20603

VAT – Default Surcharge – Reasonable excuse – Appellant’s trade  managed as part of a business together with the businesses of two connected companies – one of those other businesses suffered an unforeseeable commercial setback – insufficiency of funds – whether reason for the insufficiency afforded the Appellant a reasonable excuse – held it did – appeal allowed 

LONDON TRIBUNAL CENTRE

	STOKE PARK LIMITED	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S 
	REVENUE AND CUSTOMS	Respondents

			Tribunal:	JOHN WALTERS QC (Chairman)
					MRS. R.S. JOHNSON

Sitting in public in London on 17 October 2007

Mr. King, Managing Director, for the Appellant 

Mr. J. Holl, Advocate, for the Respondents

© CROWN COPYRIGHT 2008

DECISION

1.	This is an appeal against a default surcharge imposed for the VAT period 09/05, which is brought by Stoke Park Limited, the Appellant.  The default surcharge in issue is imposed at 15% and amounts to £77,772.21.  The Appellant runs the Stoke Park Club at Stoke Park, Stoke Poges, Bucks
2.	The Appellant was in default in respect of the period 09/03, but no surcharge was imposed for that period.  It was also in default in respect of the periods 09/04, 03/05 and 06/05, and surcharges at the rates of 2%, 5% and 10% respectively were imposed for those periods.  However no appeal is brought against those surcharges.
3.	Mr. King, Managing Director of the Appellant, submits that the Appellant accepted those surcharges as being proportionate and fair, but objects to the 15% surcharge for the period 09/05 because he says that it is so large that it is not proportionate or fair.
4.	We heard oral evidence from Mr. Milind Pradhan, Finance Director of the Appellant, and also of a company called International Hospital Group (“IHG”) which, like the Appellant, is ultimately owned by International Group Ltd. (“IG”). We accepted Mr. Pradhan’s evidence and find the facts which we have recorded in the following paragraphs.
5.	Although the Appellant, IG and IHG are three separate companies and have separate VAT group registrations, they are nevertheless run as a single company with divisions. This is for historical reasons.
6.	As part of this arrangement, the Appellant’s, IHG’s and IG’s banking arrangements are intertwined and IHG and IG gave financial support to the Appellant (although IHG, IG and the Appellant have different bank accounts).  At the relevant time (up to 2005) IG (or IHG) had a term loan from Bank of Scotland, and overdraft facilities with Royal Bank of Scotland and the Bank of Luxembourg.
7.	IHG’s biggest contract was with the Government of Ghana. It represented 90% of IHG’s sales. The contract covered the management of the design, construction and commissioning of a healthcare facility in Ghana.  Unfortunately the Government of Ghana was slow with its payments on this contract, and this subjected IG, IHG and the Appellant to financial strain.  It was either legally or practically impossible to sue the Government of Ghana in relation to the late payment, although eventually IHG expects to receive some compensation for the delays.
8.	This led to the Royal Bank of Scotland requesting repayment of IG’s overdraft in 2005.
9.	IG had realised that non-payment, or delayed payment, by customers was a problem with its business, and decided to invest in the acquisition of the Stoke Park Club, a business with a steadier cash flow, to compensate for this.  Unfortunately the crisis in IG’s relationship with the Royal Bank of Scotland occurred at the time when the Stoke Park business was not yet yielding a positive cash flow, on account of the initial investment in the acquisition and improvement of the building which is the Club premises.  
10.	The Royal Bank of Scotland agreed to continue but not enlarge its facility to IG on certain terms, provided that IG looked for alternative banking arrangements.  IG, IHG and the Appellant judged it necessary that payments of VAT and other taxes (including payments due from the Appellant) should be postponed by means of an instalment agreement to be made with HMRC.  In fact, the Appellant had made instalment agreements with HMRC since 2003.
11.	A decision was taken to try to sell Stoke Park by a private sale (the investors thought that an auction would have damaged the business, although ultimately the Royal Bank of Scotland might have insisted on an auction sale).  A potential purchaser was found but after six months lost interest in the purchase.
12.	VAT due from the Appellant was paid by instalments as follows: the VAT due for the period 09/04 was paid over the period from 27 October 2004 to 18 July 2005; the VAT due for the period 03/05 was paid over the period from 25 July 2005 to 3 November 2005; and the VAT due for the period 09/05 (the period relevant to this appeal) was paid over the period 15 November 2005 to 15 August 2006.
13.	The VAT due from the Appellant for the period 09/05 was £518,481.46.  This related to VAT on subscriptions charged to members of the Stoke Park Club.  There are about 2,000 members.  The subscription for a golf-playing member is between £2,000 and £2,500 a year, and the subscription for a health club member of £1,000 a year.  The instalment agreement relative to the period 09/05 was recorded in HMRC’s letter dated 28 October 2005.  The agreement stated in terms that acceptance of the arrangement offered “does not prevent or cancel recording of defaults, liability to surcharge, and interest where applicable”.
14.	There was no problem obtaining subscriptions from the members who were liable to pay the Appellant the £518,481.46 representing VAT due for the period 09/05.  The financial difficulty was that the bank expressly or impliedly imposed the requirement for stage payments of VAT by the Appellant as a condition of continuing support to IG and IHG in the face of the delay by the Ghana Government in meeting its payment obligations to IHG.
15.	IHG had received £43m. from the Ghana Government in connection with this contract, and so it was readily explicable as a matter of commercial judgment that IHG should not have walked away from the contract in 2005, but should have continued with it in the hope of late payment from the Ghana Government.  This in fact has (to some extent at any rate) materialised.  £2m, of the £4m outstanding on the contract, had been received in the week before the appeal hearing.
16.	IHG eventually secured replacement banking facilities in early 2006 and overcame its cash flow problems on the sale of two properties (not Stoke Park) in September 2006 and January 2007.
17.	IHG itself had not had great difficulty meeting its VAT obligations.  This is because most of its supplies are made to overseas customers and are zero-rated.  Three out of four of IHG’s VAT returns are repayment returns.
18.	Mr. King’s case for the Appellant, as indicated above, was that the surcharge is disproportionate.  He also cites Customs and Excise Commissioners v Steptoe [1992] STC 757, a decision of the Court of Appeal, and submits that the Appellant has a reasonable excuse for its default, having regard, not to the lack of funds to pay the VAT, but to the underlying cause of the lack of funds.
19.	Mr. Holl, for the Commissioners, submitted that the Appellant had not discharged the burden of proof on it to show a reasonable excuse for the default.  He pointed out that the Appellant was in funds from the VAT-element of the membership subscriptions to meet its own VAT liability on time.  He submitted that, in regard to the establishment of a reasonable excuse, we could not look beyond the affairs of the registered person in question, that is, the Appellant.  We could not take into account the exigencies of other businesses connected with the Appellant, in particular IHG’s business.  The reason for the default was the restricted overdraft facilities available to IG and IHG, and the reason for those restricted overdraft facilities was the problems with IHG’s contract with the Ghana Government.  Neither of these matters concerned the Appellant, and could not furnish the grounds for a reasonable excuse of which the Appellant would avail itself.
20.	Mr. Holl made a submission on the Steptoe case which we have not been able to follow.  He said that the fact that the Appellant incurred default surcharges in earlier periods showed that it was aware of the consequences of late payment of VAT.  This submission does not show that there was not an underlying reason for the Appellant’s default which was not lack of funds, which was the proposition for which the Appellant relied on Steptoe as authority. If this submission was, in effect, that the Appellant having not contested the earlier default surcharges could not consistently contest the surcharge under appeal, we reject it.  The Appellant is entitled to take any point in relation to the later (and much higher) surcharge which, for whatever reason, it chose not to take in relation to the earlier surcharges.
21.	Mr. Holl cited the Tribunal’s decision in the appeal of Greengate Furniture to show that a default surcharge, even at 15%, is proportionate and reasonable.
22.	Mr. King, in reply, urged us to consider the affairs of IG, IHG and the Appellant in deciding whether the Appellant had shown a reasonable excuse.  He said that the fact that the companies were not combined in a single VAT registration was because of historical reasons and not for any financial or VAT advantage.  He said that the Appellant had been subsidised by IHG for twelve years so that it could build up a business with a stable cash flow.  
23.	We reserved our decision.
24.	First of all, we reject the Appellant’s submission that the surcharge appealed against is disproportionate or unfair.  This is in accordance with the decision in Greengate Furniture. The 15% surcharge is part of the regime which Parliament has enacted to ensure timely payment of VAT.  There are successive occasions where a registered person is warned of the potential imposition of surcharges before a surcharge at 15% is imposed.  The opportunity is therefore given for action to be taken to avoid the imposition of a surcharge at 15%.
25.	The default surcharge is thus prima facie in order so far as the provisions of section 59(1) to (6) VAT Act 1994 (“VATA”) are concerned.  Those provisions set out the circumstances in which a taxable person may become liable to a default surcharge and the amount of the default surcharge.  Section 59(4) VATA imposes the default surcharge.
26.	 However, by section 59(7)(b) VATA, where a person who would otherwise be liable to a default surcharge under section 59(4) satisfies the Commissioners or, on appeal, a tribunal, that in the case of a default which is material to the surcharge there is a reasonable excuse for the return or the VAT not having been dispatched in time, that person shall not be liable to the surcharge and for relevant purposes shall be treated as not having been in default for the VAT period in question.
27.	In determining whether or not a reasonable excuse has been established, it is expressly provided by section 71(a) VATA that an insufficiency of funds to pay any VAT is not a reasonable excuse.
28.	However, as the Appellant submitted, there are circumstances where the cause of an insufficiency of funds, the underlying cause of a taxable person’s default, may give rise to a reasonable excuse within section 59(7)(b) VATA – see: Steptoe.
29.	If the Appellant is to succeed in this appeal, we must be satisfied that it has shown that it had a reasonable excuse for the default which was not simply lack of funds to pay the VAT.  The conditions laid down by the Court of Appeal in Steptoe must be satisfied.
The Steptoe decision
30.	In Steptoe, the Court of Appeal decided that (in the words of Lord Donaldson of Lymington MR) “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” (ibid. at p.770d/e).
31.	On the facts of Steptoe, a trader whose only real customer was persistently late in paying his bills, was able to show a reasonable excuse, in particular because the chairman of the tribunal had found as a fact that if he (the trader) had brought pressure to bear on his customer, he would probably have received no further orders and the bulk of his livelihood would have disappeared (see: ibid. at p.769d/e).  This was the decision of the majority of the Court of Appeal (Lord Donaldson and Nolan LJ).
32.	Scott LJ (the dissenting Lord Justice) preferred a more restrictive approach to the application of the reasonable excuse provision.  He would have dismissed the appeal because: “if the normal hazards of a taxpayer’s particular business include the late payment of bills, then the taxpayer should make arrangements to finance his cash flow on that footing.” (ibid. at p.765f/g).
33.	In a case, such as this, where the possible underlying reasonable excuse for the late payment of VAT is not some external unfortunate event (such as, for example, a burglary – see: Fat Sam’s American Food and Beverage Co. Ltd. v Customs and Excise Commissioners : LON/90/1408, unreported) but is instead a business setback, the late payment by the Ghana Government of instalments of the price due on IHG’s contract,  the question for the Tribunal is whether in all the circumstances the inability to pay the VAT on time was “reasonably avoidable” – per Lord Donaldson in Steptoe at ibid. p.770f.
34.	That question is to be answered by looking at the reality of the business situation in which the trader in question found itself.  The Commissioners and, on appeal, the Tribunal, is to “distinguish between the trader who lacks the money to pay his tax by reason of culpable default and the trader who lacks the money by reason of unforeseeable and inescapable misfortune” (see: per Nolan LJ in Customs and Excise Commissioners v Salevon Ltd. [1989] STC 907, cited by him in Steptoe, ibid. at p.767h/i).  Whether there is in any case “unforeseeable and inescapable misfortune” is to be approached on the basis that what is meant is not reasonably foreseeable and not reasonably avoidable (see; per Lord Donaldson MR ibid. at p.770e/f.
35.	Tribunals have interpreted and applied the Steptoe tests in a number of decisions.   Among them are Wood Floor Studio Limited (LON/2000/0965, Trib. Decision 17066), and Longstone Limited (LON/1999/0503, Trib. Decision 17132), both decisions of the President of these Tribunals, Stephen Oliver QC.
36.	In Wood Floor Studio, the President commented on the situation of the appellant company trading “on a financial shoestring with the added disadvantage that the bank had a floating charge over all its assets” as follows: “Trading had to continue if there was to be any chance of fully paying off creditors.  The reasonable businessman in those circumstances would have done everything in his power to keep creditors from instituting winding up proceedings”.
37.	In Longstone, some of the defaults were caused by an unsuccessful venture into a “finishing” trade as part of a publishing business.  “Finishing” involves taking delivery of printed magazines in bulk, then inserting advertising material inside each one, putting “free gifts” on the front and bagging each magazine in a polythene wrapper.  The evidence showed that the problems of the finishing trade revealed themselves quite soon after Longstone had started on that business.  The President commented (ibid. at paragraph 15): “Nonetheless the decision to embark on that activity was a serious and bona fide entrepreneurial move on Longstone’s part.  There was, I think, nothing unreasonable about the decision to go into the finishing business.  Nor could Longstone’s management be criticised for persevering in hopes of pulling it round.”
38.	The reality of the business situation in which the Appellant found itself was that its management, cash flow and banking support facilities were all intimately connected to the affairs of IG and IHG.
39.	Although this is an unusual situation, we accept Mr. Pradhan’s evidence that it came about for historical reasons and not because the companies were seeking any VAT advantage.  We regard the connection between the companies’ affairs as a reasonable way to run the businesses and we consider that it would not be just to criticise or prejudice the Appellant because its affairs were connected with those of IG and IHG in the ways we have described.
40.	Because this was the reality of the business situation (and arose out of reasonable business conduct), we consider we must have regard to it in determining whether the Appellant’s default is due to an unforeseeable and inescapable misfortune, rather than its culpable default.
41.	Therefore we reject Mr. Holl’s submission that for the purposes of identifying a reasonable excuse we cannot look further than the affairs of the Appellant.
42.	In fact, the Appellant’s default was entirely due to the Government of Ghana’s delay in discharging its obligations to IHG.  
43.	We regard this causative factor as an unforeseeable and inescapable misfortune (in Steptoe terms) rather than something for which the Appellant (or IHG or IG) can be regarded as culpable.  In this aspect the facts of the case are relevantly similar to those of Steptoe itself.  
Conclusion
44.	We regard the Appellant’s conduct of its business to have been reasonably prudent in the circumstances which prevailed.  In particular, the decisions to trade within the tight constraints in point of overdraft facility imposed by the bankers from time to time, and to persevere in the hope of bringing the business round were reasonable business decisions. Similarly, in the Tribunal’s view, the Appellant is not to be considered to have acted unreasonably in not trying more vigorously to dispose of Stoke Park (although the contrary was not argued by Mr. Holl). 
45.	In all the circumstances, we are satisfied that the Appellant had a reasonable excuse for the late payment of the VAT due for the period 09/05 – in that it was not “reasonably avoidable”.  We allow the appeal.
       
JOHN WALTERS QC

CHAIRMAN
RELEASE DATE: 6 March 2008

LON/2007/1207