18870
VAT DEFAULT SURCHARGE – Failure to make payment of VAT by due date – Reasonable excuse of bad debts and problems with a specific contract – A reasonable business person would have foreseen these difficulties – no reasonable excuse found – Appeal dismissed.

LONDON TRIBUNAL CENTRE

	ROMARK FABRICATIONS LIMITED	Appellant

	- and -

	THE COMMISSIONERS OF CUSTOMS AND EXCISE	Respondents

				Tribunal: Michael Tildesley	 (Chairman)
					    Shahwar  Sadeque MBCS (Member) 

Sitting in public in  London on 10 November 2004

Mr C R Pritchett, Managing Director, appeared for the Appellant Company

Mrs P Crinnion, Advocate  for the Respondents

© CROWN COPYRIGHT 2004

DECISION

The Appeal

1.	The Appellant is appealing against the following default surcharges imposed under section 59(4) of the VAT Act 1994: 

Surcharge
£
	% Rate
	Period	Due Date	Date Payment Received	
1851.62	10	03/03	30/4/03	28/10/03	
3064.47	15	06/03	31/7/03	24/10/03	
2231.21	15	09/03	31/10/03	17/12/03	
3873.11	15	12/03	31/1/04	06/02/04	

The Facts 

2.	Mr Pritchett and his wife set up the Appellant company in 2000 dealing with metalwork fabrication. The annual turnover of the company was about £700,000 employing 13 members of staff. The company principally acted as a sub-contractor for major building companies. Recently it had completed a large contract for Balfour Beatty at Lambeth Police Station.

3.	Mr Pritchett explained that the company had done reasonably well in the first two years with no major cash flow problems. Towards the end of 2002, the company experienced several bad debts with two of its customers going into liquidation. At the same time Botes, a Chartered Building Company, engaged the Appellant company to carry out works at Hatfield school. Mr Pritchett told the Tribunal that the Appellant company  suffered severe losses from the contract. Some of the losses were due to under pricing the contract and the imposition of penalties imposed by Botes to the tune of £19,359. However, the majority of the loss estimated by Mr Pritchett at about £60,000 was a result of the company duplicating part of the work. Mr Pritchett believed that a lorry load of steel had gone missing from the galvanisers. He could not be precise about the amount of the loss because at the time there was no job costing system in place which would have recorded the number of lots of steel sent and received from the galvanisers. The company has now implemented a job costing system and changed the firm that performed the galvanising.   

4.	The company operated the invoice system of accounting for VAT purposes. Bad debt relief had not been claimed in respect of those debts that Mr Pritchett believed to be irrecoverable. Mr Pritchett was not aware of the other forms of accounting for VAT, such as cash accounting and the construction industry scheme. Mr Pritchett was unable to pinpoint exactly when the bad debts arose. The Tribunal, however, was presented with a “Schedule of Write Offs or Contracts in Dispute as at 31/12/03” which revealed bad debts of £47,930 (VAT inclusive) or 6.8% of the estimated annual turnover of £700,000.

5.	Mr Pritchett and his wife were determined to ride out the cash flow difficulties caused by  the bad debts because they believed that the business had a future. Initially he planned to sell a separate property to his sons to inject cash into the company. This deal was supposed to be finalised in early February 2003 but the transaction encountered problems because the Abbey National was not prepared to waive the mortgage condition requiring the provision of an insolvency indemnity policy. In the end Mr Pritchett re-mortgaged the property raising £136,905 on 16 December 2003. In the interim Mr Pritchett borrowed money from friends and family and cashed in his pension to keep the company afloat. The monies obtained from the re-mortgaging discharged these debts with the remainder going into the company. 

6.	During this period of cash flow difficulty Mr Pritchett considered that it was more important to pay his employees and suppliers than the VAT due so as to avoid his company going into liquidation. Throughout this period of difficulty Mr Pritchett kept Customs and Excise informed. The company has now cleared the outstanding VAT except for the default surcharges.

7.	The Respondents carried out an analysis of the company’s bank accounts for 2003 from which they considered that the company had the funds to pay the outstanding VAT on time.  They considered that the bad debts identified were not outside the normal hazards of the business. They examined all the documents provided by Mr Pritchett but were unable to find any exceptional reasons for the Appellant’s defaulting on the VAT payments. They were, therefore, unable to use their discretion to waive the default surcharges because it would be unfair on other traders who were faced with the same business hazards as the Appellant company.

Our Decision

8.	Section 59 of the VAT Act 1994 requires the Appellant company to furnish the VAT return and pay the outstanding VAT within one month of the relevant accounting period. The Appellant failed to comply with this requirement for the accounting periods 03/03, 06/03, 09/03 and 12/03. As the Appellant was subject to a surcharge liability notice throughout these periods it was liable to pay surcharges amounting to £11020.41 for its defaults.

9.	The Appellant company can avoid the default surcharges if it can satisfy the Tribunal that it had a reasonable excuse for not furnishing the VAT returns and payments on time. We accept that the Appellant company was experiencing cash flow difficulties  from the end of 2002 and into 2003. We also acknowledge Mr Pritchett’s determination and efforts to keep his company afloat. Insufficiency of funds in itself, however, cannot in law amount to a reasonable excuse (section 71(1)(a) of the VAT Act 1994).  The reasons for the insufficiency of funds may amount to a reasonable excuse, particularly if the facts of the case demonstrate that the insufficiency was due to unforeseeable and inescapable misfortune.

10.	In this case Mr Pritchett explained that the Appellant company was unable to pay its VAT on time because of cash flow difficulties. The reasons for these difficulties were two-fold. First bad debts increased towards the end of 2002. Second the specific problems associated with the Botes’ contract for Hatfield school.

11.	We did not find the evidence about the increase in bad debts compelling. Mr Pritchett was not specific about when the bad debts arose and had taken no action to claim relief in respect of those debts. Moreover the “Schedule of Write Offs or Contracts in Dispute as at 31/12/03” produced by Mr Pritchett revealed that the “bad debts” amounted to 6.8% of the company’s turnover. We consider that this scale of bad debts was not out of the ordinary. In our view a properly run business would expect and foresee a level of  bad debts within this range.

12.	The losses suffered from the Botes’ contract for Hatfield school fall into two distinct categories. The penalties imposed by Botes were in our view an integral hazard of the normal way of conducting  business if one party to the contract fails to meet its obligations. Mr Pritchett did not advance any unusual circumstances for not meeting the contractual obligations. The £60,000 loss arising from the missing load of steel would have been avoided if Mr Pritchett had adopted the standards of a reasonable business person by implementing a system of recording the lots of steel sent to and received from the galvanisers. 

13.	We are, therefore, satisfied that the reasons put forward by Mr Pritchett for the Appellant company having insufficient funds to meet its VAT obligations for the relevant accounting periods do not amount to reasonable excuses. In our opinion a reasonable business person would have foreseen the level of bad debts experienced by the Appellant company and taken steps to avoid the problems associated with the Botes’ contract. 

14.	We dismiss the Appeal and make no order for costs. The Appellant company is, therefore, liable to pay the default surcharges for the periods 03/03, 06/03, 09/03 and 12/03. We also note that there was no Appeal against the surcharge for 03/02. We trust that the Respondents will consider granting the Appellant time to pay the surcharges.

MICHAEL TILDESLEY
CHAIRMAN

RELEASED: 29 November 2004

LON/04/807