20090

Value Added Tax  -  Default Surcharge at 2% in the amount of £70,558.68  -   Consequences of change of ownership and of senior personnel; change of accounting policies and computer systems; accounting errors and last minute changes to the VAT returns  -  Appeal allowed

LONDON TRIBUNAL CENTRE

	NEXEN ENERGY MARKETING LONDON LIMITED	           Appellant

-	and –

	THE COMMISSIONERS FOR HER MAJESTY’S REVENUE & CUSTOMS 	 Respondents

				Tribunal:	HOWARD M NOWLAN (Chairman)
						ELIZABETH M MACLEOD CIPM

Sitting in public in London on 21 March 2007

Geoff Tack of Ernst & Young LLP for the Appellant 

Phillip Webb of HMRC’ Solicitors Office, for the Respondents

© CROWN COPYRIGHT 2007

DECISION

1.    This was a default surcharge appeal in which the Appellant paid its VAT three days late.     As a result it became liable to a 2% default surcharge, amounting to a surcharge liability of £70,558.68.  The contention that the Appellant had a reasonable excuse for the late payment divided essentially into two different points.    The first points all related to the factors said to explain why the Appellant only realised in the last three or four days before the final date for paying its VAT that it had an unexpected and massive VAT payment to make.   The other part of the defence related to whether in those last few days the conduct of the Appellant was such as to demonstrate, assuming that the Appellants succeeded on the first point, that it still had a reasonable excuse for the late payment, by virtue of then acting with sufficient urgency to make a correct VAT return.  

2.     We decide in favour of the Appellant on both points, and explain our decision as follows. 

3.     The Appellant company which had earlier been called Foundation Energy Limited was acquired by a  company called Nexen Energy Marketing  Europe Limited which is part of a Canadian group on 1 June 2006.     Nothing turns on the company’s change of name, or on the fact that the company continued trading over the change of ownership in its activity of buying and selling energy products.   Its then current 3 month period had been running from 1 May 2006 and was due to end on 31 July 2006. 

4.     The due diligence exercise during the course of the acquisition had revealed that the Appellant had had two earlier filing or payment defaults  for VAT purposes (neither or which had involved any actual imposition of a charge) so that it was implicit that some of its internal procedures may have been less than perfect.    The second default had involved simply a delay in submitting the return when in fact a substantial VAT refund was due so that there was no question of any actual surcharge.  The return for that period indeed indicates the norm for the Appellant.    Since a reasonable portion of its sales were export sales, and since many of its sales were matched sales (in other words there were purchases and sales on the same date hopefully at a profit margin), the company was likely to owe VAT only on its gross margins, and not even that when export sales resulted in a portion of its outputs being zero rated.   

5.     Many events occurred after the 1 June change of control.       First it appears that many of the earlier members of senior management had left the company some time before the change of control so that new management had to be appointed.    A complete outsider with accounting experience, namely Hector Stravrinidis, was recruited to become Financial Controller on 17 July, and from mid August, Peter Raezynski, a member of senior management in the Canadian group, became Finance Director.      Mr.Stravrinidis, who gave evidence before us, stressed that because the earlier senior management had left the company well before the change of control neither he nor Mr. Raezynski  had the benefit of any “hand over” instruction from their predecessors. 

6.     Two other material changes were that the Appellant changed its method of accounting for VAT from a cash basis to an invoicing basis, and the company also sought to introduce a new computer based accounting software, known as Quickbooks. 

7.     A tax meeting was held towards the end of August, at which it was initially thought that there would be ample time in which to prepare the VAT returns and make payment electronically of any VAT due by the relevant due date, namely 7 September.     It was though at this stage that notwithstanding the new computer system it would be better to prepare the returns manually which it was expected would take a day or two since it would involve examining approximately 130 purchases and perhaps 200 sales.      It was also thought that it would be prudent to engage Ernst & Young LLP to assist in preparing the return, and they became involved on 4 September.     It should be emphasised at this point that it was still thought that little would be owed in respect of VAT, for the two reasons mentioned in paragraph 4 above, namely that most of the Appellant’s transactions were matched so that VAT would only be owed on the margin, and the VAT would then be reduced to the extent that sales were zero rated export sales. 

8.    During the preparation of the return, and certainly after September 4, it was discovered that a mistake had been made in dating 11 of the output invoices since transaction that had been effected on 1 August, and that had matched purchases also made on 1 August had been dated 31 July, whilst the purchases had been correctly dated 1 August.    We were specifically told that the mistake here was definitely not a mistake of having entered into the transactions on the different days, with unfortunate VAT consequences.   All the transactions had been undertaken on 1 August and the invoices should have been dated 1 August, and it was a recording error to date the output invoices with the date “31 July”.   It was decided that it would be impossible to correct the invoices because they had been issued and counter-parties would have relied on them, so that the VAT return would simply have to be very significantly altered to reflect the fact that millions of supplies would have been recorded as being on the last day of the period ending 31 July, while the matching purchases would be in the next period.   The VAT consequence of this was that output VAT of an unforeseen £4,284,683.62  would have to be added to the return for the period 07/06.      It was mentioned that this consequence would not have arisen had the Appellant not changed its basis of accounting for VAT from a cash basis to an invoicing basis, but far more significantly that it was the essence of all of the 11 transactions that they were matched on the same day with roughly equivalent purchases so that this enormous VAT liability could only arise because of the booking mistake that had occurred, and not because anyone should have foreseen that such a liability could ordinarily have occurred in the natural course of the Appellant’s trading. 

9.     By the time panic attention had been given to whether there was any way of rectifying the error, and by the time management had checked with European officials in Uxbridge, and management in the ultimate Canadian parent (once it was concluded that the payment did have to be made) for authorisation to make a payment of approximately £4 million, instead of being in a VAT recovery position, it was September 8.    Since the CHAPS instruction to pay the relevant VAT was made too late on that day, the VAT was not received by HMRC until the following Monday, albeit that it would have anyway been one day late on 8 September. 

10.    As we said in paragraph 1, we consider that the Appellant’s case for claiming that it had a reasonable excuse for the late payment falls to be dealt with by looking at the following two different questions.   First, did the Appellant have a reasonable excuse for not addressing its VAT filing for the 07/06 period until late in August 2006?    Secondly, when it addressed its VAT return for that period, and in particular from September 4 when Ernst & Young were appointed, did the Appellant have a reasonable excuse for the short delay that still occurred before the VAT was actually paid on 8 September.    We answer both these questions in the affirmative for the following reasons. 

11.    As regards the first issue, it is noteworthy that the Appellant had a host of uncertainties and changes to deal with.   There were new appointments of senior personnel in mid July and mid August, and the new management had no benefit of any “hand over” from their predecessors.   There was an introduction of a new computer system, and a conclusion that out of caution the VAT return would have to be prepared on a manual basis.    There was a change in the receipts or cash basis to the accounting basis (without which the miss-match would not have occurred) but by far the most significant point was that the essence of the Appellant’s pattern of trading indicated that, a reporting error apart, little if any VAT would generally be owed.   Thus the last minute and unexpected discovery of 11 wrongly dated invoices was quite unexpected.    It was incidentally mentioned that various other errors also came to light but these were ones that actually reduced the initially reported output tax since it emerged that several export transaction had been wrongly thought to be liable to full output tax, whereas they were in fact zero rated.     We think it fair to interpret this as another unfortunate consequence of all the changes then being made, and not of the fact that the new management and the new systems would in future be unreliable.  We accordingly consider that the Appellant had a reasonable excuse for not spotting that it had a massive and unexpected liability. 

12.    As to whether the matter was addressed with great urgency and efficiency in the very short time span from September 4, we consider that it was.   It is natural that there would be major discussions as to what to do in this situation, and as to whether the errors could be corrected, and as to whether the company could make the very substantial payment without checking with “higher authority”.  It seems to us that the Appellant worked exceptionally hard to submit a correct return, once the errors came to light and we do not think that it fails to sustain its reasonable excuse even though those deliberations continued until past lunch time on September 8, rather until 7 September. 

13.    Whilst our decisions recorded in paragraphs 11 and 12 result in our allowing this appeal, we might add that the consequence of the Appellant’s booking error is that the Appellant has effectively lent HMRC approximately £4 million, which will be repaid in the following period where there will, of the essence of the miss-match point, be vastly greater input deductions than output liability.    And whilst some of the counter-parties (the purchasers) might have accelerated their input deductions on account of the wrong invoices, it is by no means certain that they would all be operating 3 month VAT periods ending on 31 July, so that some might have been totally unaffected by the feature that their purchase invoices were dated 31 July and not 1 August.    In other words there seems every chance that HMRC has benefited quite considerably by the unfortunate booking errors that the Appellant made.  We accept that this has no strict bearing on whether the Appellant demonstrates that it had a reasonable excuse for the late payment, but it was potentially of relevance in one context.   The advocate for the Appellant referred to the point in closing that although the Tribunal’s decision in Greengate Furniture Limited, issued on 11 August 2003 had decided that the whole structure of the default surcharge machinery did not offend the human rights Convention and the Human Rights Act 1998, it was nevertheless possible that a particular application of the surcharge machinery might still be held at some time to have that result.   It was not sought to argue that this case was definitely that case, and in the event it would have been unnecessary to argue the point, but it is worth observing that a penalty of over £70,000 for being four days late in paying approximately £4 million in VAT, when a book keeping error apart it actually appears that there would have been a VAT refund, may be somewhat disproportionate. 

HOWARD M NOWLAN
CHAIRMAN

RELEASED: 2 April 2007

LON/2006/1298