20348

VAT – assessment – best judgment – computation by HMRS based on mark-up – burden of proof on Appellant – evidence of misappropriation – determination of assessment

LONDON TRIBUNAL CENTRE

	MRS HANG PHAM T/A THE BER STRETE GATES	           Appellant

-	and –

	THE COMMISSIONERS FOR HER MAJESTY’S REVENUE & CUSTOMS 	 Respondents

				Tribunal:	CHARLES HELLIER (Chairman)
						KEITH DUGDALE

Sitting in public in Lowestoft on 25 and 26 June 2007

Steve Christophi of Aston Barry Ltd for the Appellant 

Pauline Crinnion, instructed by the Acting Solicitor for HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2007

DECISION

1.	Mrs Pham runs a small pub in a fairly rough district in Norwich.  She bought it in September 2003.  When she bought it she was something of a novice in pub matters although she had worked in catering before. When she took over the pub she employed a manager to help her.  He apparently took her cheque book.  He lasted only 3 weeks.  Then she engaged a man who had been coming to drink in the pub for the last 5 years.  He lived nearby.  He worked part-time.  Her nephew came to help her in late 2004 and left in December 2005.  He worked about 35 hours a week in the pub.  She may have had some other part-time help.  Sometime in 2005 the part-timer who lived nearby stopped working in the pub.  Since January 2006 she has done, and prior to that apart from the help identified she did, everything else herself: cooking, serving, purchasing and cleaning.  That is everything apart from the accounting and tax returns.

2.	At the beginning of each day she has noted down the total sales from the previous day from the figure shown on the till roll.  She noted this down on a daily record sheet which periodically she sent to her husband who lives above the launderette he runs in St Ives.  He prepared monthly totals which he sent to the accountants who prepare the VAT returns and the accounts.

3.	In the Autumn of 2005 the Respondents embarked on a review of pubs in the Norwich area.  The Appellant’s pub was one of those chosen.  On 7 September 2005 she was visited by two of the Respondents’ officers, Mr Butler and Mr Jackson.  They collected information from Mrs Pham and later sought further information.  They did some calculations which suggested to them that the VAT returns understated Mrs Pham’s sales. There was correspondence and a meeting with Mrs Pham’s accountants.  Then, on the basis of some revised calculations, the Respondents assessed Mrs Pham to £4,557. Mrs Pham appealed to this Tribunal. The Respondents reduced the assessment on review to £4,320.  The assessment is still contested.

4.	Section 83(p) VATA 1994 permits a person to appeal against “an assessment … or the amount of that assessment.”  This has been taken to mean against either the making of the assessment or against its amount (or both).

5.	Section 73(1) VATA provides that where a person has failed to make returns or do certain other things or where:

“it appears to the Commissioners that such returns are incomplete or incorrect, they may assess the amount of VAT due … to the best of their judgment and notify it to him.”

The first limb of section 83(p) has therefore been taken to permit the taxpayer to argue before the Tribunal that either the conditions for assessment in section 73(1) have not been met or that the assessment was not made to the “best of their judgment”.

6.	The Court of Appeal in Rahman v Commissioners of Customs and Excise [2002] EWCA Civ 1881 [other] (“Rahman No. 2”) accepted the tests of whether an assessment had been made by the Commissioners to the best of their judgment described by Carnwath J in Rahman v Commissioners of Customs and Excise [1998] STC 825 (“Rahman No.1”) and by Dyson J in McNicholas Construction Co Ltd v Commissioners of Customs and Excise [2000] STC 553 and summarised thus by Collins J in Rahman No.2 in the High Court:-

“… to show, on an appeal to the tribunal, that an assessment has not been made to best judgment the taxpayer must show that the assessment is wrong in a material respect, and that the mistake was such that the only inference is that the assessment was arbitrary … or … dishonest, vindictive, or capricious, or is based on a spurious estimate or guess, or is wholly unreasonable.”

7.	In Customs and Excise Commissioners v Pegasus Birds  [2004] STC 1509, the Court of Appeal addressed the issue of  ‘best judgment’ and how it should be approached by the tribunal.  In relation to the question of what was the test for whether an assessment had been made to the best of the Commissioners’ judgment the Court approved the following as an authoritative statement of the law binding upon itself and the tribunal:-

“In such cases – of which the present is one – the relevant question is whether the mistake is consistent with an honest and genuine attempt to make a reasoned assessment of the VAT payable; or is of such a nature that it compels the conclusion that no officer seeking to exercise best judgment could have made it.  Or there may be no explanation; in which case the proper inference may be that the assessment was, indeed arbitrary.”  [emphasis added]

As can be seen this statement was made in relation to cases where the tribunal found, on investigating the quantum of the assessment, that there had been a mistake.  The statement is authoritative “in such cases”. The Court described the question of dishonesty, vindictiveness or caprice raised in the earlier decision as examples of where it might be said that no ‘honest and genuine attempt’ had been made to make a reasoned assessment.

8.	The Court also gave the following guidance to tribunals when faced with ‘best of judgment’ arguments (we have added emphasis):-

“(i)	The tribunal should remember that its primary task is to find the 	correct amount of tax, so far as possible on the material properly 	available to it, the burden resting on the taxpayer.  In all but 	exceptional cases, that should be the focus of the hearing, and the 	tribunal should not allow it to be diverted into an attack on the 	Commissioners’ exercise of judgment at the time of the assessment;

(ii)	Where the taxpayer seeks to challenge the assessment as a whole on 	“best of their judgment” grounds, it is essential that the grounds are 	clearly and fully stated before the hearing begins.

(iii)	In particular the tribunal should insist at the outset that any allegation 	of dishonesty or other wrong doing against those acting for the 	Commissioners should be stated unequivocally; that the allegation and 	the basis for it should be fully particularised; and that it is responded to 	in writing by the Commissioners. The tribunal should not in any 	circumstances allow cross-examination of the Customs officers 	concerned, until that is done.

(iv)	There may be a few cases where a ‘best of their judgment’ challenge 	can be dealt with as a preliminary issue.  However, unless it is clear 	that time will be saved thereby, the better course is likely to be to allow 	the hearing to proceed on the issue of amount, and leave any 	submissions on failure of best of their judgment and its consequences, 	to be dealt with at the end of the hearing.”

This is authoritative guidance from a high source.  We should therefore endeavour to abide by it.  But our approach must to some extent be affected by the nature of the appeal: where the appeal relates to a large amount and the taxpayer is represented by tax counsel and solicitors one can insist on perfection; in a smaller appeal where money is limited and the taxpayer cannot afford a grand team of advisers and advocates, the tribunal must be more flexible if justice is to be done although it must endeavour to adhere to this guidance so far as it is fair to do so.

9.	We have highlighted the phrases in the first paragraph of the guidance because they illustrate the point that the burden is on the Appellant to show what the correct amount of VAT should be. For a small trader without complex internal control systems this can be a heavy burden: if the Commissioners allege higher sales than returned how does a cash trader show that he has kept accurate records?  If he cannot produce evidence to undermine the basis on which the Commissioners have produced their figures he may need to employ third parties to conduct inspections, tests and the like. For a pub several days’ work could be needed.  That can be expensive and possibly cost more than the VAT at stake.  But the burden lies upon the taxpayer even if it is a heavy burden.

10.	Appearing before us for the Appellant Mr Christophi embarked on a course during the cross-examination of Mr Butler which in our view was at least in part directed to the question of whether the assessment was made to the best of the officers’ judgment.  After permitting that line of questioning for a while the Tribunal directed that it was not prepared at that stage to permit cross-examination directed solely to that issue but wanted instead to hear the parties on the issue of quantum, although it would leave open the possibility of the Appellant addressing the issue of best judgment at a later hearing.  A direction to that effect is appended to this decision.

11.	This determination by the Tribunal however exposed a substantial difficulty in the appeal for the Appellant.  The Appellant did not feel able to meet the cost of the fees her accountants would charge in conducting the kind of investigation of the facts which would produce the kind of substantial evidence which the Tribunal could rely upon to uphold her appeal, and the only cost effective route available to her (bearing in mind the size of the assessment) was (1) to seek to dispute the assessment in general terms based upon her own oral evidence and the casting of doubt upon the Respondents’ computation (which was a fairly unsatisfactory approach) and (2) to attack the best judgment of the Respondents.  Our determination removed, at least for the time being, what the Appellant’s advisers regarded as her most effective method of challenge.

12.	However, whilst we have directed that the Appellant may formally argue the best judgment issue, we hope that the invitation is not accepted.  That is for the following reasons.

13.	First, having heard a fairly extensive cross-examination of Mr Butler which dealt directly and collaterally with this issue and some questioning of Mr Jackson upon it we do not believe that the Appellant will succeed.  In our view almost all the evidence points to the Respondents’ officers doing their honest best.  There was to our minds nothing to indicate dishonesty, vindictiveness, caprice, or an arbitrary approach.  Their approach to the assessment was based on a careful, sensible set of calculations presented in correspondence and based on facts given to the officers.  It is true that the meeting between the Appellant’s accountants and the Respondents’ officers was not good humoured for the reasons we shall explain later, and it is also true that in his evidence before us Mr Butler was somewhat defensive or reticent and unhelpful on particular topics, but all of that fell well short of dishonesty vindictiveness or lack of bona fides.

14.	Second if the issue is pursued and the Appellant loses the Respondents have indicated that they would seek costs against the Appellant.  Whilst we cannot decide that issue now, on the present evidence we would be minded to accede to the Respondents’ request.

15.	Third, because even if the Tribunal held that the assessment was not made to best judgment, it would have in mind the words of Carnwath LJ in Pegasus Birds at paragraph [28] and [29]:-  

“[28] Where, however, the complaint is in substance not against the assessment as such, but is that the amount has not been arrived at by “best of their judgment”, I see nothing in the statute or in principle which requires the whole assessment to be set aside.  Clearly much will depend on the nature of the breach.  … Fortunately … allegations of actual fraud or corruption … are likely to be very rare indeed.  What is more likely is an allegation that in ‘the heat of the chase’ … the officers have consciously or unconsciously cut corners or closed their minds to relevant material …

[29]	In my view, the tribunal, faced with a “best of judgement” challenge, should not automatically treat it as an appeal against the assessment as such, rather than against the amount.  Even if the process of assessment is found defective in some respect applying the Rahman (2) test [set out in paragraph 6 of this decision], the question remains whether the defect is so serious or fundamental that justice requires the whole assessment to be set aside, or whether justice can be done simply by correcting the amount to what the tribunal finds to be a fair figure on the evidence before it.  In the latter case the tribunal is not required to treat the assessment as a nullity, but should amend it accordingly.”

In other words even if Mr Christophi succeeded in his attack this Tribunal could direct an assessment in the amount provisionally determined by this decision.

16.	We now turn therefore to the issue of the quantum of the assessment.

The evidence and the facts

17.	We heard oral evidence from Mrs Pham and from the Respondents’ officers Andrew James Butler and Malcolm John Jackson.  We had before us copy documents which included (i) the Appellant’s accounts, (ii) copies of the Appellant’s menus, (iii) manuscript notes made by the officers on their visits, (iv) the Respondents’ typewritten summary of events and (v) correspondence between the parties including the Respondents’ calculations which led to the assessments.

18.	The Appellant’s till rolls became available during the course of the hearing. We directed a small sample exercise to be conducted to compare the daily totals on the till rolls with the totals on the daily takings sheets which were also available.  This fairly random sample showed that apart from the figure for pence the till roll total had been accurately transferred to the daily takings sheet in 11 out of 12 cases, and in the remaining case a figure of £185.80 on the till roll had been recorded as £175.

19.	From the evidence before us we find the following facts in addition to any set out in the introductory section of this decision:-

(1)	Mrs Pham has a fair understanding of spoken English; when you get 	used to her speech she is generally understandable. When she first 	acquired the pub her grasp of spoken English was not quite as good as 	it is now.

(2)	Income and Expenditure Accounts were prepared by Mrs Pham’s 	accountants for the first 6¾ months of running the pub (for the period 	to 31 March 2004), and for the years to 31 March 2005 and 2006.  	They permit the following figures to be adduced:-

			31 March 2003         31 March 2004         31 March 2005

Gross receipts		     28,271		71,503		       73,531
Cost of sales		     18,150		52,400		       47,037
Gross profit		     10,121		19,103		       26,494

Mark up percentage:	           36%	                27%	                       36%
Net profit/(loss)	     (7,197)	              5,807	                     3,726

(3)	The turnover declared on Mrs Pham’s VAT returns for the VAT 	periods 01/04 to 10/05 was consistent with the gross receipts in the 	accounts.

(4)	The Respondents’ officers conducted an exercise to estimate Mrs 	Pham’s mark-up on the various types of drinks sold in the pub. They 	used the estimated mark-up to estimate from her purchases the amount 	of her VATable turnover.  The figures for that exercise were:

(i)	in the case of Mrs Pham’s purchases obtained from her 	purchase records for the months of September and October 	2005, 

(ii)	in the case of selling prices obtained from Mrs Pham’s 	advertised selling prices.

(5)	The officers calculated the mark-up on each line of goods sold in that 	period.  From 	this they calculated a weighted average mark-up, 	weighing each mark-	up by reference to the cost of the relevant items.  	This was 146.36%.  They assumed:

(i)	in the case of draught beer there was 10% wastage;

(ii)	there was no wastage in relation to canned or bottled drinks or 	wine or spirits.

	They then calculated from Mrs Pham’s declared purchases (standard 	and zero-rated – zero-rated being food) the total sales of (a) drinks and 	(b) food, by applying the weighted average mark-up to purchases in 	each category to estimate sales.  They then compared this with the 	declared sales. This suggested an underdeclaration of some £99,000 	over a period of some 27 months.

	They then adopted a more generous method of calculation.  They took 	each category of drink sale (the categories being: draught beer, cans 	and bottle, spirits, wine and miscellaneous) and identified the lowest 	mark-up in each category in the two month period (so that for example 	they identified the mark-up on draught guinness as being the lowest 	mark-up in the draught beer each category in the two month period.  	Then they calculated a weighted average mark-up for all categories of 	drink sales by reference to these lower mark-ups. That was 76%. They 	applied this mark-up across all purchases (drinks and food) to calculate 	(after taking into account an increase in stock levels of £1,000 – a 	figure provided by Mrs Pham) for each of the periods in the 27 months 	their estimate of what the sales were. This exercise suggested an 	underdeclaration of sales of some £31k, and a consequent 	underpayment of VAT of £4,560.

	On a review these calculations were refined and corrected.  	Assessments were made for the relevant periods totalling £4,232.  It is 	against these assessments that the appeal is now made.

(6)	These assessments are therefore based on the following assumptions:-

(i)	all sales are at advertised selling prices;

(ii)	the September/October 2005 purchase prices are representative 	of those in the period of the assessments;

(iii)	the actual weighted average mark-up on purchase price in any 	category of sales was not by reason of a change in the mix of 	sales or fluctuation in purchase price less than the lowest mark-	up in that category in the September/October 2005 period;

(iv)	save to the extent that such loss is covered by taking the lowest 	mark-up of any product within a sector, and except for draught 	beer, there was no wastage; and 

(v)	the mark-up on food after wastage was 76%; 

(vi)	that stock increased by £1,000.

(7)	As regards these assumptions we accept the following evidence of Mrs 	Pham:-

(i)	sometimes she sold items at less than selling price – for 	example to regular customers at closing time;

(ii)	there was wastage in produce lines other than draught beer.  	Bottles are broken, cans are damaged, products which for a 	time were popular with one or more customers cease to be and 	are not sellable;

(iii)	there is wastage in relation to food;

(iv)	sometimes free drinks are provided to customers e.g. to 	celebrate a birthday;

(v)	sometimes goods are sold at less than list price for example at 	closing time to a customer who wishes to take a bottle home;

(vi)	if, as happened when she initially started business at the pub, 	she misunderstood an order, then the drink erroneously 	provided would be thrown away and not charged for.

(8)	We also accept Mrs Pham’s evidence that she had problems between 	2003 and 2005 with the staff she employed and that products had been 	disposed of by them without requiring payment, or had been taken, or 	that monies received for sales had not always been put by them into the 	till.  Mrs Pham told us that she estimated this as giving rise to a loss of 	20% of turnover.  Although this was unchallenged evidence we were 	not convinced that this figure had been rigorously arrived at.

(9)	The till roll exercise suggested to us that on balance the till takings 	were reflected in the VAT return figure for sales.

(10)	We find that it is more likely than not that Mrs Pham put all the takings 	she herself received into the till and that they appeared on the till rolls.

20.	As we note above the Respondents’ computation for the actual sales is based upon various assumptions, and we find that not all those assumptions are correct.  However, there is a considerable margin allowed in those calculations: the assessment is based on the lowest mark-up in each category rather than the weighted average.  That suggests that the weighted average mark-up on goods actually sold (i.e. excluding wastage and theft of goods) at the normal selling price (excluding gifts etc) was greater than that used in the assessment.  In the absence of evidence as to the level of wastage, theft and gifts etc, it seems to us not unreasonable to suppose that the effects of wastage, theft and gifts on the turnover of the business are reflected in the difference between the potentially higher weighted average mark-up and the lower mark-up used to make the assessment.  It does not therefore seem to us that the Respondents’ assessment is unreasonable on the evidence before us.

21.	At the meeting between the Appellant’s accountants and the Respondents’ officers referred to in paragraph 13, and in cross-examination Mr Christophi sought to get Mr Butler and Mr Jackson to agree estimates for wastage, theft, gifts etc which could be applied to the calculations.  Mr Butler’s disinclination to identify an acceptable figure caused some friction between the parties.  The identification of estimates for those items causes us some concern. We can only do so if we have before us some evidence.  We return to this issue below.

Discussion

22.	Thus on the one hand we have accounts prepared from till roll records which suggest that the VAT return figures for sales were accurate and Mrs Pham’s evidence that there was wastage, that she made little profit on food, and that she provided, on occasion, free drinks or sold goods at less than listed selling prices; and on the other hand:-

(i)	we have Mrs Pham’s evidence of the dishonest activities of her staff – 	and to the extent that the staff made sales but pocketed the cash, these 	were still for VAT purposes sales by the business on which VAT was 	due even though Mrs Pham did not receive the money; and

(ii)	we have the Respondents’ figures which, for the reasons set out above, 	do not seem to us to give an unreasonable result and which suggest an 	understatement of sales.

23.	Leaving aside the question of the siphoning off of goods or cash by staff (to which we shall return), it is clearly possible that by flexing the assumptions used in the Respondents’ calculations, a figure for sales could result which was compatible to the declared figure. But that requires some evidence based argument for different figures – and for specified figures. Even if we accept that there was wastage we cannot determine whether it resulted in a loss of turnover greater than that taken into consideration by the use of the lowest mark-up per sector rather than the weighted average mark-upper sector unless we have some idea of what the rate of wastage was in each sector.  But there was no evidence before us of what that rate was.

24.	Without such evidence it may be impossible to find for the Appellant.  For the burden of proof is on the Appellant.  That evidence could have been a believable record prepared by Mrs Pham of the wastage and gifts etc in a recent week and of the actual food purchases and sales in the week coupled with some believable assurance that it was representative of what had happened in the past.  It could have been a number of days’ sales audited by a third party coupled with an opening and closing stock take and a tested figure for purchases.  The Tribunal, if such evidence had been before it, could have decided what was the most likely result.  But without such evidence it is left floundering.  

25.	In such circumstances it is with regret that the Tribunal is bound by the requirement that the onus of proof is on the Appellant.  That is not to say that the Appellant has to prove conclusively what the sales were, but it has to provide evidence which at the very least puts in doubt the Respondents’ figures and points to different figures.  Merely to say the Respondents’ figures are wrong is not enough; even to say why they are wrong may not be enough where no evidence is volunteered as to how they should be different. 

26.	The Tribunal tested the Respondents’ assessments against the available evidence thus.

27.	First we considered what the actual mark-up on each item actually sold (i.e. ignoring wastage) would have been had there not been the 20% misappropriation attested to by Mrs Pham.  For this purpose we took the 12 months covered by the 07/04 to 04/05 returns:

(i)	the declared outputs in that period were £74,266.  This figure was 	probably representative of till takings and was consistent with the 	accounts for the period to 31 March 2005 (an overlap of 11 months) 	which showed sales of £71,503.  The declared purchases were £52,053.

(ii)	had there been no misappropriations the sales would have been 	£74,266 ÷ 80% = £92,832.

(iii)	if there had been wastage of 10% across all categories the cost of the 	items actually sold (rather than wasted) would have been 90% x 52,053 	= £46,847.

(iv)	that indicates an average mark-up between the cost of the goods 	actually sold and what they should have been sold for of  98%.

(v)	if the wastage had been 20% the cost of the items actually sold would 	have been £41,642, and the mark-up 123%.

(vi)	these mark-up figures are somewhat short of HMRC’s weighted mark-	up of 146.3% but do not suggest it is an unreasonable starting point.

Second we considered the mark-up on the total cost of all purchases using the same period’s figures:-

(i)	without 20% misappropriation the goods would have sold for £92,832

(ii)	the total cost was £52,053 (ignoring wastage)

(iii)	that is a mark-up of 78% on actual cost of goods purchased

28.	Thus if Mrs Pham’s figure of 20% for defalcations is correct, and assuming that all the defalcations represented goods sold at selling price where the cash did not find its way to the till, she would, absent those defalcations have achieved a level of sales which represented a mark-up of 78% on the total cost of her purchases.  That figure of 78% is after taking account of any actual wastage because anything thrown away would not have formed part of the reported sales figure or that which would have been the sales figure absent the (assumed to be cash) defalcations.

29.	HMRC’s figure is computed on a different basis.  But our task is to determine whether the evidence points to a different figure.  The evidence before us suggest that, if all the defalcations were cash defalcations, HMRC’s figure is not wrong because on the evidence before us (and on the assumption as to the nature of the defalcations) her sales would have been of an amount substantially the same as that which results from HMRC’s calculations.

30.	Thus we concluded that there was nothing in the evidence before us to indicate that, if all misappropriations had been paid for at selling price, the assessment was wrong.

31.	That leaves the question of whether the defalcations represented sales made where the cash had found its way to the pocket of someone else, or whether they represented stock taken or given away by the defaulters.  If it was the former the defalcations represented VATable sales.  There was no evidence before us to suggest it was one rather than the other, and thus no evidence upon which we can say that on balance Custom’s assessment is the wrong amount.

32.	The same percentage mark-up has been used by the Respondents to estimate food sales as was used for drink sales.  The only evidence before us as to the mark-up on food was:-

(i)	a manuscript note made by Mr Jackson of a conversation with the 	Appellant in which it is recorded that she gave him to understand – by 	example or otherwise – that the mark-up was 100%.  There was no 	indication however whether this was after taking into account wastage; 	and

(ii)	Mrs Pham’s oral assertion to us that she did not make money on 	selling food and did it only to retain drink sales (as a sort of loss 	leader).

33.	We cannot conclude on that evidence that the figure of 76% is likely to be wrong.  The Appellant may cast doubt on it but has provided nothing by way of coherent evidence which enables us to conclude that a different figure was more likely.

34.	On the question of quantum therefore we cannot say that on the balance of probabilities the assessment was wrong.

Conclusion

35.	Accordingly we DIRECT that unless within 30 days of the date of release of this decision the Appellant notifies the Tribunal that it wishes to contest the question as to whether the assessment was made to the best of the Commissioners’ judgment, this appeal be dismissed.

36.	If the Appellant does so notify the Tribunal then we direct that:

(1)	with that notification it gives full written particulars of its claim and in 	particular any allegation of dishonesty, malice or vice by the 	Respondents’ officers;

(2)	within 30 days of that notification being given to the Respondents the 	Respondents provide a written reply; and

(3)	as soon as possible thereafter there be a directions hearing before either 	this Tribunal or the chairman sitting alone (as the tribunal shall direct) 	to give directions for the resumption of the appeal.

CHARLES HELLIER
CHAIRMAN

RELEASED: 21 August 2007

LON 2007/36