MS Foods v Revenue & Customs [2010[ UKFTT 440 (TC) (16 September 2010)

DECISION

Introduction

1. The disputed decision of the Commissioners for Her Majesty’s Revenue & Customs (the “Commissioners”) is an assessment in the sum of £18,520 plus interest notified to the Appellant on 22 May 2007.

Background

2. The Appellant operates a food distribution business from a warehouse The Warehouse, Camford Way, Luton, Bedfordshire LU3 3AN. They were registered for VAT on 20 January 1992 (registration number 600482676).

3. A VAT inspection, occasioned by an increase in input tax claims, was conducted on 28 November 2005. After the inspection, the Appellant was asked to produce various documentary evidence relating to ales, day books and sales to EU countries, which they were unable to do. A further visit was undertaken on 16 January 2006. One of the officers on that visit, Higher Officer Jim Pink, conducted a credibility exercise on two VAT periods. He compared the input tax claimed on standard rated food and drink purchases recorded for tax declared in both periods. In both exercises, input tax claims exceeded output declared. This caused concern. Officer Pink asked a director of the company, Mohammed Saghir to provide reasons for the difference between the input and output tax figures. He explained that the deficit was due to the following :

(i) a large amount of standard rated goods were given away as a loss leader in order to sell zero rated stock

(ii) large consignments of fizzy drinks were damaged and unable to be sold and were awaiting destruction

(iii) there had been a build up of unsold standard rated stock over a period of time

4. Officer Pink conducted further analysis based on information which was taken away at the time of his visit. An analysis of the VAT return submitted for the ten VAT periods from 07/03 to 10/05 input tax exceeded output tax on standard rated goods by £428,608

5. On 31 January 2006 Officer Pink wrote to the Appellant. He explained that during spanning ten VAT periods input tax exceeded output tax on standard rated goods by £428,608. He noted that the gross margin on all goods sold between VAT periods 07/04 and 07/05 was only 6.7%, which represented a low mark up. He asked the Appellant to undertake a review of the sales between the periods 07/03 and 10/05 and to provide the following information:

(i) Value of standard rated goods (per period) given away free.

(ii) Value of stock disposed of (or to be disposed of) with details of dates of purchase and disposal.

(iii) Value of all stock at year end .

(iv) The gross profit margin expected/achieved over the ten VAT periods on standard and zero rated goods for resale.

(v) Copies of tax analysis for purchases in periods not already provided and additional purchase reports on VAT in respect of goods for resale. .

6. On 14th March 2006 the Appellant responded giving details of wastage, stock given away, stock figures, profit margins and details of standard rated items included in the purchase report that were not for resale, such as pizza boxes, cling film and packaging. The requested purchase analysis reports were also produced.

7. The Appellant also made the following points

(i) Between the VAT periods 07/04 and 04/05 offers were made to customers such as “buy 5 cases of chips and get a case of free drinks”.

(ii) Between VAT periods 07/04 and 04/05 over £100,000 (net) of stock was given away.

(iii) Similar offers were made in VAT periods 07/05 to 01/06. £50,000 of stock was given away.

(iv) Most drinks are imported and suffer significant damage, for example, in the period 07/03 there was £60,000 damages and in VAT periods 07/04 and 01/05 there was approximately £25,000 of damaged stock in each period.

(v) After moving to new premises with better loading facilities the damages decreased.

(vi) A deal was done with Multiple Marketing Ltd in respect of £160,000 of drinks. The stock did not sell as expected, with sales being below cost price. The goods were short shelf life and had to be disposed of. The value of the goods disposed was £70,000.

8. This meant that losses, as stated by the Appellant, resulting from damage to drinks exceeded £170,000 and a further £160,000 was lost in a line of drinks that proved unpopular and had to be sold below cost. The total loss of purchased drinks averaged 9.3% over 11 VAT periods.

9. The Commissioners enquired of the Appellant whether the goods condemned had been insured for loss or damage and whether insurance claims had been made. It was confirmed that no insurance claim had been made by the Appellant for either damage or out of date stock.

10. The level of losses caused concern to the Commissioners. They did not find the level of losses to be acceptable. Officer Pink thought it necessary to undertake a comparative review with other similar companies of the losses which they had suffered. They approached two other wholesale drinks and food distributors to try and determine the level of wastage which was acceptable to the industry. Both businesses informed Officer Pink that their wastage was below 1%.

Officer Pink requested further information from the Appellant including computer back up discs for the periods in question and asked for a proper examination to be conducted of their stock records The Appellants were unable to produce any disc or relevant information to assist in this verification process.

11. On 22 May 2007, Officer Pink wrote to the Appellants with his conclusion which can be summarised as follows:

(i) The increase in stock levels over an extended period of time was accepted.

(ii) The level of goods given away as a loss leader to promote the level of zero rated sales was accepted.

(iii) Given the research of two comparable businesses, the level of damaged goods was not accepted.

(iv) The damages figure for goods (drinks) of 9.3% was not credible and a figure of 2% damages was considered realistic and accurate for the period before 04/05 ( old warehouse) and 1% for periods thereafter (new warehouse with better unloading facilities).

12. An assessment was raised on the Appellant on best judgment (S.73(1) VATA 1994).

13. The Appellant did not accept Officer Pink’s assessment of the situation. Mr Saghir said that Officer Pink had not visited the former premises (old warehouse), which were not equipped to off load unpalletised goods. He therefore could not make an accurate assessment of its capability. Further, he said that proper account had not been taken of the short dated stock which had to be sold quickly and which resulted in significant losses. The businesses which were used for comparison were not importers of goods nor did they buy short dated stock. Therefore the comparison with those businesses was unfair. The Appellant said that the level of losses was sustainable because the free drinks which were given away boosted overall turnover and gross profit and the business was showing a profit margin of 6.6% over the eleven VAT periods in question. This was partly due to buying in cheaper goods from the Far East.

14. What emerges from the correspondence between the parties is that while they were able to agree most outstanding points, there was no agreement on the wastage or damages levels. The Commissioners were unable to accept the level of damaged goods which the trader provided. During the two years to July 2005, the Appellant stated that the damages incurred was around three pallets a week which equated to 360 cases of soft drinks (8640 cans) on average each week. Over eleven VAT periods the declared losses ranged from 2.4% to 17.1% of drinks purchased with the overall average loss being 9.3%. The Commissioners found that these losses were not sustainable in the business and further it was unusual that no insurance claims had been made for these losses. Additionally, in making comparables with similar businesses, the Commissioners found that the level of loss was nearer 1% -2%.

15. The Appellant could provide no records to show what had been given away. They were only able to provide an estimate based on the recollections of employees.

16. The main issue in this dispute concerns the damage or wastage allowance. The Appellant was not able to provide records to substantiate their figures and their level of losses. The Appellant submitted, in support of their figures, that the suppliers would not take back damaged goods where the percentage of damaged goods amounted to 10% or less of the total goods imported. The Tribunal however was not provided with evidence to support this position.

17. The Commissioners was of the view that the Appellant should have been a net payer of VAT .given that drinks made up 90% of the standard rated supplies of the Appellants business. They were not convinced of the Appellant’s figures

18. A point about profits. The Appellant’s profit margin is approximately 6.6%. If more goods were sold and less destroyed then the profit margin in the business would have increased. Officer Pink provided helpful calculations which showed that with a lower 1% wastage allowance, the profit margin on drinks would have been in the range of 18.6% based on drink sales of approximately £1.7 m. The Appellant themselves have provided figures for a three year period (03 to 06) which showed a gross profit margin of between 13% and 29% for drink sales. There is no dispute that the sale of drinks gives significant profits and wastage reduces that profit margin.

The Appellants’ submissions

19. The Appellant submit that the comparable business figures provided by the Commissioners are not reliable. This is because the wholesale drinks businesses which were visited were not appropriate comparables to their business. Those businesses did not have similar warehouses problems (poor loading facilities), they did not buy short dated stock and their goods were not imported from overseas. These factors contributed to the high level of losses. The Appellant said that when moved into more modern premises in 2005, with proper facilities for off loading, the level of stock damage reduced significantly. Insurance claims were not made because insurance companies would not entertain a weekly claim amounting to roughly £1,000 and the fact that a claim was not made for these losses is not a significant point.

20. The Appellant also say that they made an estimation of the damages of short dated stock as no paperwork was available to support the amount of loss. Their assessment of the situation was provided after speaking to employees who assisted in providing an estimate of the loss. They accept that this method may not be the most accurate way of providing relevant information.

21. The Appellant contend that since there was a profit of approximately 6.9% it was in their business interest to keep giving away free drink as a loss leader. This business model worked for their business. The Appellant submits that the losses arising on the drinks was tolerable given that profits were being made in the overall business even with a 9% wastage allowance. Further, the purchase of wholesale drinks at roughly half the normal price (from the Far East), meant the business could tolerate a higher level of losses and still be ahead of the game.

22. The Appellant does not accept the Commissioners position and does not accept the wastage allowances used in making the assessment.

The Commissioner’s submissions

23. The Commissioners draw reference to section 73(1) VAT 1994 which provides -

“where a person has failed to make any returns required under the Act (or under any provision repealed by this Act) or to keep any documents and afford the facility necessary to verify such returns where it appears to the Commissioners that such returns are incomplete or incorrect, they may assess the amount of VAT due from him to the best of their judgment and notify it to him”.

24. Based on credibility exercises in two VAT appeals, the Commissioners say that the Appellant’s input tax claimed exceed output tax declared and further investigations of the Appellant’s wastage level for standard rated drinks purchased for resale found that the level of 9.3% over a total of eleven VAT periods was not acceptable. Further, the fact that no insurance claims had been made for these losses does not support a convincing argument.

25. The Appellant has provided no documentary evidence to support their position and further their losses figures was estimates. In the absence of records and relevant supporting evidence, the Commissioners believe that wastage or damage levels in the business was excessive and not allowable.

26. They therefore arrived, after looking at comparables, at a wastage level of 1% and the higher figure of 2% for the pre 2005 period.

27. The Commissioners believe that the gross profit margin figure for the business should be nearer 18.6% using their revised wastage allowances. They have therefore calculated that the Appellant have under estimated output tax in the sum of £18,520 and contend that the assessment raised by the Officer was issued at their best judgment and reasonable in the circumstances.

Conclusion

28. The parties do not dispute the core facts as laid out but do dispute the wastage allowance.

29. It is important to establish the legal principles which apply and then the facts to be applied.

30. Section 73(1) VATA 1994 allows the Commissioners to make a best judgment assessment if it appears that returns are incorrect .They must exercise their power honestly and in a bona fide manner. The case law (Van Boeckel v The Commissioner 1981 STC 290) makes it clear that, there must be some material before the Commissioners on which they can make their judgment. Although their decision must be reasonable and not arbitrary, they are not required to do the work for the tax payer in by carrying out exhaustive investigations but if they do, they must take into account material disclosed to them. The tribunal’s function is supervisory.

31. The law evolved through other cases including M H Rahman (trading as Khayam Restaurant) v Customs and Excise Commissioners (1998) STC 826. The core principles of law which arise from the cases are as follows. First, the Tribunal should not treat an assessment as invalid merely because it disagrees as to how the judgment has been exercised. If however, the judgment was exercised in the manner which was dishonest or vindictive or capricious or simply guess work and was wholly unreasonable then it would not stand. If an assessment is shown to have been wholly unreasonable or not bona fide, there could be sufficient grounds for setting it aside but such a case is likely to be extremely rare. Finally, it should be assumed that the Commissioners have made an honest and genuine attempt to reach a fair assessment. The Tribunal should concentrate on whether the amount of the assessment should be sustained in the light of the material available. The tribunal does not have to look at all the material afresh, it must only look to see that it is made to the best of the Commissioner’s judgment.

32. If we apply these principles to the facts of the appeal, we find that there is material on which the Commissioners could have based a decision when making an assessment. They have visited the Appellant’s premises on 20 November 2005 and again on 16 January 2006. A further visit was undertaken on 24 July 2006. Secondly Officer Pink conducted a credibility exercise in two VAT periods and compared the input tax claimed on standard rated food and drink purchases with output tax declared in the period. He had before him purchase reports, confirmation that insurance claims were not made, information of the gross profit margins of the Appellant, details of stock, information on the level of goods that were given away as loss leaders, research undertaken on two comparable businesses, gross profits for 2004 and 2005 and stock levels and annual reports among other information. He had also asked the Appellant to provide a review of sales between 07/03 and 10/05 and the value of standard rated goods which were given away and the value of stock disposed of, gross profit margins expected over ten VAT periods, copies of tax analysis, prints for purchases and additional purchase reports. The Commissioners had also prepared a schedule for the periods 07/03 to 01/06, showing purchase of standard rated drinks for resale calculation at £1,824,524 and made allowances for drinks given away and a wastage allowance which showed a gross profit margin of 18.6%. There was therefore sufficient available relevant information on which to base their judgment.

33. The Commissioners must also exercise their powers in such a way that is reasonable. The Appellant submit that the Commissioners did not exercise their power in a reasonable manner since they compared businesses which were not similar. While it is correct to say that the businesses were not exactly similar in that may not have had short dated stock or imported most of their products overseas, the companies were involved in the same sector and given the wastage levels from visits to these businesses, the Commissioners found that over eleven VAT periods wastage of £170,000 representing 9.3% of purchased stock was not an acceptable level in the drinks trade, more so since the Appellant could provide no evidence to support their claim. The Commissioners believed that the figures which they obtained from other similar companies were credible and realistic for companies operating in that sector. The Tribunal finds that while the comparable companies may not have been identical, the fact that they operated in the same sector and conducted similar businesses that they were realistic comparables for the purpose of the wastage allowances. Further the difference in loss levels between the Appellant and the comparable companies, 1% v 9%, was noticeably different. even making some allowance for the points made by the Appellant.

34. The next question which should be asked is whether we should treat the assessment as invalid merely because we disagree as to how the judgment was exercised. The Tribunal does not find that Mr Pink, based on his oral and written evidence was dishonest, vindictive or capricious in the way he went about the assessment. Neither was his assessment a spurious estimate or guess on which all elements of judgment were missing. The Commissioners made an honest and genuine attempt to reach a fair assessment. They were prepared to accept the increase in stock levels over an extended period of time and the levels of goods which were given away as loss leaders to promote the level of zero rated sales. However, the one area of dispute between the parties concerned the wastage allowance. It is this figure which was some 8% higher than comparable businesses, a level found to be unacceptable. The Commissioners were not prepared to accept 360 cases of soft drinks on average each week was being damaged especially where no documentary evidence was available from the Appellants to support this position. The Tribunal does not find the assessment to be unreasonable and not bona fide. The Commissioners considered carefully the figures which were supplied by the Appellant and accepted a significant amount of that information, in particular the increase of stock and promotional zero rated sales. The Commissioners believed that the level of loss suffered by the Appellants in the period was not sustainable and this is borne out by evidence provided by other businesses. Certainly they would not have been sustainable in the long term. It is recognised by the Tribunal that short term profit margins and lower cost prices allowed the Appellants to continue trading at a profitably.. However the issue is about the level of profit,, if a business had to choose between making 6% profit and 18% profit, it is clear which would be chosen.

35. The wastage allowance of 2% (old warehouse) and 1% (new warehouse) are reasonable in the circumstances. The Tribunal is confident that the assessments were made of best judgment and not excessive.

36. Further, the onus is on the Appellant to prove their case and provide evidence which rebuts the evidence. The Appellant provided very little, if any, evidence to show their side of the story. They recognised that they were unable to provide documentary evidence to support their claim. There was no sage software computer back up disc of stock records and no evidence was produced for previous trading periods. Mr Saghir accepted in questions from the tribunal that he had stock records but said that the damaged and other goods, which formed the basis of the wastage, were not recorded in the stock data. This struck the tribunal as very surprising.

37. The Tribunal is mindful of the points made by the Appellant. One point made was that the high proportion of losses occurred in the old premises which were not equipped to off load containerised goods which were loose loaded (unpalletised) which resulted in damage to the drinks when they were off loaded. The Tribunal accepts there would be damage to goods in such circumstance but accepts that 2% allowance would be appropriate given the experience of other traders. The second point made by the Appellant is that they purchased short dated stock which has to be sold quickly. The Tribunal accepts that this type of stock was kept by the Appellant but the level of loss appeared to the Tribunal to be very high and not fully explainable by the short dated stock. It is for this reason that the Commissioners did not accept the one off loss arising from the Multiple Marketing Ltd transaction of approximately £160,000. It is the sort of loss the Tribunal feels should have been the subject of an insurance claim. The Appellant did provide some evidence to the Commissioners as well as photographic evidence of goods which had been damaged accidentally and during their visits the Commissioners was able to see first hand examples of damaged goods. However that evidence was not sufficient to convince the Commissioners of the loss levels which the Appellant had claimed.

38. In the end, the actual levels of loss and damage proved to be unrealistic. It seems very strange that this level of loss was allowed to continue without steps being taken to reduce the level of damage or to alert the suppliers of the losses and require that the packaging be improved. The Appellant bought sufficiently large quantities of goods that a supplier would have made some effort to correct the problem of damaged stock on importation or to offer to reimburse damaged goods if there was no insurance claim made. The Appellant seems to have allowed the losses to mount up over time and made no attempt to address the continued damage to goods through its dealings with the suppliers or the insurance company. The Appellant claimed that the suppliers would not tolerate any losses which were 10% or less, which operated as a sort of excess clause, so that the Appellant were their own insurance for that amount of loss. However the Tribunal has seen no documentary evidence to support this position .It is not therefore a matter which the Tribunal considered.

39. The Tribunal therefore believes that the assessment raised by Officer Pink was issued to best judgment, reasonable and not arbitrary basis and based on material which was before the Commissioners. The officer had calculated what he considered a reasonable amount of wastage based upon all the information available to him at the time and using the established principle of best judgment.

40. In the circumstances the assessment should be upheld and the appeal should be dismissed. The assessment in the sum of £18,520 plus interest therefore will stand. We understand that the Appellant has already satisfied this sum by making payment to the Commissioners. No issues of costs were raised.

41. This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application must be received by this Tribunal not later than 56 days after this decision is sent to that party. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.

First-tier Tribunal (Tax)

TAX

THE COMMISSIONERS FOR HER MAJESTY’S

REVENUE AND CUSTOMS Respondents

DR K KHAN

RELEASE DATE: 16 September 2010

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You are here: BAILII >> Databases >> First-tier Tribunal (Tax) >> MS Foods v Revenue & Customs [2010[ UKFTT 440 (TC) (16 September 2010) URL: http://www.bailii.org/uk/cases/UKFTT/TC/2010/TC00705.html Cite as: MS Foods v Revenue & Customs [2010[ UKFTT 440 (TC)