19671
	VAT — small businesses flate-rate scheme — public house — bar sales and food sales almost equal but food sales higher — on joining scheme appellants selected ‘Pubs’ as main business claiming that bar sales expected to exceed food sales in following year — food sales continued to exceed bar sales — retrospective change of sector to ‘Restaurants’ by HMRC — whether change reasonable — appeal dismissed 

	VAT — misdeclaration penalty — whether appellants belief that bar sales would exceed food sales constitutes reasonable excuse — held on facts that there was reasonable excuse until first anniversary of appellants joining scheme — appeal allowed in part

MANCHESTER TRIBUNAL CENTRE

MR & MRS MORGAN trading as THE HARROW INN	Appellant

- and -

THE COMMISSIONERS FOR
HER MAJESTY’S REVENUE AND CUSTOMS	Respondents

Tribunal:	David Demack (Chairman)
Susan Stott FCA CTA

Sitting in public in Manchester on 30 June 2006

Steve Porter, accountant, for the Appellant 

Sara Williams, counsel, instructed by the Acting Solicitor for HM Revenue and Customs for the Respondents 

	© CROWN COPYRIGHT 2006

DECISION

1.	The Appellants, Mr Anthony Francis Morgan and Mrs Maria Annette Morgan, his wife, are the tenants of The Harrow Inn, Edge Green Road, Ashton-in-Makerfield, Wigan.  Until 1998 they operated separately registered businesses for VAT purposes; Mr Morgan made bar sales, and Mrs Morgan sales of food.  In that year, Her Majesty’s Commissioners for Revenue and Customs (“HMRC”) determined that they carried on a single taxable business, and they were so registered with effect from the end of December 1998.  From then until 2003 they made their returns in the ordinary way.
2.	But in 2003, the Flat Rate Scheme for Small Businesses (“the Scheme”) was introduced.  Businesses using it may calculate their liability to tax as a percentage of their VAT-inclusive turnover.  The Scheme is open to businesses whose annual taxable turnover (not including VAT) does not exceed £150,000, and whose total turnover (including the value of exempt and non-taxable income but not including VAT) does not exceed £187,500 a year.  It is common ground that in 2003 Mr and Mrs Morgan’s turnover fell within those limits.  
3.	The Scheme, for which section 26B of the Value Added Tax Act 1994 provides, is dealt with in detail in regulations 55A to 55V of the Value Added Tax Regulations 1995.
4.	Regulation 55H provides that:
 “(1) The appropriate percentage to be applied by a flat-rate trader for any prescribed accounting period, or part of a prescribed accounting period (as the case may be), shall be determined in accordance with this regulation and regulations 55JB and 55K.
(2)	For any prescribed accounting period – 
(a)	beginning with a relevant date, the appropriate percentage shall be that specified in the Table for the category of businesses that he is expected, at the relevant date, on reasonable grounds, to carry on in that period.”
And Regulation 55K provides:
“(1)	Where, at a relevant date, a flat-rate trader is expected, on reasonable grounds, to carry on business in more than one category in the period concerned, paragraph (3) below shall apply.
(2) 	…
(3)	He shall be regarded as being expected, on reasonable grounds, to carry on that category of business which is expected, on reasonable grounds, to be his main business activity in that period
(4)	In paragraph (3) above, his main business activity in a period is to be determined by reference to the respective proportions of his relevant turnover expected, on reasonable grounds, to be generated by each business activity expected, on reasonable grounds, to be carried on in the period.”
5.	It is common ground that the flat rate percentage provided by ‘the Table’ for ‘Pubs’ was 6 before 1 January 2004 and 5.5 thereafter; and that the corresponding percentages for ‘Catering services, including restaurants and takeaways’, were 13 and 12. 
6.	HMRC’s interpretation of the above regulations is to be found in their Notice 733.  Paragraphs 6.1 and 6.2 thereof read as follows:
	“6.	Determining your flat rate percentage
6.1	Which flat rate applies to my business?
To work out the flat rate for your business, look at the table in paragraph 6.3 and decide which of the sectors most closely describes what your business will be doing in the coming year.  Just give the words their ordinary meanings.  If you have difficulty deciding on a sector, go to the flat rate scheme ready reckoner at www.hmce.gov.uk/business/services/vat-flat-rate.htm
The number allocated to your trade sector is your flat rate percentage.  You apply the flat rate percentage to your VAT inclusive turnover (see section 7) to get the VAT payable to us under the scheme.
6.2	What if you disagree with my choice of sector?
If we approve you to join the scheme, we will not change your choice of sector retrospectively as long as your choice was reasonable and you have kept a record or why you chose it.”
7.	Paragraph 6.3 of Notice 733 contains the Table set out in regulation 55K, so we need not repeat it.  We then move on to paragraph 6.5, which reads:
	“6.5	What if my business falls into more than one of the sectors?
If your business includes supplies in two or more sectors, you must apply the percentage appropriate to your main business activity as measured by turnover.  Choose the sector for which your business gets the greater part of its turnover.  Do not split your turnover or apply more than one percentage.
Example
If a taxi business also did some car repairs it would have to decide from which of the two trade sectors it expected to get the larger amount of turnover.  It would apply the flat rate percentage appropriate for that trade sector to the whole of its VAT inclusive turnover.”
8.	On 19 September 2003, Mr and Mrs Morgan applied to join the Scheme, choosing in their application ‘Pubs’ as the description that most closely described what their business would be doing in the coming year.  By letter of 29 September 2003, HMRC authorised them to use the Scheme as from 1 October 2003, and informed them that they must notify HMRC if the nature of their business changed.  In the year to 30 September 2004, Mr and Mrs Morgan accounted for tax under the Scheme at rates appropriate to ‘Pubs’.
9.	In the two consecutive accounting periods ended on 30 June 2003 and 30 September 2003, Mr and Mrs Morgan’s bar sales aggregated £54,527, whereas their food sales aggregated £56,807, and for the twelve months ended on 9 October 2003, their records showed respective figures of £72,353 and £81,450.  
10.	Shortly after Mr and Mrs Morgan registered under the scheme, the Harrow Inn was closed and the bar was refurbished at a cost of some £20,000.  At the same time the lounge was redecorated.  The Inn re-opened late in October 2003, and the Appellants continued to trade as before.  (We should perhaps add that there is no restaurant at the Harrow Inn.  Food is served in the lounge and other public areas).
11.	A taxpayer becomes ineligible to use the scheme if, at the anniversary of his start date, the tax inclusive value of his supplies for the year ended exceeded £225,000 (regulation 55M(1)(a)).  That did not happen in the case of Mr and Mrs Morgan in the year to 30 September 2004, so that they were entitled to remain in the Scheme.  But they were required to review the balance between the two parts of their business on the first anniversary of their start date for, to quote paragraph 6.6 of Notice 733, which in our judgment correctly reflects the 1995 Regulations:
	“6.6	What happens if the balance between parts of my business changes?
If the balance changes but you continue to do all the same activities, continue to use the percentage that was appropriate at the beginning of the year until the anniversary of you joining the scheme.  Review the balance between the parts of the business each year.  Make this review for the first day of the VAT period in which the anniversary of your joining the scheme falls.  If on that date, the balance has changed, or you expect it to change over the year ahead, change trade sectors to that for the larger portion of your expected business.  A change of trade sector may also mean that your flat rate changes. If this occurs use the new flat rate from the start of the VAT period in which your anniversary falls; not just from the anniversary to the end of the period.”
12.	Mr and Mrs Morgan failed to carry out the required review, and continued to account for VAT at the rate of 5.5 per cent.  Had they carried out the review, they would have had to account at the rate of 12 per cent.
13.	There matters rested until an HMRC officer visited the Inn on 29 June 2005.  On examining Mr and Mrs Morgan’s records, she found that they had been accounting for VAT under the Scheme on the basis that they were running a ‘Pub’.  As a result she recalculated the output tax due using what she considered to be the correct flat rate percentages, i.e. those for restaurants.  And it is against the assessments made as the result of the recalculation that Mr and Mrs Morgan now appeal.
14.	In evidence which both gave to us, they claimed that the correct category of the Harrow Inn for the purposes of the Scheme was that of ‘Pubs’.  They so claimed on the basis that the sale of food was ancillary to that of bar sales; that whilst in the accounting period immediately preceding their joining the scheme food sales did exceed bar sales it was only by a small margin; that following refurbishment of the bar they expected bar sales to increase and exceed those of food; that for planning and rating purposes the Harrow Inn was classed as a public house; that they held an on-licence permitting sales of intoxicating liquor of all descriptions (again pointing to its being a public house as opposed to a restaurant); and that their lease of the premises described them as a public house.
15.	In his submissions to us, Mr S Porter, Mr and Mrs Morgan’s accountant, elaborated on the various points mentioned in that last preceding paragraph.  But principally, he claimed that they reasonably expected the improvements carried out to the Harrow Inn in October 2003 “drastically” to increase bar sales, and take them beyond food sales, so that their choice of ‘Pubs’ on their main trading category had been a reasonable one.  He further submitted that in those circumstances, their choice of sector should not be disturbed retrospectively.
16.	What neither party brought to our notice was that whilst there is a right of appeal to the tribunal against a decision of HMRC as to the appropriate percentage or percentages applicable under the Scheme, we may not allow the appeal unless we consider that HMRC would not reasonably have been satisfied that there were grounds for the decision (see section 84 (4ZA) of the Value Added Tax Act 1994).  That is not the test Mr Porter invited us to apply in determining his clients’ appeal against the tax assessments.  The test is that laid by Lord Lane CJ in Commissioners of Customs and Excise v J H Corbitt (Numismatists) Limited [1980] STC 231 at page 239:
“Assume for the moment that the tribunal has the power to review the Commissioners’ discretion.  It could only properly do so if it were shown the Commissioners had acted in a way which no reasonable panel of Commissioners could have acted; if they had taken into account some irrelevant matter or had disregarded something to which they should have given weight”.
17.	In our judgment, in the instant case, HMRC have not taken into account any irrelevant matters, nor have they ignored something to which they should have given weight.  Further they have not acted in a way in which no reasonable panel of Commissioners could have acted.  It follows that we must reject Mr Porter’s submissions.  We dismiss the appeal against the tax assessments.
18.	That leaves the appeal against the penalty assessments.  A person is liable to a misdeclaration penalty if he makes a return understating his liability to tax (see section 63 of the Value Added Tax Act 1994).  The prescribed rate is 15 per cent of the tax which would have been lost, but HMRC have power to mitigate the penalty.  They chose not to do so in the instant case.
19.	We have carefully considered the evidence of Mr and Mrs Morgan.  Both maintained, in our judgment with justification, that the main if not sole purpose of carrying out the bar refurbishment works was to increase bar sales, their ability to borrow from their landlord or brewery for the purpose being dependent on the amount of such sales.  Consequently, they claimed that it was not unreasonable of them to hope, indeed to expect, that their bar sales would increase, perhaps at the expense of food sales.  And since their turnover was more or less equally divided between bar sales and food sales in the period immediately before they joined the scheme, we consider them to have a reasonable excuse for claiming that their main trade sector was that of ‘Pubs’.  But we take the view that the excuse was exhausted at the end of September 2004 when they should have carried out a review of their projected turnover in the following year.  We therefore allow the appeal against the penalty assessments in respect of periods 12/03, 03/04 , 06/04 and 09/04, but confirm the assessments for the following two periods.
20.	We make no direction as to costs. 

DAVID DEMACK
CHAIRMAN
Release Date: 26 July 2006
MAN/05/0726