20552

VAT – default surcharge – whether a reasonable excuse for trader on cash accounting – on particular facts, yes – appeal allowed

LONDON TRIBUNAL CENTRE

	SEEK-IT LIMITED	Appellant

	- and -

THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

			Tribunal:	JOHN CLARK (Chairman)
					CAROLINE DE ALBUQUERQUE

Sitting in public in London on 5 December 2007

Amanda Whiteland-Smith, Administrator, for the Appellant

Pauline Crinnion, Senior Officer of Her Majesty’s Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2008

DECISION

1.	This is a default surcharge case. At the hearing we announced our decision that we considered the Appellant to have a reasonable excuse for the default in question. On behalf of the Respondents (“HMRC”), Mrs Crinnion requested us to provide a reasoned decision rather than the short form often issued in such cases. In this decision we use the first names of two of the parties involved; this is to avoid confusion, and is not intended to imply either familiarity or disrespect.
The facts
2.	From the evidence, which consisted of the bundle of documents and unsworn oral evidence given at the hearing by Ian Whiteland-Smith (“Ian”), the Managing Director of the Appellant, we find the following facts.
3.	The Appellant began in business in 2000. It provides the service of dealing with waste or redundant IT and electrical equipment. In doing so, it assists in meeting the needs of the EU WEEE Directive.
4.	The Appellant’s skills in this developing area led to involvement with the County Council and a joint project with the Hampshire Natural Resources Trust from December 2004. At that time it was expected that the WEEE Directive would become law by the summer of 2005 and that the Appellant would be in a position to serve this new market. The rapid expansion caused major problems with the Appellant’s cash flow, as payment from the joint project created a high liability to VAT, but the actual receipt of the payments was significantly in arrears. The financial problems were further compounded when the project came to an end in September 2005, but implementation of the WEEE Directive was delayed, initially to January 2006.
5.	The problems caused to the Appellant’s business by the continuing delay in implementing the Directive resulted in various defaults. In a review letter dealing with a default which occurred before the period covered by the present appeal, HMRC commented:
“An appeal on the grounds of insufficiency of funds can only be considered where a taxpayer is able to demonstrate that the circumstances that led to the loss of income and subsequent default were unforeseen and outside their influence and control. Although the problems you describe are by no means minor, many traders are operating in similar circumstances and in order to maintain the credibility of the surcharge regime, the system must be seen to be equitable. Your decision to expand the company in anticipation of the WEE Directive becoming law appears to indicate a loss of anticipated income, which cannot be regarded as a reasonable excuse for late payment of your VAT.”
6.	Ian acknowledged at the hearing that the Appellant was not disputing the question of the earlier defaults. However, we have included the above information as essential background to the events relating to the default surcharge notice for the period 03/07, the subject of the present appeal.
7.	Amanda Whiteland-Smith (“Amanda”) wrote as follows to HMRC dated 27 April 2007:
“Please find enclosed the return for the period 03/07.
We have delayed sending the return as we have been waiting for funds from a major client to clear. We deal with this company on a monthly basis and have not experienced problems with payments during the last 6 months we have worked with them. I have spoken to their accounts department and there had been an error with the Purchase Order. The company is a multi-national company and we have no reason to doubt the reason for the delay.
We have been assured that funds will be cleared to us by 4th May. In light of this we do not feel able to issue the full payment. We enclose a cheque for £8,104.87 with this return and I anticipate that the £8,000 outstanding balance will be posted to you on 4th May.
You will see from our record that we have been through a very difficult time financially, which unfortunately resulted in a number of penalty payments. These have been difficult to meet, during a period of trading at a loss whilst we waited for the Government to implement the WEEE Directive. Our financial situation has improved substantially since November and we have managed to clear arrears to HMRC for PAYE and arrears of rent. Clearing these repayments has meant working very close to our cash flow limits, hence the problem we have with meeting the payment in full.
We would ask that consideration be given to waiving any penalty that would be charged for lateness, as we will have the amount cleared in full within the 2nd week of May.”
8.	The return for period 03/07 was dated 27 April 2007 and was signed by Amanda. The VAT due was shown as £16,104.87.
9.	Her subsequent letter to HMRC dated 4 May 2007 gave the following information. [It continued with an explanation of the Appellant’s reasons for contesting the default surcharge, which we do not reproduce.]
“Please find enclosed the balance payment of £8,000 for the return for the period 03/07. Shortly after our telephone call with the Southampton Debt management office we were advised by our bank that the cheque issued with the return was not met and we are in dispute with the bank as the Lloyds factoring service had approved the payment on 3rd May. Lloyds TSB have confirmed that the original cheque will be met when represented [ie re-presented].
From our conversation with the Southampton Debt Management office yesterday, we understand that a 15% Default Surcharge Penalty will be implemented and wish to raise a formal complaint about this.
In the specific circumstances of our case we were waiting for a payment of £20,000 from one of our major clients. The payment should have been processed by the 15th of the month, but there was an error in the purchase order and their member of staff responsible for issuing the Purchase Orders was on leave until 1st May. We received notification from Lloyds TSB factoring on Wednesday morning, that the invoice had been approved and that a CHAPS transfer had been arranged to our Lloyds bank account.
Unfortunately communicating with our bank and arranging short term finance were particularly difficult at this time as our Managing Director was in Spain visiting his mother who is recovering from surgery for cancer of the colon. He was due to return to the UK on Wednesday 2nd May, but he missed his flight due to a motorway accident en route for the airport. He was unable to arrange a return flight before Friday 4th May.”
10.	HMRC’s response dated 21 May 2007 (from their Poole Reconsiderations Team) indicated that the default surcharge had been raised because the cheque for the initial part payment of VAT was returned unpaid, and the remaining payment was received late. HMRC did not accept that the Appellant had a reasonable excuse for being in default for the period. The following is an extract from the later part of the letter:
“Although we sympathise with the circumstances that you describe in your letter, the fact remains that you should not rely on the receipt of one payment in order to pay the VAT. As a VAT registered trader you have charged VAT to your customers in the three months of the quarter and are required by law to render it with the appropriate return by the due date.
I realise you may be disappointed by this decision. However I would remind you that a lack of funds is specifically excluded in law from being a reasonable excuse for the late payment of VAT. This type of appeal can only be allowed where a trader is able to demonstrate that the loss of income amounts to a significant percentage of the business turnover. In this case the shortfall of £20,000 only equates to approximately 13% of the declared outputs and is therefore deemed to be a normal hazard of business.”
11.	In a letter to HMRC’s Poole Reconsiderations Team dated 16 November 2007, Amanda provided financial information relating to the Appellant. During the period from 1 January 2007 to 30 April 2007, the receipts from general customers were £73,940.04, and those from Veolia, the “major client” mentioned in Amanda’s letter dated 27 April 2007, were £54,658.80; the total was £128,598.84. During the period 1 April 2007 to 30 April 2007 the receipts from general customers were £13,545.21, and those from Veolia £3036.60, giving a total of £16,581.81; the Veolia receipts were so low because of the delay at Veolia in providing a purchase order number for an invoice issued on 26 April 2007 for consultancy services. The amount invoiced was £20,244 plus VAT.
12.	She explained that the Appellant operated two bank accounts. One with HSBC was used for the sales side of the business; the overdraft limit was £7,500. The main account for the service side of the business was the Lloyds TSB account. The Appellant had a factoring arrangement under which 82 per cent of the invoice total could be accessed, with a further 15 per cent becoming available once payment had been received from the client. Approximately 3 per cent covered the costs of the arrangement. She supplied copies of bank statements for the relevant period.
13.	The customer base consisted of some 600 clients using the Appellant’s services, as and when those clients needed to dispose of IT and office equipment. She supplied a copy extract from the Appellant’s day book, setting out a list of service payments from clients. The Appellant operated the Cash Accounting scheme for VAT purposes. All invoices requested payment within 30 days; the Appellant’s credit control had begun to chase payments after 6 weeks and there had been a significant improvement in the debts outstanding.
14.	In order to minimise company costs, the Appellant’s book-keeping was prepared and checked by Ian’s mother Mrs Ann Whiteland-Smith, a retired accountant living in Spain. Details of invoicing, income and expenditure were sent by e-mail and Mrs Ann Whiteland-Smith had access to the factoring account on line.
15.	In a letter dated 22 November 2007, which made no reference to Amanda’s letter dated 16 November, HMRC’s Poole Reconsiderations Team stated without giving any reasons their view that the Appellant did not have reasonable excuse for failing to submit its VAT on time. [We comment on this at the end of this decision.]
16.	In giving evidence, Ian confirmed that the day-to day book-keeping was carried out by means of a totally automated system generated from the invoices. All the sales invoices were on-line. The receipt of an item triggered an invoice. A spreadsheet was then generated by the computer. His mother, Mrs Ann Whiteland-Smith, used to make up the VAT returns. The VAT was dealt with on the cash accounting basis. The Appellant used a factoring company. His mother handled the factoring invoices, based on an Excel spreadsheet. Invoices were not sent to the factor. Everything was done on-line; his mother passed details to Lloyds TSB. Once she had provided those details to them, the monies would be released to the Appellant three or four days later.
17.	In relation to period 03/07, the Appellant needed the cash payment in April to pay the VAT due. During the previous month it had paid the rent. It was expected that the Veolia payment would be used to pay the VAT in April.
18.	Ian referred to the Appellant’s previous difficulties resulting from the delayed implementation of the WEEE Directive; in early 2006 he had consulted his MP, who had relayed details of those difficulties to the Secretary of State for Trade and Industry and to the South East England Development Agency. The past severe financial hardship had meant that the Appellant was having to trade at a loss. At the point covered by the appeal, the Appellant had nearly had a “clear year” for surcharges.
19.	The debt problems had stemmed from October 2005, when a project with Hampshire County Council had ended. The Appellant had had severe cash flow problems. The Appellant had had another firm of accountants, but they had not provided tax advice. In mid-June 2006 the previous administrator had left, and his mother had taken over.
20.	At the point when his mother was undergoing treatment for cancer of the colon, culminating with her operation on 7 March 2007, Ian became concerned by this, as well as being concerned to ensure that the Appellant’s administration would not suffer. He had not sought help from other accountants at that point. There had been a problem concerning a PAYE penalty. He decided that he would help his mother while she was recovering. (The administration for the Appellant involved 100 invoices a month.) He made several lengthy trips to Spain, staying there for much of March and returning at the end of April, when there was a set-back in his mother’s recovery.
21.	The VAT return for period 03/07 had been dealt with on time. The cash problem had caused a two day delay. He had known how much VAT was due. The Appellant had on-line banking. His return to the UK had been delayed, as described in the correspondence. The bank making Veolia’s payment had been requested to send the money by CHAPS, but had sent it by BACS, which had caused the payment to be delayed. Certain payments had been disallowed by the factor. The result had been an unexpected cash crisis. He pointed out that the Lloyds TSB on-line bank details were only updated 24 hours in arrears. Amanda had prepared the VAT return and signed the cheque, but had no access to the on-line account; nor had he while back in the UK from 23 March to 27 April. The overdraft limit on the account was £10,000. At the end of April 2007, the debit balance on the account was £7,428.27. The Appellant had followed previous advice to send in its return on time rather than late. In view of the delay in obtaining credit for the Veolia invoice, Ian had decided that a part payment of the VAT should be made, with a cheque for the balance of £8,000 being sent on 8 May.
22.	It would not have been possible to transfer funds from the HSBC account to the Lloyds TSB account, as this would have taken three days. Particularly given his extended working hours, 14 hours a day at the time, there would have been no time to seek any help from the bank, and in any event it was unlikely, based on the Appellant’s financial record, that the bank would have been prepared to assist.
Arguments for the Appellant
23.	The main arguments for the Appellant were set out in an attachment to its Notice of Appeal. This was not included in the bundle; we comment on this at the end of this decision.
24.	Under paragraph 4.2 of VAT Notice 700/50/04 an unexpected cash crisis caused by sudden non-payment by a normally reliable client could provide a reasonable excuse. In the present case, an invoice amounting to approximately 50 per cent of the Appellant’s monthly income had been delayed unexpectedly. The Appellant was in a vulnerable position because this one client was responsible for such a high proportion of the Appellant’s income. The factoring agreement only allowed access to 80 per cent of the funds invoiced until payment had been made by the client. There was no doubt as to the client’s financial credibility, but its processes were bureaucratic, making resolution of payment problems difficult. The person responsible for issuing a purchase order was on annual leave, and the resulting delay took the payment into an additional month of credit for the client. As soon as the purchase order had been issued, the Appellant had paid the additional charges for a CHAPS transfer from Lloyds TSB Factors to the Appellant’s Lloyds TSB Business Account, but the funds were not cleared by the bank until a day later than the Appellant had expected.
25.	With reference to the guidance at paragraph 4.3 of Notice 700/50/04 that account should be taken of all the circumstances of the case, including whether the problem could be foreseen and any alternative arrangements that could be made, Amanda made the following points:
(1)	Whilst not ideal to rely on one company for such a large proportion of the Appellant’s income, the very size of the client as a multi-national indicated that creditworthiness should not be an issue.
(2)	The nature of the waste industry and the uncertainty in the WEEE sector had caused the Appellant great difficulty in securing any form of funding through banks or government schemes. This earlier drain on the personal resources of Ian as Managing Director had made it impossible for him to find additional funds.
(3)	The Appellant had paid additional costs to Lloyds TSB to try to secure access to invoiced funds within the required time scale.
(4)	The Appellant’s bank statement showed that the cleared funds were available the day after the cheque was presented to the bank. The Appellant had been extremely disappointed with the actions of Lloyds TSB, as the Appellant believed that there was better communication between Lloyds TSB Factoring and the Lloyds TSB bank branch.
(5)	The Appellant had kept the VAT office informed of the problem and had been given verbal confirmation that a deferred payment would be accepted. However, such an agreement had no value unless the default surcharge was waived. It was accepted that the Tribunal could not consider the issue of proportionality, but a system of penalties which showed no distinction between inability to pay and unwillingness to pay appeared grossly unjust.
26.	At the hearing, Amanda made the following additional points. Ian had e-mailed the relevant individual at Veolia on her first day back in the office to ask her about the purchase order; she had confirmed just over half an hour later that this had been signed. Veolia’s payment had been delayed until 4 May. There had been difficulties with preparation of the VAT return because of Mrs Ann Whiteland-Smith’s illness; she had been discharged from hospital on 15 March, having had cancer of the colon, but despite her illness, the return had been submitted on time. Part payment of the VAT had been sent on 27 April; the Appellant’s bank statement showed that the cheque had been returned on 2 May. HMRC’s records showed that the second part of the payment had been received by them on 25 May 2007.
27.	There had been two key issues. Difficulty had arisen because Ian had not been in the UK at the crucial time. Secondly, the payment sought from Veolia was a large proportion of the Appellant’s monthly receipts. One reason for Ian having been in Spain was that he needed to get the VAT return sorted out. In the absence of the relevant person at Veolia, there had been no-one else to authorise the payment from that client. The amount which had been due from Veolia was nearly 60 per cent of the expected receipts for the relevant month.
28.	Amanda referred to the VAT guidance notes. There had been a loss of key personnel, and unexpected events. Subsequent action had been taken to avoid these potential problems. New Chartered Accountants had been appointed. There had been problems with a previous administrator. She referred to insufficiency of funds. It was accepted that such insufficiency did not of itself amount to a reasonable excuse, but she referred to the cash crisis which the Appellant had suffered. To verify Ian’s movements, she listed details of his flights to Spain, and emphasised that his mother lived on her own there. She contended that the Appellant had had a reasonable excuse for the failure to pay the tax for period 03/07 by the due date of 30 April 2007.
Arguments for HMRC
29.	Mrs Crinnion referred to section 59(1)(a) and (b) of the Value Added Tax Act 1994. The due date for the tax in respect of period 03/07 was 30 April. The Appellant’s cheque sent with the return to cover part of the tax due had bounced. HMRC’s records showed the receipt of the payment of £8,000 as 8 May 2007.
30.	Under section 71 VATA 1994, insufficiency of funds was not a reasonable excuse. The Appellant was using the Cash Accounting scheme. A payment made in respect of an April invoice was to be dealt with in the June return. The Appellant had been in the position of having insufficient funds by using the VAT received in respect of period 03/07 for other purposes. Reliance on another person did not amount to a reasonable excuse. The return had been submitted on time, but the payment of the VAT for the period had been late. The appeal should be dismissed.
Discussion and conclusions
31.	As Mrs Crinnion argued, under section 71(1)(a) VATA 1994, an insufficiency of funds to pay any VAT due is not a reasonable excuse. This principle has been qualified in various cases, in particular Customs and Excise Commissioners v Steptoe [1992] STC 757 in the Court of Appeal. This confirmed that in some circumstances the underlying cause of the insufficiency of funds might amount to a reasonable excuse. At p 768 Nolan LJ said:
“This passage does not of course deal in terms with the difficulties which may affect a trader who is required (as traders normally are) to account for tax on the basis of output tax due less input tax owing, rather than on the basis of payments less receipts. Such a trader may well encounter cash flow problems, particularly if he is in a small way of business. That is why the cash accounting scheme for small traders exists. It will generally deprive such a trader from putting forward delays in payment by his customers as a reasonable excuse for non-payment of his tax.”
32.	We interpret Nolan LJ’s use of the word “generally” as indicating that there might be some situations in which a trader within the cash accounting scheme could demonstrate that, exceptionally, the cause of insufficiency of funds did amount to a reasonable excuse.
33.	It is clear that the Appellant has had a series of difficulties causing it to be in a difficult financial position at a series of stages since its commencement of business. A principal cause of difficulty had been delay in implementing the WEEE Directive. Following the hearing, we have established that the UK regulations implementing the WEEE Directive were laid before Parliament on 12 December 2006 and came into force on 2 January 2007. Amending regulations were laid before Parliament on 11 December 2007 and came into force on 1 January 2008, but did not involve any major policy changes. Thus period 03/07 was the first VAT period in which the legislation underlying the Appellant’s business was actually in force and therefore began to permit it to carry on that business in the manner intended.
34.	Until that change in the law, the Appellant’s business had continued to be in problematical position. This led to the Appellant’s financial situation being very tight. During the period 03/07, the Appellant had rent to pay; it is clear to us that this was essential in order to continue its business operations. Payment of this rent meant that the expected payment from Veolia was required to provide the cash flow to enable the Appellant to make the payment of the VAT due in respect of that period. The payment from Veolia was delayed because of the absence of a purchase order, an administrative requirement of Veolia. Thus it was beyond the Appellant’s control that the absence of any person at Veolia who could approve the purchase order led to delay in the payment being approved. The problem was compounded by the use of BACS for Veolia’s payment instead of the CHAPS method requested. It was further compounded by the decision of Lloyds TSB Factors to withhold credit for certain of the Appellant’s invoices. Ian was prevented from taking appropriate action to resolve matters with the Appellant’s bank because of his absence in Spain and the travel difficulties which delayed his return.
35.	In their letter dated 21 May 2007 (see paragraph 10 above), HMRC referred to the delayed payment from Veolia as amounting to approximately 13 per cent of the Appellant’s declared outputs. However, this involved applying a fiction. If £20,244 is compared with the outputs for 03/07 amounting to £128,598, it is true that it is only a modest percentage of that total. The difficulty with HMRC’s comparison is that it involves expressing the amount of a payment due to be received in April 2007 as a percentage of the outputs for the three month VAT period ending 31 March 2007. On our calculations, the percentage is slightly greater, at 15.74 per cent.
36.	The crucial issue is that of timing. The Appellant expected to be able to use a payment from a major customer, due to be received before the end of April 2007, as available funds to cover the VAT payment due with the VAT return for 03/07. As Amanda argued, if the “missing” Veolia payment is expressed as a percentage of the receipts for the single month of April 2007, ignoring Veolia’s other payments for that month of £3,036.60, it represents 59.9 per cent of the expected payments for April. This is a much more substantial percentage. Subject to the question discussed below concerning the use of a payment for a later period to pay the VAT due in respect of an earlier period, it seems to us far more logical to compare the “missing” amount with the receipts for the month in which that amount would have been expected to be received.
37.	As a result of the delay in Veolia’s payment, it was decided that the Appellant should make a part payment of just over half the VAT due. This was frustrated by the decision of Lloyds TSB Factoring not to give credit for relevant invoices. Mrs Crinnion did not make it clear whether her reference to reliance on another person was intended to apply to the Appellant’s reliance on Lloyds TSB Factoring. If it was, we would question whether it is appropriate to consider this relevant for the purposes of the VAT legislation, as it appears to us that section 71(1)(b) VATA 1994 is intended to apply only to persons carrying out functions relevant to a trader’s VAT compliance. Reliance on some person to provide finance is a very different matter. Similarly, we do not think that the sub-section can be intended to apply to reliance on a person working for a customer where that person has responsibility for dealing with purchase orders establishing approval of payments by the customer to the trader. Nor do we consider that it can apply in the present case to reliance on Ian as the Appellant’s Managing Director.
38.	Despite Nolan LJ’s use of the word “generally” in the Steptoe case, should there be a conclusive presumption that a trader on the cash basis who has not retained enough to cover the liability to VAT in respect of a particular VAT period can never have a reasonable excuse for his failure to do so? We think not. We accept the basic principle that a trader who has received payments from his customers or clients ought, as a mater of prudence, to reserve out of those monies a sufficient amount to discharge the resulting liability to account for VAT. However, we feel that it would extend this principle too far to regard failure to comply with it as leading to an irrebuttable presumption that the trader had no reasonable excuse for any resulting default.
39.	Given the importance of this basic principle, we think that any trader who seeks to argue reasonable excuse in such circumstances is required to provide cogent proof of the particular reasons for relying on subsequent payments from customers or clients to meet the VAT liability for an earlier period. We think it likely that very few traders will be able to provide adequate reasons to explain why appropriate resources were not reserved out of customers’ payments received in that earlier period. The present case is exceptional, resulting from a unique combination of circumstances established by the Appellant’s evidence, and it is for this reason that we decided to allow the appeal.
40.	As indicated above, we have certain comments on the management of these default surcharge appeals. Our first comment is on the inadequacy of the review letter sent by HMRC’s Poole Reconsiderations Team to the Appellant on 22 November 2007 less than two weeks before the hearing. The relevant paragraph of the letter (which is similar to letters which we have seen in other cases) stated:
“We have reviewed the imposition of the Surcharge Assessments on the information available and regret we do not consider that you have reasonable excuse for failing to submit your VAT on time.”
41.	We do not think that this amounts to a proper explanation of the results of the review, or more particularly the reasons for arriving at the conclusion expressed. A proper review would record the circumstances, set out details of the relevant legislation taken into account, and explain the specific reasons why, based on that legislation, the conclusion was that the trader did not have a reasonable excuse. We accept that some details of the legislation were given in the Poole Reconsiderations Team’s letter dated 21 May 2007, but as Ian pointed out at the hearing, the detailed provisions were not spelt out to the Appellant until Mrs Crinnion put HMRC’s arguments to us. He felt that appellants should be given a proper opportunity to consider the law in advance of any hearing. We feel that appellants deserve to have a complete and properly reasoned review letter in sufficient time before the hearing, to enable them to assess whether it is appropriate for them to pursue their appeal.
42.	Our second comment, which relates to all default surcharge appeals, is that a copy of the Notice of Appeal and any supporting arguments submitted at the time should be included in the bundle of documents, rather than putting the members of the Tribunal to the inconvenience of having to extract copies from the Tribunal file.
43.	The appeal is allowed, with no order as to costs.

JOHN CLARK

CHAIRMAN
RELEASE DATE: 28 January 2008

LON/07/1075