18823
DEFAULT SURCHARGE – Reasonable excuse – Shortage of funds – IT software – Whether shortage attributable to WTC attack – Whether attack underlying cause of defaults within Steptoe [1992] STC 757 – VATA 1994 s.71 – Appeal dismissed 

LONDON TRIBUNAL CENTRE

	KENNEDY CARTER LTD	Appellant

-	and –

	THE COMMISSIONERS OF CUSTOMS AND EXCISE	Respondents

				Tribunal:	THEODORE WALLACE   (Chairman)
						ROY JENNINGS, FCA, FTII 

Sitting in public in London on 6 October 2004

Alan Kennedy, managing director, for the Appellant 

Philip Webb for the Respondents

© CROWN COPYRIGHT 2004

DECISION

1.	This was an appeal against default surcharges for the five periods from 10/01 to 10/02.  

2.	Mr Kennedy contended that the Appellant had a reasonable excuse in that it was unable to pay the VAT at the due dates because of the fall in demand for services in its type of business as a result of the terrorist attack on the World Trade Centre on 11 September 2001.  He submitted that this was the underlying cause of the default within Customs and Excise Commissioners v Steptoe [1992] STC 757, CA.

3.	Mr Kennedy gave evidence and was cross-examined at length.  Customs produced a bundle of documents of 136 pages and Mr Kennedy produced profit and loss and cashflow graphs, monthly profit and loss account summaries, a statement showing available funds compared with VAT liabilities and a four year summary showing the budget and the actual performance.

4.	We find the following facts.

5.	The principal activity of the Appellant was to develop and sell intelligent object orientated software engineering tools.  The report to July 2003 referred to the conclusion to a three-year plan to deliver to the market new technology that will provide advanced capabilities needed in the development of complex software systems.

6.	The Appellant’s business was very technology driven.  The accounts show the main assets as being intangible, comprising development  costs and goodwill.  Before the periods in question  the Appellant’s market was eroded by the adoption of a new standard; considerable investment was needed to make the Appellant’s products compatible with this standard.

7.	Up to May 2001 cashflow was adequate and the VAT was paid regularly.  The default giving rise to the surcharge liability notice was for 07/01 for which £34,136 was due by 31 August 2001 but was paid a week late.

8.	In the year to July 2001 turnover was £1,326,560, only a little down from the budget of £1,377,000.  59 per cent of sales were product sales, the balance being services.  Salaries absorbed £769,000 and there was a profit of £68,042.  Turnover had fallen for the second successive year from £1,588,093 in the year to July 1999.  The directors were more confident however and had budgeted for sales of £1,592,100 for 2001/02.

9.	Mr Kennedy could not identify any cause for the default for 07/01 apart from tight trading conditions and the need for substantial spending on research and development.  Net current liabilities according to the accounts at 31 July 2001 were £288,604.  The Appellant was up against its overdraft limit and was factoring its bills but simply did not have sufficient funds for VAT on 31 August 2001.

10.	We find that there was no reasonable excuse for that default since insufficiency of funds by itself is not a reasonable excuse, see VATA 1994, section 71(1)(a).

11.	The three largest customers to July 2001 were GCHQ with 33 per cent of turnover, Lockheed with 19 per cent and Thales with 13 per cent.  The Appellant was changing from a services company to a product company.  It had a new sales team and was budgeting for a 20 per cent increase in sales for 2001/02.

12.	Mr Kennedy told us that he strongly believed that the Appellant’s market was particularly badly affected by the World Trade Centre attack (“9/11”).  There was a slump in sales in 2001/02 of 30 per cent, almost all being due to lower project sales due to deferrals.  He could not point to any specific contracts cancelled.  He said that no one was spending after 9/11 but accepted that no customers had stated that they were cutting back because of this.  GCHQ remained the largest customer and sales to it were not affected by 9/11.  He said that the real effect was a lack of new customers.

13.	The VAT for 10/01 due by 30 November 2001 was considerably lower at £14,992.  The cashflow schedule showed that there were in fact sufficient funds at 30 November although the overdraft limit would have been exceeded a week later.

14.	Mr Kennedy told us that payment terms were nominally 30 days from billing, payment in reality being normally 45-60 days.  The factoring company advanced 70 per cent of bills invoiced within 4 or 5 days of receiving invoices.

15.	We do not see how the effect of 9/11 could have fed through sufficiently quickly to be relevant to the default for 10/01.  Insofar as potential business may have been lost, we cannot see how that business could have been secured and billed in time for that payment.

16.	The VAT for period 01/02 was £19,441 due by 28 February 2002.  The Appellant was narrowly short of available funds and again defaulted.  By that time 9/11 could have affected business.

17.	The first letter to Customs from the Appellant concerning its cash problem was a letter of 15 April 2002 asking for time to pay £10,000.  The letter referred to “a period of very bad cashflow” but made no mention of 9/11 being the cause, nor did further letters on 24 May, 18 July and 19 September 2002.

18.	No further letter from the Appellant was produced until one dated 4 September 2003 appealing against the surcharges.  This was a detailed letter with three pages of single spacing.  The letter included this,

“Our trade revolves around the development of specialised computer programmes.  The whole industry has encountered difficulties over the last five years and we, as a company, are no exception.  Kennedy Carter Limited has experienced particular problems as a major portion of  our client base was with Telecom companies, a sector particularly hit by the downturn.”

The letter again contained no mention of 9/11.  Nor did a further even more detailed letter of 29 October 2003.

19.	The first reference to 9/11 being the cause of the fall in business resulting in the cash difficulties was in the Appellant’s outline argument for the appeal hearing.

20.	Having considered the evidence of Mr Kennedy and all the material before us with care, we are not satisfied that 9/11 was a sufficiently clear and identifiable cause of the shortage of funds to overcome section 71 which provides that a shortage of funds is not a reasonable excuse.  We readily accept that 9/11 added to the Appellant’s problems.  However the Appellant had defaulted before that event and was already in a difficult position at that date.

21.	Mr Kennedy gave detailed evidence of the subsequent efforts to overcome the Company’s difficulties and we can see little else which could have been done.  We do not accept the submission by Mr Webb that the problem could have been overcome by laying off staff.  As Mr Saunders the company secretary pointed out this would have involved costly redundancy payments as well as damaging the morale of remaining staff of a company depending on its intellectual resources.

22.	We have considerable sympathy with the Appellant but have no alternative to dismissing the appeals.

THEODORE WALLACE
CHAIRMAN

RELEASED: 29 October 2004

LON/04/1048
££Kennedy Carter Ltd v Customs and Excise [2004] UKVAT V18823 (29 October 2004)