TEMPERTECH (WALES) Ltd v Revenue & Customs [2006] UKVAT V19888 (20 November 2006) 

19888

VAT DEFAULT SURCHARGE: Reasonable Excuse for not paying VAT on time for period 05/06 –General Manager sought to destabilise the Appellant company by poaching key members of staff and principal customer for his rival business – The Managing Director completely unaware of the General Manager’s action which was the underlying cause of the Appellant’s failure to pay the VAT due on time  –  A prudent business person acting with due diligence and reasonable foresight could not have anticipated the difficulties caused by the General Manager –reasonable excuse found – Appeal allowed. 

LONDON TRIBUNAL CENTRE

TEMPERTECH (WALES) LIMITED	Appellant

- and -

HER MAJESTY’S REVENUE and CUSTOMS	Respondents

Tribunal: MICHAEL TILDESLEY OBE	 (Chairman)
ANGELA WEST FCA		  (Member)

Sitting in public in Cardiff on 18 October 2006

Neil Bevan, Accountant for the Appellant 

Pauline Crinnion, Advocate for HM Revenue & Customs, for the Respondents

© CROWN COPYRIGHT 2006

DECISION
The Appeal

1.	The Appellant was appealing against the imposition of a default surcharge in the sum of £2,251.48 for the period 05/06.
The Issue in dispute
2.	The Appellant operated from two factories in South Wales manufacturing toughened glass. Although the Appellant submitted its VAT return for period 05/06 in time, it was unable to pay the VAT due. The Appellant’s reason for its default was that its general manager unbeknown to the managing director had set up a rival business and in the process poached key members of staff and the Appellant’s principal customer. The Appellant concentrated its efforts on rescuing its business, which meant that it could not make the payment of VAT due by 30 June 2006.
3.	The Respondents considered that the Appellant’s reason for not paying the VAT amounted in effect to a lack of funds. 
4.	The issue in dispute was whether the Appellant had a reasonable excuse for its default. Insufficiency in funds cannot in law constitute a reasonable excuse.
The Evidence
5.	We heard evidence upon oath from Jeff Edwards, the managing director of the Appellant. The Respondents supplied us with a bundle of documents and correspondence.
The Facts
6.	In 1989 Mr Edwards founded the Appellant’s business with the aid of a grant from the Prince of Wales Trust. Mr Edwards started as a sole trader but later incorporated his business to form the Appellant company. The Appellant was a manufacturer of toughened glass. Its annual turnover was approximately £2 million operating from two factories with 50 employees.
7.	During the last four years the Appellant company employed Mr Paul Irvine as its general manager. Mr Edwards entrusted Mr Irvine with the running of the Appellant’s business including its sales operations. 
8.	On 28 April 2006 Mr Irvine tendered his resignation with effect from 1 June 2006. Mr Irvine informed Mr Edwards that he was leaving to work on a self employed basis outside the glass industry. Mr Edwards wished him well on his new venture and offered him assistance.
9.	Around 20 May 2006 Mr Edwards took his annual vacation with his wife, intending to return on 2 June 2006 when he would catch up with Mr Irvine about any issues arising during his leave before Mr Irvine left his employment. In the event Mr Edwards arrived back on 1 June 2006 and decided to visit the factory to deal with any correspondence received during his absence. On arrival he learnt that Mr Irvine would not be in work on the 2 June, and that five other key members of staff, which included the production supervisors at each of the Appellant’s factories had resigned. The effect of the resignations was that the Appellant lost at a stroke its two management layers immediately below Mr Edwards.
10.	Mr Edwards discovered that Mr Irvine had set up a rival business, Glass Solution (Wales) Limited, dealing with toughened glass, which commenced trading on 5 June 2006.  Glass Solution (Wales) Limited was incorporated on 9 May 2006 with Mr Irvine named as its sole director. The incorporation of the company occurred when Mr Irvine was still in the Appellant’s employment. Mr Irvine’s company operated from premises formerly occupied by Omega Glass and located about 40 miles away from the Appellant’s premises. 
11.	In April 2006 Mr Edwards and Mr Irvine visited the premises of Omega Glass with the Appellant placing a bid for the machinery with the liquidators, which was unsuccessful. Mr Edwards believed that Mr Irvine used the confidential information gained from his employment to place a higher bid than the Appellant, which secured the ownership of the machinery for his new company. 
12.	Whilst Mr Edwards was on holiday, Mr Irvine was actively recruiting the Appellant’s employees for his company. Mr Irvine informed the employees that the Appellant’s business was on the verge of insolvency, and that they were about to be made redundant. The majority of employees decided to await the return of Mr Edwards before making their minds up about the job offer from Mr Irvine.
13.	 Mr Edwards also discovered that Mr Irvine had approached the Appellant’s customers to solicit their business for Mr Irvine’s company.  Mr Irvine gained the business of the Appellant’s principal customer, Solar Windows, which accounted for £700,000 of the Appellant’s annual turnover. Solar Windows also refused to pay the Appellant’s invoices to the value of £150,000 issued during the period 05/06, on the ground that the glass supplied was of poor quality. The Appellant took action to enforce the debt owed by Solar Windows with the result that the debt was paid intermittently in instalments with the final payment made just before the hearing.
14.	Mr Irvine’s actions took Mr Edwards by complete surprise. Mr Edwards had placed his trust in Mr Irvine, and relied upon him to run the Appellant’s business. 
15.	Mr Edwards on his return from holiday was required to take immediate action to save his company. He held meetings with the Appellant’s employees to re-assure them about their jobs. He made sure that the Appellant retained its remaining customers. Mr Edwards also took charge of production, as he had lost his management team.
16.	 As well as organising the operations of the Appellant company, Mr Edwards took stock of the financial situation. The Appellant owed the bank £1.5m in loans, debts to suppliers of about £100,000, and an outstanding sum of £140,000 due to Revenue and Customs for National Insurance and VAT. Mr Edwards held an urgent meeting with the Appellant’s bank, which indicated that it would support the Appellant through this difficult period but did not formally extend its overdraft facility of £25,000.  On 23 June 2006 Mr Edwards wrote to the Respondents advising them of the situation and that the Appellant would not be able to pay its VAT liability for the quarter ending 30 May 2006 by the due date of 30 June 2006. The Appellant, however, submitted its VAT return for 05/06 on time and sought an arrangement to pay off the outstanding sum to the Respondents. The Appellant has kept to the terms of the arrangement with one payment left to clear off the debt.
17.	Mr Edwards instigated proceedings against Mr Irvine in the High Court for an interim injunction which was granted on 26 June 2006. The Appellant was now seeking a claim for damages against Mr Irvine and his company. 
18.	 Since 2000 the Respondents have issued eight default surcharges and liability notices upon the Appellant company, with the majority of them being liability notices. The most recent default surcharge prior to the one issued for period 05/06 was for period 11/05 in the sum of £1,117. This surcharge arose from an under-declaration of VAT for the said period. The Appellant company paid a central assessment of £8,734 for that period. This was considerably less than the VAT of £55,850 declared in the 11/05 return which was submitted late. The Respondents issued a mis-declaration penalty of £7,067 for not declaring the correct amount of VAT. The penalty was, however, reduced to zero when the Appellant put forward its mitigating circumstances. The Respondents also instructed bailiffs to recover from the Appellant the amounts due under the centrally raised and revised assessments.
19.	  The Appellant’s value of outputs in the 05/06 return was £477,295 which was higher than the values declared in the 02/06 and 08/06 returns of £385,367 and £468,891 respectively.  The value of outputs in the 05/06 return, however, was some £46,000 less than the average value of outputs for the preceding six periods from 08/04 to 11/05. The value of inputs declared in the 05/06 return of £221,361 was considerably less than the values of £378,740 and £410,272 declared respectively in the 02/06 and 08/06 returns. This meant that the amount of VAT due in the 05/06 return was considerably higher than that for the other two quarters for 2006: £45,029 compared with £1,364 (02/06) and £10,500 (08/06).
20.	Mr Edwards accepted that the Appellant had got into financial difficulties towards the end of 2005. At the time he considered that the difficulties were a result of production problems. Mr Edwards now realised that he had his eye off the ball, and that Mr Irvine was secretly undermining the Appellant’s business in anticipation of setting up his rival company. The Appellant was not contesting the default surcharge imposed for period 11/05. Mr Edwards viewed the circumstances pertaining to the 05/06 default fundamentally different from those existing for 11/05 default.
Reasons for Our Decision
21.	Section 59 of the VAT Act 1994 requires the Appellant to furnish VAT returns and pay the outstanding VAT within one month of the relevant accounting period. The Appellant failed to pay the VAT due within one month for the accounting period 05/06 and was liable to pay a surcharge of five per cent of the tax due amounting to £2,251.48.
22.	The Appellant can avoid the default surcharge if it satisfies the Tribunal on a balance of probabilities that it had a reasonable excuse for not furnishing the VAT payments on time. 
23.	Insufficiency of funds in itself cannot in law amount to a reasonable excuse (section 71(1)(a) of the VAT Act 1994) but the cause of that insufficiency, the underlying reason of the taxpayer’s default, might constitute a reasonable excuse.
24.	Lord Donaldson of Lymington MR in Customs and Excise Commissioners v J B Steptoe [1992] explored when underlying causes of insufficiency of funds might be regarded as a reasonable excuse. He said at page 775:
“ …. if the exercise of reasonable foresight and of due diligence and a proper regard for the fact that the tax would become due on a particular date would not have avoided the insufficiency of funds which led to the default, then the taxpayer may well have a reasonable excuse for non-payment, but that excuse will be exhausted by the date on which such foresight, diligence and regard would have overcome the insufficiency of funds”.
25.	Thus in order for the Appellant to satisfy us that it had a reasonable excuse for not paying its VAT on time, the Appellant would have to establish first the underlying cause for the insufficiency of funds. Next, to demonstrate that  the consequences which flow from the underlying cause could not by avoided by the exercise of reasonable foresight and due diligence on its  part, whilst having proper regard to the due payment date for VAT.
26.	The Respondents considered that the Appellant’s failure to pay the VAT due on 30 June 2006 was a continuation of the financial difficulties that beset the company at the end of 2005, which resulted in the default surcharge for the period ending 11/05 and the instruction of bailiffs to collect the monies owing. In the Respondents’ view the Appellant’s turnover for the period 05/06 was sufficient to discharge its VAT debt for that period but the Appellant chose to apply the income received to other debts that arose during the earlier period. The Respondents contended that the Appellant’s reason for not paying the VAT was essentially insufficiency of funds which had been caused by financial mismanagement dating back to 2005.
27.	The Appellant submitted that the circumstances in June 2006 were fundamentally different from those that existed in the latter part of 2005.  Mr Edwards had no prior knowledge of the actions of Mr Irvine, which threatened the very existence of the Appellant’s business. Mr Edwards was required to take immediate action to secure the survival of the business, which included arranging to pay the VAT debt by instalments in order to establish a sound financial footing for the Appellant company in the future.
28.	We find the following facts:
(1)	The circumstances surrounding the departure of Mr Irvine on 2 June were completely different in nature and scale from the financial problems that beset the Appellant company at the end of 2005.  They involved the complete removal of the management team below Mr Edwards, upon which the Appellant relied to run its business.  The loss of the Appellant’s principal customer, which accounted for at least 30 per cent of the Appellant’s income. The customer also refused to pay the Appellant’s invoices which had an immediate impact on the cash available to pay the VAT due on 30 June 2006. Finally the actions of Mr Irvine seriously undermined the morale of the Appellant’s workforce and customer confidence in the Appellant’s business. Mr Irvine’s actions posed an immediate and serious threat to the survival of the Appellant’s business.
(2)	Mr Edwards as managing director had no prior knowledge of the actions of Mr Irvine. Mr Irvine was a trusted colleague who had given as his reason for his resignation a desire to set up his own business outside the glass industry. Mr Irvine undertook his coup against the Appellant company when Mr Edwards was on holiday abroad with his wife.
(3)	On his return from holiday Mr Edwards was required to take urgent and decisive action to save his company. Mr Edwards’ first steps were to restore the confidence of his workforce and customers by holding face to face meetings, and ensuring that orders were met and production maintained. Mr Edwards kept the Appellant’s bank informed of the situation. Although the bank did not formally extend the Appellant’s overdraft facility, it agreed not to pull the plug whilst Mr Edwards sorted out the financial affairs of the Appellant company.
(4)	Mr Edward’s focus on production meant that he neglected the supply side of his business, which resulted in a lower figure for input tax and a higher VAT liability in the 05/06 period when compared with the preceding and subsequent VAT accounting periods for 2006.
(5)	Mr Edwards in his capacity as managing director did not ignore the Appellant’s responsibilities for VAT. Mr Edwards submitted the 05/06 VAT return in time. Further Mr Edwards advised the Respondents in writing before the deadline of 30 June 2006 that the Appellant was unable to meet the VAT due, and offering to pay the debt by instalments. The Appellant subsequently made an arrangement with the Respondents to clear the debt, to which it has adhered.  
29.	 We are satisfied that the Appellant’s failure to pay the VAT due for 05/06 was a direct consequence of Mr Irvine’s actions to destabilise the Appellant company. Those actions left the Appellant in a perilous financial situation. The Appellant’s principal customer refused to pay the Appellant’s invoices, which constituted 30 per cent of its income for that period. Mr Edwards concentrated on production, which had the adverse effect of increasing its VAT liability. Thus Mr Irvine’s actions constituted the underlying cause for the Appellant’s inability to meet the VAT due.
30.	We find that Mr Irvine’s actions would not have been foreseen by a prudent business person exercising due diligence. We hold that Mr Edward’s actions on behalf of the Appellant in response to the situation were those of a reasonable business person mindful of his responsibilities in respect of VAT and having proper regard to the due date for the payment of VAT.
31.	We find for the reasons set out above that the Appellant had a reasonable excuse for the non-payment of the VAT due for the period 05/06.  We, therefore, allow the Appeal. We make no order for costs.

MICHAEL TILDESLEY OBE
CHAIRMAN
RELEASE DATE: 20 November 2006

LON/