kirkinner because they were impressed with the work done at Rowantree Court and that KH then subcontracted this work to JJ.
Submissions by HMRC
42.	HMRC say that the IH contract was carried out by JJ as a sole trader; that there is no evidence of a contract between JJ and KH in relation to this work; that there is no paperwork at all to connect KH to IH; that the original quotation was made by JJ on his sole trading business stationery; that three invoices were raised to IH by JJ again on JJ’s stationery; that monies were paid to JJ as a sole trader by KH; that monies were received by JJ in a sole trader’s bank account and that JJ correctly recorded the payments as a sole trader.  
43.	HMRC state that their assessment must stand until the tax payer proves that it is wrong and referred to Walton, J in Nicholson v Morris who stated that “it is the duty of every individual tax payer to make his own return and if challenged to support the return he has made or if that return cannot be supported to come completely clean and if he gives no evidence whatsoever he cannot be surprised if he is finally lumbered with more than he has in fact received.  It is his own fault he is so lumbered”.
44.	HMRC state that it is the evidence that is important and not the intention and refer the opinion of Rowlett, J in The Cape Brandy Syndicate v The Commissioners of the Inland Revenue who stated that “in taxation you have to look simply at what is clearly said.  There is no room for any intendment; there is no equity about a tax:  there is no presumption as to a tax; you read nothing in; you employ nothing, but you look fairly at what is said and what is said is said clearly and that is the tax”.
45.	HMRC submit that the appeal should be dismissed.
Submissions by JJ

46.	JJ says that his sole trading company did not carry out private house building work or property development work and this was only carried out by KH.  It was KH’s intention that the work for IH was carried out by KH and that the paperwork was overlooked at the time but before the accounts were submitted an adjustment was made to reflect what was intended.
47.	JJ state there was no written contract between JJ and IH.
48.	JJ state that issues of ill health may have resulted in the paperwork being overlooked to record what they believe is the correct treatment of the work on the IH contract.
49.	JJ state that there is no issue of the income not being declared and that the reason for the adjustment was in furtherance of an obligation on JJ to particularly ensure in his bookkeeping that any profits due to KH were properly recorded as these had to be split with HD when he was his co-shareholder.  JJ contends the decision to move the profit on the IH contract from JJ’s account to KH’s account was necessary to correct a bookkeeping error and to correctly record the transactions of both businesses.
50.	The process of preparing and reviewing draft accounts is precisely to correct these types of errors as far as possible before accounts are submitted to HMRC and Companies House.
Reasons for the Decision
51.	The Tribunal noted that, in Mr Moore’s view, JJ kept good bookkeeping records and that the work for the second phase of the IH contract was quoted for by JJ as a sole trader, invoiced by him and the funds were received by him in the same way.  
52.	The Tribunal have sympathy for anyone with chronic fatigue syndrome and the pressures this can cause but feel that there is insufficient evidence to show that the work for IH was as a result of a legal contract with KH.
53.	The Tribunal note that the practice in Wigtown is not to have written contracts but this does not remove the necessity of the taxpayer to have the records required by law, namely, to keep all such records as may be requisite for the purpose of enabling the taxpayer to make and deliver a correct and complete return for the year or period.
54.	The Tribunal finds that on the evidence before it that the IH work was carried out by JJ and, accordingly, the assessment stands.
55.	The appeal is, therefore, dismissed.
56.	This document contains full findings of fact and reasons for the decision.  Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.  The application must be received by this Tribunal not later than 56 days after this decision is sent to that party.  The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice. 

W RUTHVEN GEMMELL
TRIBUNAL JUDGE

RELEASE DATE:  17 JANUARY 2011