Eastwell Manor Ltd v Revenue & Customs [2011] UKFTT 293 (TC) (05 May 2011)

DECISION

1. This is the appeal of Eastwell Manor Limited (“the Company) against a VAT default surcharge of £18,453.66 for the quarter ended 30 September 2010. The Company’s VAT payment was received on Monday 8 November instead of on Friday 5 November.

2. The issues in the case were whether the Company had a reasonable excuse for the late payment and whether the surcharge was disproportionate.

Legislation and concession

3. The surcharge was levied under s 59 Value Added Tax Act 1994 (“VATA”). The legislation is set out in the Appendix to this Decision.

4. The Company was on a quarterly basis for VAT, so its VAT return and the related payment were due on or before the end of the month following each calendar quarter [1].

5. HMRC have discretion to allow extra time for both filing and payment when these are carried out by electronic means [2]. Under that discretion, HMRC allow a further seven days for such electronic filing and payment. The rules are set out in By VAT Notice 700 at paragraph 21.5, which paragraph includes the following (with emboldening in the original text).

“If you choose to pay the VAT shown as due on your return by Bankers Automated Clearing System (BACS), Bank Giro Credit Transfer or Clearing House Automated Payment System (CHAPS), you may receive up to 7 extra calendar days for the return and payment to reach us. Here are some important facts you need to know if you want to benefit from this concession:

· The 7 day extension to the due date will be applied automatically every time you pay your VAT return using BACS Direct Credit or Bank Giro Credit Transfer. You may also pay by CHAPS but please note that this may be the most expensive payment method for you. Payment cannot be made via Girobank.

· Payment must be in our bank account on or before the 7th calendar day. If the 7th day falls on a weekend, we must receive payment by the Friday. When the 7th day falls on a bank holiday, payment must be in our bank account by the last working day beforehand.

· To make sure that your payment reaches us in time, you should check with your bank how many days they need to complete the transaction.”

Evidence

6. Mr Parrett represented the Company and also gave oral evidence on its behalf.

7. Mr O’Leary, for HM Revenue & Customs, provided us with a bundle of documents. Some of the material in this bundle, in particular a letter dated 13 April 2011 from HMRC to Mr Parrett, had not been received by him in advance of the hearing. We therefore allowed time for Mr Parrett to consider the new material and asked him if he wanted an adjournment. He said there was nothing unexpected in the bundle and he did not want an adjournment.

8. From the evidence before us we find the following facts.

Facts

The VAT payments and defaults

9. The Company’s VAT payment history, so far as relevant to this Appeal, is as follows:

Period to	VAT due £	Due date	Method	Date paid	Paid by due date £	Rate of sur-charge	Amount £	No. of default
30/6/08	197,103	31/7/08	cheque	12/8/08	Nil	0%	0	1
31/12/08	137,711	31/1/09	cheque	9/2/09	Nil	2%	2,754	2
31/3/09	67,202	30/4/09	cheque	8/5/09	nil	5%	3,360	3
31/3/10	110,907	7/5/10	CHAPS	10/5/10 12/5/10	50,000	10%	6,090	4
30/6/10	139,094	31/7/10	electronic	Due date	all	-	-	-
30/9/10	123,024	7/11/10	BACS	8/11/10	nil	15%	18,453	5

10. The payment made on 30 September 2010, with which this Appeal is concerned, was made by BACS. Because it was paid electronically, an extra seven days were allowed for its receipt. The due date was thus 7 November 2010 rather than 30 October 2010. However, 7 November 2010 was a Sunday, and the money therefore had to be received by HMRC by Friday 5 November. In fact it was not received in until Monday 8 November.

11. Because this was the Company’s fifth default, the rate of surcharge was 15% and the amount was £18,453.66.

Background

12. The Company runs a luxury hotel. In addition to food and accommodation, it offers leisure and beauty facilities. Many of its costs are fixed and the recession has caused some financial difficulty. In December 2009 it entered into a Time to Pay arrangement with HMRC; this had come to an end before the period relevant to this Appeal.

13. We were provided with the Company’s VAT returns for the four quarters ending March 2010. These showed input tax of around 1/3 of the output tax. In the year to March 2010 the Company had a trading loss of £314,000 on a turnover of £4.7m; in the previous financial year the turnover was over £5m. The owners have injected more funds into the Company from personal resources. The Company employs around 150 staff, mostly from the local community.

14. In September 2010 the Company had reached its borrowing limit with the bank. In order to pay its VAT it arranged to receive a loan of £100,000 from another company under the same ownership.

15. This sum was received into the Company’s bank account on Wednesday 3 November. On Thursday 4 November it paid £123,024.44 by BACS. The difference between the £100,000 borrowed and the full amount due was funded by credit card receipts from customers.

16. Mr Parrett was aware when the BACS payment was made that it would not reach HMRC’s bank account until Monday 8 November, and he was also aware that, to avoid a surcharge, the money had to be in HMRC’s account by Friday 5 November. He also knew that the surcharge rate would be 15%.

17. In answer to questions from the Tribunal, Mr Parrett said that he could have paid the £100,000 which had been received on Wednesday 3 November by same day bank transfer, and agreed that this would have ensured that most of the money was received by HMRC before the due date.

18. He also accepted that the Company had made part payments of the VAT due in the first quarter of the year, on 30 April 2010, and that the April part-payment had reduced the default surcharge for that quarter. Furthermore, those payments had been made by CHAPS, so they would have been received by HMRC on the day they were made by the Company.

Submissions for the Company

19. For the Company, Mr Parrett said that he accepted the payment was late. The Company’s business had been struggling, particularly with cash flow, and had previously had a Time to Pay arrangement with HMRC. At the time of setting up that arrangement, the Company had tried to agree a schedule relating to future VAT payments, but been told this was not possible because a debt has first to have crystallised before its payment terms can be renegotiated. Mr O’Leary confirmed that this was the case.

20. Mr Parrett said he understood the law on reasonable excuse and accepted that the Company did not fall within its scope. However, he argued the surcharge was disproportionate. He relied on the First-tier Tribunal decision of Enersys Holdings UK Ltd v R&C Commissioners [2010] UKFTT 20 (TC) (“Enersys”), and drew attention to the similarities between that case and the Company’s position.

21. He said that the Company’s payment had been only one day late, as in Enersys and that the sum was excessive both in relation to the company’s overall business and as an absolute amount. He said that the £18,000 would pay the wages of a member of staff for a year.

22. In relation to the balancing amount of £23,024, which when added to the loan of £100,000 made up the total VAT due, Mr Parrett said that he waited to ensure that sufficient credit card receipts were available to cover this part of the VAT payment. He further said that he did not want this sum to leave the Company’s bank account until the following Monday 8 November, so as to ensure that the Company did not exceed its borrowing limits. The Tribunal noted that the Company had made a BACS transfer for the full amount of £123,024.44 on Thursday 4November, and asked if Mr Parrett was sure that this sum would remain in his account until Monday 8November. He said that this was his understanding of the way the bank transfers worked.

Submissions for HMRC

23. Mr O’Leary said that the Company was well aware of the implications of making late VAT payments. It had already incurred four default surcharges, none of which had been appealed. On each occasion it would have been sent a Schedule headed “Advice to help you avoid a default surcharge”, a copy of which was provided to the Tribunal.

24. This Schedule contained the following information:

(1) details of the Business Payment Support Service, including its telephone number;

(2) a paragraph which said “if you can’t pay the full amount shown on the VAT return, you should consider making a part payment by the due date. That will reduce the amount of surcharge as it is based on a percentage of the VAT that remains unpaid at the due date”;

(3) details of the 7 day extension, together with a reminder that “if the 7^th day falls on a weekend or bank holiday, payment must reach our account by the last working day beforehand.”

25. Mr O’Leary said that the Company had previously used Time to Pay and thus was familiar with how it operated. It would have been possible for the Company to have used this facility again, but it had not done so.

26. He drew the Tribunal’s attention to the recent First-tier Tribunal decision of Kaizen Search v R&C Commissioners [2010] UKFTT 20 (TC) (“Kaizen”). This case was distinguished from Enersys on the facts, and a penalty of £6,901.85 was not found to be disproportionate.

27. In both Enersys and Kaizen the default happened in a quarter where the VAT due was unusually high, but in Kaizen the Tribunal had said that the taxpayer should have anticipated this would be the position. Mr O’Leary said that in the Company’s case, the VAT due for the quarter in question was not unexpectedly high: the schedule of VAT payments showed that it was in line with previous sums due. Like Kaizen, this case should be distinguished from Enersys.

28. Furthermore, he said that in Enersys the default had been accidental; in the instant case, the Company knew the payment would be received late and was fully aware of the consequences of that late payment.

Discussion and decision

29. The Tribunal found this a difficult and troubling case. The quantum of the penalty, - £18,453.66 for a very short delay - is extraordinarily high. Although the Company had not sought to argue reasonable excuse, we did examine this possibility before going on to consider proportionality.

Reasonable excuse

30. The Company had cashflow difficulties, and we accepted that it had reached its overdraft limit. Although inability to pay is not a reasonable excuse (s 71(1)(a) VATA), the underlying reason for that inability to pay can constitute a reasonable excuse (Steptoe v R&C Commrs [1992] STC 527 (“Steptoe”)).

31. The test in Steptoe requires the Tribunal to take for comparison a person in a similar situation to that of the actual taxpayer who is relying on the reasonable excuse defence. The Tribunal must then ask itself - with that comparable person in mind - whether, notwithstanding that person’s exercise of reasonable foresight and of due diligence and a proper regard for the fact that the tax would become payable on the particular dates, those factors would not have avoided the insufficiency of funds which led to the failures.

32. The Tribunal thus needs to be persuaded that that reasonable competent businessman would have defaulted when faced to by the same or similar predicament, despite exercising reasonable foresight.

33. In this case the Company’s cashflow difficulties were neither new nor sudden. We found that the reasonable competent businessman would have either sought a Time to Pay arrangement with HMRC in advance of the deadline, or ensured that he had secured sufficient funds from other sources in sufficient time to pay the VAT due. We thus found that there was no reasonable excuse.

34. We also considered the Company’s point that it had previously asked HMRC to agree a Time to Pay agreement which covered future quarters, and whether HMRC should have provided the Company with this assistance.

35. As Mr O’Leary made clear, HMRC do not offer Time to Pay arrangements on the basis of estimates, and thus the HMRC officials with whom the Company dealt would have been unable to offer such an arrangement. The Tribunal notes in passing that it is in the nature of VAT that it arises as a result of trading, and cannot accurately be predicted in advance. Once a business is aware of a VAT liability, it can then ask for Time to Pay. In the case of the Company, this had clearly worked in the past. Mr Parrett gave no reason to us as to why a further approach had not been made on this occasion.

Proportionality - the principles

36. The parties referred us to both Enersys and Kaizen. We also considered Greengate Furniture Ltd v Customs and Excise Commissioners [2003] VATDR 178 (“Greengate”). We were grateful for these decisions, and in particular for the detailed review of legislative history and case law development set out in Greengate and Enersys, which we do not repeat here.

37. If a penalty is disproportionate to the gravity of the offence, it is clear from the authorities that the Tribunal has a duty under European law to intervene (Garage Molenheide BVBA and others v Belgium (Joined cases C-286/94, C-340/95, C-401/95 and C-47/96) [1998] STC 126).

38. The Human Rights Act 1998 obliges the Tribunal to comply with Convention rights, and these also require that there be “a reasonable relationship of proportionality between the means employed and the aim pursued”, see Gasus Dosier-und Fördertechnik GmbH v Netherlands (Application 15375/89) (1995) 20 EHRR 403.

39. The case law of the ECJ and the European Court of Human Rights (“EctHR”) do not disclose material differences in the meaning of proportionality, and UK case law in this area thus relies on cases from both the ECJ and the EctHR.

40. In International Transport Roth GmbH v Home Secretary [2003] QB 728 at [26] Simon Brown LJ set out the test for assessing proportionality. He said:

“… it seems to me that ultimately one single question arises for determination by the court: 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? In addressing this question I for my part would recognise a wide discretion in the Secretary of State in his task of devising a suitable scheme, and a high degree of deference due by the court to Parliament when it comes to determining its legality. Our law is now replete with dicta at the very highest level commending the courts to show such deference.”

41. The “not merely harsh but plainly unfair” test sets a high threshold before a court or tribunal can find that a penalty, correctly levied on the taxpayer by statutory provisions set by parliament, should be struck down as disproportionate. Perhaps higher still is the threshold set by Waller LJ in R (Federation of Tour Operators) v HM Treasury [2008] STC 2524 at [32], when he said that the penalty in that case was disproportionate as it was “devoid of reasonable foundation”.

42. Earlier Tribunals have considered whether proportionality was a test which applied to the whole default surcharge system, or whether it was possible to consider individual penalties. We agreed with Judge Bishopp in Enersys, when he said at [55]:

“I see no inherent difficulty in the possibility that a usually reasonable and—within the bounds of the state’s margin of appreciation—proportionate system might occasionally lead to an unacceptable result, one which cannot be salvaged by recourse to the proposition that because, by and large, the system produces reasonable results the occasional disproportionate outcome must be tolerated, and an individual taxpayer’s rights offended, in the interests of the greater good.”

43. Nevertheless, this paragraph was set against the detailed review of the default surcharge system in Greengate, which was heard in 2003, and we thus considered the regime in its current form, to see whether there have been structural changes which affect proportionality.

44. The regime was designed to include elements which help it to be proportionate. We noted in particular the absence of any penalty for the first offence, the graduated penalties thereafter and the resetting of the surcharge period after a year of compliance. None of these are new.

45. But Greengate was decided before the introduction of the extra seven day period given for electronic payments, introduced with effect from 22 July 2004 [3]. This provides businesses with further flexibility, allowing them longer to establish their VAT position and to organise payments. It thus plays some role in mitigating the harshness of the regime.

46. The second new factor is the existence of the Time to Pay arrangements operated by the HMRC Business Support Service. These were introduced in November 2008, and they also have the practical effect of providing a structured alternative for those who cannot meet their deadlines, allowing them to avoid penalties altogether.

47. In assessing the proportionality of the surcharges, we took these two factors into account. But they were not decisive and we would have come to the same decision on the facts of this case, had neither the seven day period nor Time to Pay been in existence.

Proportionality - application

48. The Tribunal is required to consider whether the penalty levied on the Company was disproportionate to the gravity of its offence. When carrying out the similar exercise in Enersys Judge Bishopp considered the following factors:

(1) whether the default was “innocent” or “deliberate”;

(2) the number of days of the default;

(3) the absolute amount of the penalty, about which he said “The absence of an upper limit may be justifiable upon the basis that it is a necessary consequence of a tax-geared penalty, though in my view there must come a time, even in the case of a large company, when that justification breaks down”;

(4) the “inexact correlation of turnover and penalty”; and

(5) the absence of any power to mitigate.

49. Turning to the first of the five elements set out above, the Company’s position is easily distinguishable from Enersys, where that company made a mistake and accidentally paid one day late. Here, the Company paid its VAT in full knowledge that it would be received late by HMRC, and clearly understood the default surcharge implications of so doing.

50. The second factor is the number of days of default. Here, the sum was received one day later than the due date of 7 November. However, because 7 November was a Sunday, the real due date was Friday 5 November, and the taxpayer knew this. It is also clearly set out in VAT 700 leaflet and in the Notice sent to the Company on the occasions of previous default surcharges. The payment was thus three days late. Having said this, and noting that three days is longer than the single day in Enersys, it is still a very short period.

51. The third factor was the absolute amount of the penalty. This is undoubtedly extremely high. However, it would have been an easy matter for the Company to have paid £100,000 of the sum due in good time, so avoiding the surcharge on over 80% of the VAT. This would have reduced the surcharge by £15,000 to £3,453.66.

52. When assessing the absolute quantum of a penalty we thus take into account the fact that Company could easily have reduced the surcharge of £18,453.66 by 80% to the much lower figure of £3,453,66 by making a part payment.

53. The fourth factor is that the penalty is based on VATable turnover, which is a very inexact measure of the size of the business. As Judge Bishopp says in Enersys at paragraph 24:

“For example, two manufacturers may have similar levels of turnover and profit, but if the major cost component of the products of one is attributable to standard-rated raw materials, he will have a smaller exposure than the other, whose product has a high labour content, since the former will, and the latter will not, have a large amount of input tax to set against his output tax, leaving a smaller net liability—the penalty being assessed by reference to the net liability.”

54. In this case, the Company’s input tax recoveries were about 1/3 of the output tax, as one would expect of a hotel with high labour costs. We also noted that the Company made losses for the year which immediately preceded the VAT quarter in question.

55. However, this is not a small business. The turnover is around £5m most years, so the penalty is less than 1% of the turnover. There are 150 staff. While turnover is not necessarily a reflection of business size, on the facts of this case, the penalty is not disproportionate to the size of the business.

56. While discussing the same point, Judge Bishopp noted in Enersys (at [25]) that the amount of VAT for the quarter under appeal was unexpectedly high, and said that “had the error occurred in another period the penalty, for exactly the same mistake, would have been much less.” Mr O’Leary distinguished Enersys on this point, and we agree: the VAT payment in the instant case was in line with previous quarters, and this was a further reason to distinguish it from Enersys.

57. Finally, it is accepted that neither HMRC nor the Tribunal have a power to mitigate the default surcharge regime.

58. Taking these considerations together, and being mindful of the “high degree of deference” which courts and tribunals must properly give to statutory regimes put in place by parliament, we found that the penalty, while “harsh”, is not “plainly unfair” or “devoid of reasonable foundation”.

59. In coming to our conclusion we noted in particular the deliberate nature of the late payment and the extent to which the quantum of the penalty could have been easily reduced by the taxpayer’s own action.

60. We therefore dismiss the appeal and confirm the surcharge.

Concluding remarks

61. Before concluding we add a few comments on what appears to us to be a standard letter from HMRC to the taxpayer rejecting the appeal against the surcharge. It contains the following passages (with original emboldening):

“Please note that you cannot appeal simply on the grounds that you consider a surcharge is too severe. The rates of surcharge are laid down in law, and the law grants neither this Department nor the VAT Tribunal [sic] any discretion to mitigate any surcharge…

The Tribunal will only remove a surcharge if:

(a) it is satisfied that the taxpayer had a reasonable expectation that the return and/or payment would be received by HMRC by the due date; or

(b) there is a reasonable excuse for the return or tax not having been sent in on time.”

62. These statements are incorrect as a matter of law and could lead some taxpayers to believe that the issue of proportionality cannot be considered by the Tribunal. We trust therefore that appropriate amendments will be made.

63. 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.

Anne Redston

TRIBUNAL PRESIDING MEMBER

RELEASE DATE: 6 May 2011

The Value Added Tax Act 1994

S59 Default Surcharge

59 The default surcharge

(1) Subject to subsection (1A) below If, by the last day on which a taxable person is required in accordance with regulations under this Act to furnish a return for a prescribed accounting period—

(a) the Commissioners have not received that return, or

(b) the Commissioners have received that return but have not received the amount of VAT shown on the return as payable by him in respect of that period,

then that person shall be regarded for the purposes of this section as being in default in respect of that period.

(1A) A person shall not be regarded for the purposes of this section as being in default in respect of any prescribed accounting period if that period is one in respect of which he is required by virtue of any order under section 28 to make any payment on account of VAT.

(2) Subject to subsections (9) and (10) below, subsection (4) below applies in any case where—

(a) a taxable person is in default in respect of a prescribed accounting period; and

(b) the Commissioners serve notice on the taxable person (a “surcharge liability notice”) specifying as a surcharge period for the purposes of this section a period ending on the first anniversary of the last day of the period referred to in paragraph (a) above and beginning, subject to subsection (3) below, on the date of the notice.

(3) If a surcharge liability notice is served by reason of a default in respect of a prescribed accounting period and that period ends at or before the expiry of an existing surcharge period already notified to the taxable person concerned, the surcharge period specified in that notice shall be expressed as a continuation of the existing surcharge period and, accordingly, for the purposes of this section, that existing period and its extension shall be regarded as a single surcharge period.

(4) Subject to subsections (7) to (10) below, if a taxable person on whom a surcharge liability notice has been served—

(a) is in default in respect of a prescribed accounting period ending within the surcharge period specified in (or extended by) that notice, and

(b) has outstanding VAT for that prescribed accounting period,

he shall be liable to a surcharge equal to whichever is the greater of the following, namely, the specified percentage of his outstanding VAT for that prescribed accounting period and £30.

(5) Subject to subsections (7) to (10) 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 in respect of which the taxable person is in default during the surcharge period and for which he has outstanding VAT, 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;

(d) in relation to each such period after the third, the specified percentage is 15 per cent.

(6) For the purposes of subsections (4) and (5) above a person has outstanding VAT for a prescribed accounting period if some or all of the VAT for which he is liable in respect of that period has not been paid by the last day on which he is required (as mentioned in subsection (1) above) to make a return for that period; and the reference in subsection (4) above to a person's outstanding VAT for a prescribed accounting period is to so much of the VAT for which he is so liable as has not been paid by that day.

(7) If a person who, apart from this subsection, would be liable to a surcharge under subsection (4) above satisfies the Commissioners or, on appeal, a tribunal that, in the case of a default which is material to the surcharge—

(a) the return or, as the case may be, the VAT shown on the return was despatched at such a time and in such a manner that it was reasonable to expect that it would be received by the Commissioners within the appropriate time limit, or

(b) there is a reasonable excuse for the return or VAT not having been so despatched,

he shall not be liable to the surcharge and for the purposes of the preceding provisions of this section he shall be treated as not having been in default in respect of the prescribed accounting period in question (and, accordingly, any surcharge liability notice the service of which depended upon that default shall be deemed not to have been served).

(8) For the purposes of subsection (7) above, a default is material to a surcharge if—

(a) it is the default which, by virtue of subsection (4) above, gives rise to the surcharge; or

(b) it is a default which was taken into account in the service of the surcharge liability notice upon which the surcharge depends and the person concerned has not previously been liable to a surcharge in respect of a prescribed accounting period ending within the surcharge period specified in or extended by that notice.

(9) In any case where—

(a) the conduct by virtue of which a person is in default in respect of a prescribed accounting period is also conduct falling within section 69(1), and

(b) by reason of that conduct, the person concerned is assessed to a penalty under that section,

the default shall be left out of account for the purposes of subsections (2) to (5) above.

(10) If the Commissioners, after consultation with the Treasury, so direct, a default in respect of a prescribed accounting period specified in the direction shall be left out of account for the purposes of subsections (2) to (5) above.

(11) For the purposes of this section references to a thing's being done by any day include references to its being done on that day.

S71 Construction of sections 59 to 70

(1) For the purposes of any provision of sections 59 to 70 which refers to a reasonable excuse for any conduct-

(a) an insufficiency of funds to pay any VAT due is not reasonable excuse; and

(b) where reliance is place on any other person to perform any task, neither the fact of that reliance nor any dilatoriness or inaccuracy on the part of the person relied upon is a reasonable excuse.

(2) …..

First-tier Tribunal (Tax)

THE COMMISSIONERS FOR HER MAJESTY’S

REVENUE AND CUSTOMS Respondents

Anne Redston

TRIBUNAL PRESIDING MEMBER

RELEASE DATE: 6 May 2011

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