[2011] UKFTT 214 (TC)

TC01079

Appeal number:  TC/2010/07084 and 			TC/2010/07085

INCOME TAX – construction industry scheme – gross payments status – self assessment defaults – whether later loss relief claim negates defaults - yes

FIRST-TIER TRIBUNAL

TAX 

	ANNETTE NODEN AND PETER NODEN	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

				TRIBUNAL: Mrs B Mosedale (Tribunal Judge)
						Mrs C S De Albuquerque (Tribunal Member) 

Sitting in public at Holborn Bars, London WC1 on 7 February 2011

Mr Beattie for the Appellants

Mrs Gardiner, officer of HMRC, for the Respondents

© CROWN COPYRIGHT 2011

DECISION

1.	Mr and Mrs Noden (now divorced) trade together in partnership.  Mrs Noden is the nominated partner and was present at the hearing.  Mr Noden was not present as he could not take the time off work to come to the hearing. The partners appeal against the withdrawal of gross payment status under the construction industry scheme notified to them by HMRC in a letter of 1 February 2010.
2.	Mrs Noden gave evidence and we found her to be a good witness and accepted what she said and indeed HMRC did not challenge her evidence.
3.	The business of the partnership is fixing cladding to the outside of high rise concrete buildings as subcontractors to main contractors refurbishing normally publically owned buildings.  Currently the partnership has 20 subcontractors.  They have been in business some 29 years.  Over the time the partnership has varied between having employees, subcontractors, or a mix of both.
4.	The partnership is paid on the basis of how many panels have been fixed.  It is paid in arrears.  The main contractor supplies the panels and the partnership’s main cost is labour.
5.	Apart from late payments at issue in the appeal it was the Appellant’s evidence which we accept (and it was not challenged) that there have been no other late payments of tax in the 29 years.
The law
6.	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”).
7.	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,”
8.	In other words, HMRC considered that, had the Appellants not been registered but applying for registration, they would not have registered them.  So to determine whether this is correct, the Tribunal needs to look at the test for registration for gross payments.
9.	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 accepted that the Appellants met the business and turnover tests and they are not relevant to this appeal.  They deregistered the Nodens because they considered the Nodens failed the compliance test.
10.	The compliance is set out in paragraph 8 of Schedule 11 (for firms).  This provides that:
“(1) Subject to sub-paragraphs (2) and (3), each of the persons who are partners at the time of the application must have complied, so far as any such charge to income tax or corporation tax is concerned as falls to be computed by reference to the profits or gains of the firm’s business, with -  
(a)	all obligations imposed on him in the qualifying period (see paragraph 14) by or under the Tax Acts or the Taxes Management Act 1970; and
(b)	all requests made….”

11.	Paragraph 14 gives the qualifying period as “the period of 12 months ending with the date of the application in question”.  In this case HMRC ran a test on 1 February with a deemed application date of 20 January 2010. HMRC considered that the Nodens failed the test and wrote to them by letter of 1 February 2010 informing them that gross payment status would be withdrawn.
12.	A further part of the compliance test is set out in paragraph 8(4) which states that:
“There must be reason to expect that each of the persons who are from time to time partners in the firm will, in respect of periods after the qualifying period, comply with such obligations and requests as are referred to in sub-paragraph (1).”
This is known as the “reason to expect test” and it is separate to the test of actual compliance.  In other words the Nodens are liable to deregistration if they failed to comply with tax obligations within the 12 month test period or if there is reason to expect that they will fail to comply with tax obligations.
13.	Going back to the compliance test, paragraph 8(2), to which sub-paragraph (1) above is expressed to be subject, brings certain tolerances into the rules.  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 applicant or company is to be treated as satisfying the conditions in paragraphs 4(1), 8(1) and 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)the amount liable to be deducted under section 61 of the Act from payments made during that tax period, or
(b) tax liable to be decucted 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	
Obligation to pay income tax	(1)	Payment is made not later than 28 days after the due date, and
(2)	The applicant has not otherwise failed to comply with this obligation within the previous 12 months.”	
Obligation to submit a self-assessment return within the required period	Return is submitted after the due date	

14.	A further tolerance within the rules is in sub-paragraph (3) of paragraph 8 of Schedule 11 to the Finance Act 2004, which provides:
“Where a person has failed to comply with such an obligation or request as is referred to in sub-paragraph (1)  the firm is to be treated, in relation to that partner, 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 person had a reasonable excuse for the failure to comply, and
(b)	if the excuse ceased, he complied with the obligation or request without unreasonable delay after the excuse had ceased.”

15.	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.  In this case HMRC were not satisfied that the Appellants had a reasonable excuse.  
Nature of Tribunal’s jurisdiction
16.	The Nodens’ appeal is under s67(4) Finance Act 2004, which provides that:
“The jurisdiction of the tribunal on such an appeal that is notified to the tribunal 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.”
Therefore our jurisdiction includes (but is not limited) to reviewing any decision of HMRC taken under s66 (cancellation of registration for gross payment).  
17.	Is our jurisdiction limited to a supervisory one?  Lightman J decided it was not in the case of Hudson (Inspector of Taxes) v JDC Services Ltd [2004] EWHC 602 (Ch) in relation to the predecessor section to s67:
“I therefore hold that the decision could not successfully be challenged on the ground that it proceeded on the basis that the commissioners were not free to substitute their own judgment.”
18.	  This decision was in relation to S561(9) ICTA 88 which referred to “the jurisdiction of the Commissioners on such an appeal shall include jurisdiction to review any relevant decision taken by the Board in the exercise of their functions under this section.”  Lightman J considered (paragraph 21) the historical context of the legislation and noted that at originally the Commissioners’ jurisdiction had been expressly limited to a supervisory one but that restriction had been intentionally removed indicating that the Commissioners (now the Tribunal’s) powers were not merely supervisory.
19.	Lightman J went on to consider (paragraph 22) the statutory context of the words and concluded on four grounds that the intention of Parliament was to grant full appellate jurisdiction.  The second of these reasons is that HMRC were given no discretion on whether or not to cancel gross payment status.  This ground would may no longer to apply in that s66(1) uses the word “may” rather than the “must” which is used in s64.  Nevertheless, all the other grounds given by Lightman J for deciding that the Commissioners had appellate jurisdiction under the predecessor legislation are still applicable:  those grounds are the use of the word “include” noted above; the serious consequences of removal of gross payment status on  any appellant and consistency with other decided cases.  We consider ourselves bound by his decision and, even if we are not, we consider it is the right decision.
20.	We conclude that we have full appellate jurisdiction.  Therefore, we consider whether the Mr & Mrs Noden were in breach of their tax obligations and not whether at the time the decision was taken HMRC reasonably thought that they were.
21.	We therefore move on to consider the facts in this case.
The facts
Schedule of defaults (combined for both partners)
			Days late	
Year 2007/8	Payment on account due 31 July 2008	Paid 5 August 2008	5 days late	
	Balancing payment due 31 January 2009	Paid 5 March 2009	33 days late	
Year 2008/9	1st payment on account due 31 January 2009	Paid 5 March 2009	33 days late	
	2nd payment of account due 31 July 2009	Paid 15 September 2009	46 days late	
	Returns due 31 January 2010	Partnership and both personal returns submitted 23 February 2010	23 days late	
Year 2009/10	1st payment of account due on 31 January 2010	Paid in full by 26 February 2010	26 days late	

22.	This schedule shows the self assessment defaults alleged by HMRC.    We have put in italics the two defaults which were outside the 12 month period of the gross payment status compliance test.  There was no balancing payment due on 31 January 2010 for year 2008/9 as the payments on account during 2009 exceeded the liability (and reduced the 1st payment on account for 2009/10).  The second payment on account for 2010 (due 31 July 2010) was paid early.
23.	It was part of the case put by Mr Beattie that HMRC’s record of his clients’ affairs was so chaotic that the record might not be right.  He points out that client got letters saying they had underpaid PAYE/CIS in 2007/8 but then had letters saying they had overpaid in 2009/10. Although nothing in the papers in front of us explained how the overpayment and underpayment arose we note there is nothing inherently contradictory in having an underpayment in one year and an overpayment in another.  In any event, crucially, at the hearing Mr Beattie said that he accepted that the schedule of self assessment failures was correct.  We find it was correct.
24.	The following table is the alleged CIS/PAYE failures:
Due Date	Date actually paid	
19 June 2009	23 June 2009	
19 July 2009	23 July 2009	
19 August 2009	25 August 2009	
19 September 2009	24 September 2009	
19 October 2009	24 October 2009	
19 November 2009	24 November 2009	

Technical fault with notification
25.	A ground of appeal given in the Notice of Appeal by Mr Beattie was that HMRC’s letter of 1 February 2010 notifying the Appellants that their gross payment status would be withdrawn was flawed.  He pointed out that (a) it failed to take account of the fact that the partners were in credit for four of the six alleged periods of “PAYE” defaults (see below on this) and (b) referred to PAYE defaults when the failures were CIS failures.
26.	HMRC explained that PAYE and CIS deductions were collected in the same manner and HMRC used the expression “PAYE” to refer to both and in any event the partners were on the “PSC” scheme which combined PAYE and CIS payments (as they had had both employees and sub-contractors).
27.	We do not agree with Mr Beattie that the notification was invalid because of these alleged mistakes.  It was clear to the Tribunal that Mr Beattie and the partners had not been misled by the notice.  Indeed there had been a lot of correspondence about it subsequently with HMRC in which, while clear the parties did not agree on the withdrawal of the gross payment status, it was also clear the appellants understood the purport of the letter and the alleged defaults. 
Alleged breach of PAYE/CIS  obligations
28.	Mr Beattie raised a number of arguments about whether the CIS payments due in 2009 were actually paid late.  However, these arguments which included one on whether or not Mrs Noden did post the cheques late or not is, we find, besides the point.  In their email to Mr Beattie of 11 August 2010, HMRC stated that the partnership had overpaid PAYE in 2009/10 to such an extent that the overpayments were carried back and set against an underpayment for a previous year but still left them in credit for 2009/10.
29.	We were not given evidence of when the overpayment arose nor was it explained to us how it arose.  We note that Mr Beattie did not appear to know the answer to this as he had unsuccessfully sought clarification from HMRC in the past.  Mrs Gardiner did not know having taken over the case on the morning of the hearing from an officer who was sick.
30.	HMRC reallocated the overpayments to the Noden’s account in August 2010 and from this it appears the overpayment occurred on 7 August 2009 as the Statement of Account credits the Nodens with 7 August 2009 as the date of payment (except where payment was actually made earlier).
31.	The effect is that of the late payments listed in the letter to the Nodens of 1 February 2010 and set out above notifying them of the loss of gross payment status, actually the only late payments of PAYE/CIS occurred in June and July 2009.  And for these two months the payments were only made 4 days late.  The regulations allow three late payments as long as they do not exceed 14 days.
32.	We find these late payments are clearly within the tolerances as set out above and permitted by Regulation 32 of the Income Tax (Construction Industry Scheme) Regulations 2005 and by themselves do not amount to a breach of the compliance test.
33.	We note that the skeleton argument prepared by the officer who was to have presented the case (but had fallen ill at the last moment) made no mention of PAYE/CIS failures and we presume that for the reasons set out above he did not intend to pursue this matter in any event.  
34.	We uphold the Appellant’s appeal in so far as it relates to PAYE/CIS failures.
Late submission of tax returns
35.	As can be seen from Regulation 32 set out above, late submission of self-assessment tax returns is within the tolerances allowed and is not by itself a breach of the compliance test.
Tax not due
36.	We find the partnership was notified in March 2010 that a client was claiming over £800,000 in damages against them for alleged negligence relating to work carried out in 2007.  Their insurer refused cover.  We find that the partnership made a claim for loss relief in the following tax year because of the claim against the partnership for some £800,000 mentioned above.  This led to a repayment by HMRC to the partners of all the tax paid set out in the schedule above.
37.	Mr Beattie claimed that the partners were therefore not in default of their obligations to pay tax by the due date as they did not (with the benefit of hindsight) owe any tax in 2009.  Mrs Gardiner’s view was that they were in default of their known obligations in 2009 and at the date the test was run.
38.	We were not directed to any authority on this point.  The Income Tax Act 2007 at section 23 provides for the calculation of income tax liability.  It requires as Step 1 “the amount of income on which the taxpayer is charged to income tax” to be identified.  Step 2 requires the deduction of “the amount of any relief under a provision listed in relation to the taxpayer in section 24 to which the taxpayer is entitled for the tax year.”
39.	Section 24 lists section 64 (trade loss relief against general income) and section 83 (carry-forward trade loss relief) under one of other of these sections the loss must have been allowed against the 3 tax years concerned.  From this we conclude that a person’s tax liability is the liability after deduction of all reliefs to which they are entitled.
40.	Therefore, it is our view that, although it was not known to either the Nodens or HMRC, Mr & Mrs Noden had no tax liability in year 2007/8 and were therefore not liable to make the balancing payments (which were paid late) on 31 January 2009.  
41.	As it is apparent HMRC repaid the balancing payments for 2007/8 it follows (although we were not shown any written evidence of this) that the Nodens’ self assessments for 2007/8 were amended to nil.  The effect of that under s59A (4A) is that the payments of account due under s59A(2) in 2009 are deemed to have always been nil.  The payments on account, therefore, also were not late as they were not due.
42.	We have already ruled that our jurisdiction is appellate:  the question is whether Mr & Mrs Noden were in breach of the compliance test, not whether HMRC at the time reasonably thought that they were.  This is an important distinction in this case as clearly HMRC were reasonable to think at the time of their letter of 1 February 2010 that Mr & Mrs Noden were in breach of their obligations as the claim for loss relief had not been made at that time:  it could not have been as it seems even Mr & Mrs Noden did not know of the claim until March 2010. However, by the time of the hearing it was clear that they had made a successful loss relief claim extinguishing their tax liabilities at issue in this appeal.
43.	On this ground therefore we find that Mr  & Mrs Noden were not in breach of the compliance test as set out in paragraph 8(2) as set out above.   
Reasonable Excuse
44.	Mr Beattie put forward a number of matters as reasonable excuse for the failures.  In view of our decision above our findings on reasonable excuse are now irrelevant but we include our decision as recorded below:
45.	Proportionality:  Mr Beattie said that HMRC’s decision was disproportional.  We explain below why we agree with him on this.  However, we did not agree that this was relevant. HMRC cited Judge Staker in John Grosvenor where he said 
“I further find that the consequences of cancellation of gross payment status is not relevant to the issue of whether or not there is a reasonable excuse…”
46.	We consider this to be a correct statement of the law.  The normal use of English language in our view is that an excuse is causative.  It is a reasonable explanation for why something happened.  It therefore follows that something that is not causative cannot be an excuse.  The consequences of the cancellation were (obviously) not the cause of the breaches leading to the cancellation and therefore cannot be an excuse for them.  We do not consider the disproportional effect on the Nodens of the loss of gross payment status to be a reasonable excuse.
47.	We deal with the other suggested reasonable excuses 
48.	Postal problems:  It was the Appellants’ case that all cheques for tax were posted on time; that HMRC would not necessarily open post on the day it was received and that there were wild cat postal disputes at the time the cheques were sent.
49.	It is for the Appellants to make out their case on this and we find they have not.  There were 6 late payments in the 12 month period of the qualifying test, three for each partner.  They were all substantially late.  We were not given any evidence (apart from assertion) that there were strikes which could have caused such delays.  Mrs Gardiner’s evidence which we accept was that HMRC did open post on the day it was received.
50.	We do not accept that the cheques were posted in time.
51.	Insufficiency of funds:  Mrs Noden went on to say that she believes the cheques would have been late because she would have been waiting for payments from the main contractors.  In order to stay in business, their priority had to be to pay the workers and their PAYE first and only then to pay income tax.
52.	Mr Beattie had raised cash flow problems as a cause of the late payment in correspondence with HMRC.  He had been repeatedly asked by HMRC for evidence of cash flow problems and an explanation of their cause.  His reply was in general terms:  that it is well known that the country is in severe recession and the construction industry is one of the worst hit.
53.	At the hearing Mr Beattie reiterated what he had said to HMRC:  he could not show unpaid sales invoices or bad debts to the Tribunal.  We find that the partners’ main cash flow problem was that the main contractors were slow payers. We consider that cash flow problems by themselves could not amount to a reasonable excuse.  The Appellants would need to show that they had arisen due to unforeseen contingency beyond their control.  They have not shown this.  We reject insufficiency of funds as a reasonable excuse.
54.	Reliance on Mr Noden: For Mr Noden it was put forward that he had a reasonable excuse in that he was forced to rely entirely on Mrs Noden:  most of the firm’s work was carried on in Scotland and that was where he lived.  Mrs Noden lives in London where she does all the bookkeeping for the firm.  Mr Noden believed she had done everything properly.
55.	We do not consider that reliance on another person can (in most cases) amount to a reasonable excuse for non-compliance with tax obligations as it is not open to a taxpayer to avoid his obligations by passing them on to another person.  Failures of the third party relied upon must be counted as failures by the taxpayer.  If the third party has a reasonable excuse then this should no doubt also be attributed to the taxpayer but that is not the case here.  We do not find Mr Noden’s reliance on Mrs Noden to be a reasonable excuse.
 “Reason to expect” test
56.	Our decision that in the test period the Nodens were not in breach of their obligations is not the end of the matter as HMRC also say the Nodens fail the compliance test on the “reason to expect” test of paragraph 8(4) as set out above.
57.	The reason for this view by HMRC is set out in their conclusions on review letter of 11 August 2010 in which they say:
“In addition the ‘reason to expect’ test…is also not passed, as there are late payments of self assessment tax made after the end of the qualifying period due on 31 January 2010 but not paid for each partner until 26 February 2010.”
58.	Mr Beattie considers this unreasonable as no credit is given for the previous 25 years of tax compliance.  
59.	We have already ruled that our jurisdiction is appellate.  We note in passing that we think HMRC ought to have considered the Noden’s overall compliance record for the full 29 years they had been in business and even if our jurisdiction was limited to a supervisory one we might on these grounds have found HMRC’s decision to be unreasonable.  However, the question is whether we the Tribunal consider that there is reason to expect that Mr & Mrs Noden will fail to pay their tax.  We can take into account their loss relief claim and that it is likely they will have no tax to pay for some time to come.  Also taking into account their undisputed good compliance record for 25 years prior to the late payments in this case (which now turn out not to have due at all), and the Nodens’ early payment of their second payment on account in 2010, we think on the contrary that there is reason to expect that they will meet their future tax obligations.
60.	That finding concludes the appeal in favour of Mr & Mrs Noden.
Proportionality
61.	We were addressed on the question of proportionality.  Mr Beattie’s point was that it was disproportional to take away the partners’ gross payment status the inevitable result of which would be to put them out of business.  They had been compliant for over 25 years:  why should they be put out of business for a few late payments of tax during particularly hard times?  
62.	It was Mrs Noden’s evidence that the partnership would cease to trade if it lost its gross payment status.  They supply labour.  The greatest part of the charge they make to the main contractor will be the cost to them of the 20 subcontractors.  The 20 subcontractors must be paid on payday or word would spread and the Nodens would find it difficult if not impossible to keep and recruit labour.  If the payment to the Nodens by the main contractor were now to have a 20% retention because the partnership has lost its GPS status, we find the Nodens will be unable to pay their subcontractors on the due date, so we accept Mrs Noden’s evidence that loss of gross payment status will put them out of business.
63.	For these reasons, if we were called upon to decide proportionality (which we are not- see below) we would consider the penalty to be out of proportion to the defaults.  We also consider that removal of gross payment status lacks proportionality because the rules appear inherently unfair:  loss of gross payment status would be less likely to put them out of business if the Appellants traded through a company and not as a partnership.  Section 62(2) only allows an individual to set off the deductions against its income tax liability.  A company (under section 62(3) Finance Act 2004 and the Income Tax (Construction Industry Scheme) Regulations 2005 SI no 2045 (mentioned above) paragraph 56(2)) is entitled to set the deductions against its liabilities to pay NIC, PAYE and CIS deductions to its own employees and subcontractors.  A subcontractor which is a partnership is unable to benefit from these set-offs so would not only have to suffer a 20% CIS deduction on its income but continue to pay PAYE or CIS deductions in respect of the labour it hires.
64.	However, the High Court has ruled in Barnes v Hilton Main Construction [2005] EWHC 1355 (Ch) that the Commissioners could not apply a test of proportionality and in particular concluded that the Human Rights Act did not require the UK courts to read in a test of proportionality in the gross payment 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 now by the “reasonable excuse” exemption which must be even more likely to be seen as proportionate) and because in the last resort the taxpayer could always seek to recover gross payment status 12 months after it was removed if it could demonstrate compliance.
65.	This decision can only be challenged in the Upper Tribunal.  It is binding on this Tribunal and although it is in respect of the predecessor legislation we see nothing in that legislation which is materially different for the question of proportionality.
HMRC’s discretion
66.	We express the view, although we had no argument on it, and in the event it is not relevant to our decision, that the terms of s67 that the Tribunal’s jurisdiction “shall include jurisdiction to review any relevant decision” of HMRC under s66 suggests that the Tribunal does have supervisory jurisdiction to review any exercise of (or failure to exercise) HMRC’s discretion implicit in the use of the word “may” in Section 66.  
67.	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.

Barbara Mosedale

TRIBUNAL JUDGE
RELEASE DATE: 28 MARCH 2011