[2011] UKFTT 107 (TC)

TC00983

Appeal number: TC2010/03929

VAT – PENALTY FOR A CARELESS ERROR – Appellant misunderstood the tax point for a land transaction – Premature claim for input tax – Appellant received maximum discount for prompted disclosure – one-off technical error – no real likelihood of tax loss – unusually large value of the transaction aggravated the monetary penalty –  were there special circumstances – yes – penalty reduced to 7.5 per cent of the monetary value – Appeal allowed in part 

FIRST-TIER TRIBUNAL

TAX 

	G D & MRS D LEWIS T/A RUSSELL FRANCIS INTERIORS	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

		TRIBUNAL: 	MICHAEL TILDESLEY OBE (TRIBUNAL JUDGE)
				TERENCE BAYLISS FFA FAIA		
						
Sitting in public at Auchinleck House, Broad Street, Birmingham B15 1DL on 24 August 2010. Adjourned for additional submissions which were to be considered on 10 December 2010

James Sibley of King Freeman Chartered Accountants for the Appellant

Cheryl Payne-Dwyer for HMRC

© CROWN COPYRIGHT 2011

DECISION
The Appeal
1.	The Appellant was appealing against a penalty in the sum of ₤5,062 dated 18 December 2009. The penalty was imposed for an error in the Appellant’s VAT return for the quarter ending 06/09 which HMRC classed as careless pursuant to schedule 24 of the Finance Act 2007.
2.	The Appellants were in the furniture business. They held a small property portfolio. The Appellants had opted to tax on their property transactions. On 29 May 2009 they exchanged contracts for the purchase of a commercial warehouse, which required them to pay a deposit of ₤25,000 plus VAT of ₤3,750. The purchase was completed on 14 July 2009 when the balance of ₤225,000 plus VAT of ₤33,750 was paid.  The Appellants mistakenly believed the date of the exchange of contracts was the tax point for the transaction. In this respect they incorrectly claimed the whole amount of VAT on the transaction in the quarter 06/09, rather than submitting the claim for ₤33,750 for the balance of the purchase monies in quarter 09/09. 
3.	On 7 August 2009 HMRC advised the Appellants that their VAT claim for quarter 06/09 was subject to verification. On 11 August 2009 HMRC amended the Appellant’s VAT 06/06 return by disallowing the claim for ₤33,750, and informed  the Appellants that they may have to pay an inaccuracy penalty.  On 18 December 2009 HMRC imposed a penalty of ₤5,062 which was 15 per cent of ₤33,750. In arriving at the size of the penalty HMRC gave the Appellants, the maximum discount permitted under the legislation for their prompted disclosure. On 29 March 2010 HMRC confirmed the penalty on review.
4.	The Appellants appealed the penalty on the ground that it was unduly harsh, pointing out that the misinterpretation of the tax point merely advanced the input tax claim by one quarter and effectively HMRC suffered no tax loss. 
5.	The Appeal was heard on 24 August 2010. This was one of the first appeals under the new penalty regime imposed by schedule 24 of the Finance Act 2007, and raised novel points which had not been previously considered by a Tribunal. In those circumstances the Tribunal directed the parties to provide additional written submissions, in particular whether special circumstances applied pursuant to paragraph 11 of schedule 24. The parties supplied their submissions by the required dates. The Tribunal indicated that it would reconvene on 10 December 2010 to consider the Appeal in the absence of the parties. Unfortunately the meeting in December 2010 was cancelled due to adverse weather conditions, which has led to a slight delay in the publication of the decision.
The Law
6.	Prior to the implementation of schedule 24 Finance Act 2007, section 63 of the VAT Act 1994 enabled penalties to be imposed for misdeclarations in VAT returns. Section 63 imposed a penalty equal to 15 per cent of the VAT which would have been lost if the inaccuracy had not been discovered. Section 63(10) of the 1994 Act permitted the Tribunal to waive the penalty if a reasonable excuse existed for the error. Section 70(1) of the VAT Act 1994 gave the Tribunal discretion to reduce the penalty to such amount (including nil). Section 70(4) specified matters that could not count as mitigation which included insufficiency of funds, no significant VAT loss and that the tax payer had acted in good faith.
7.	The penalty regime under schedule 24 of the Finance Act 2007 provides a uniform penalty code for errors in all tax returns, and is not restricted to errors in VAT returns. The structure of schedule 24 is more prescriptive than that for misdeclaration penalties under section 67 of the 1994 Act, and introduces concepts and powers not found under the previous VAT regime for misdeclaration penalties. In this respect the Tribunal considers that the new concepts should not be interpreted against the terms of reasonable excuse and mitigation as applied by the VAT Act 1994.
8.	Paragraph 1(1) of schedule 24 provides that a penalty is payable by a person where he gives HMRC a document of a kind listed in table 1 which includes a VAT return and conditions 1 and 2 are satisfied.  Paragraph 1(2) states that condition 1 is that the document contains an inaccuracy which amounts to, or leads to a false or inflated claim to repayment of tax. Condition 2 is that the inaccuracy was careless or deliberate on the person’s part. Paragraph 3(a) defines careless if the inaccuracy is due to a failure by a person to take reasonable care. Paragraph 4 states that the penalty for careless action is 30 per cent of the potential loss revenue. Paragraph 5(1) defines potential lost revenue  in respect of an inaccuracy in a document is the additional amount due or payable in respect of tax as a result of correcting the inaccuracy or assessment. Paragraph 5(2) provides that an additional amount due or payable includes an amount which would have been repayable by HMRC had the inaccuracy or assessment not been corrected. Paragraphs 9 and 10 permit a reduction in the penalty of 30 per cent if the person discloses the error to HMRC. The 30 per cent penalty for careless errors may be reduced to nil for an unprompted disclosure and to 15 per cent for a prompted disclosure.  Paragraph 9(2) states that a disclosure is unprompted if made at a time when the person making it has no reason to believe that HMRC have discovered or are about to discover the inaccuracy, and otherwise is prompted. Under paragraph 11 HMRC can reduce the penalty even further if they think it right because of special circumstances. Paragraph 11(2) states that reducing the penalty includes reference to staying a penalty, and agreeing a compromise in relation to proceedings for a penalty. Special circumstances do not include the ability to pay or the fact that a potential loss of revenue from one taxpayer is balanced by a potential over-payment by another. Paragraph 14 gives HMRC the facility to suspend all or part of a penalty for a careless error. The notice of suspension must specify what part of the penalty is to be suspended, the period of suspension not exceeding two years, and conditions of suspension. If the person complies with the terms of the suspension, the penalty will be cancelled.  
9.	Paragraphs 15 to 17 deals with Appeals against penalties imposed under schedule 24 of the 2007 Act. Paragraph 15 gives four separate rights of Appeal, which includes against a decision that a penalty is payable, or not to suspend a penalty (paras. 15(1) & 15(3)), the amount of the penalty (para. 15(2)), and the conditions of suspension (para. 15(4)). Paragraph 17 specifies the Tribunal’s jurisdiction in respect of appeals against penalties. On an appeal under paragraph 15(1) the Tribunal may affirm or cancel HMRC’s penalty.  On an appeal under paragraph 15(2) the Tribunal may affirm HMRC’s decision or substitute for HMRC’s decision another decision that HMRC had power to make. If the Tribunal substitutes its decision for HMRC’s the Tribunal may rely on paragraph 11 to the same extent as HMRC which may mean applying the same percentage as HMRC to a different starting point or to a different extent but only if the Tribunal thinks that HMRC’s decision in respect of the application of paragraph 11 was flawed. Paragraphs 17(4) and 17(5) deals with the Tribunal’s powers where the penalty is suspended.
Reasons  
10.	This Appeal raised two procedural matters. The Appellants did not state which subsection under paragraph 15 they were relying upon in their Notice of Appeal. The Tribunal took the view that the Notice of Appeal should refer to which aspects of the jurisdiction under paragraph 15 the Appellants wished the Tribunal to address. The Appellants’ Notice of Appeal simply stated they were appealing against the imposition of the penalty which on the face of it excluded the Tribunal’s powers to consider quantum and suspension. Of more significance the Appellants did not indicate they wished the Tribunal to examine the question of a special reduction which had not been considered by HMRC in its original and review decisions. The Tribunal considers that HMRC should be given the opportunity to decide on the question of special reduction first because of the wording of paragraph 17(3) which may require a determination of Tribunal that HMRC’s application of special circumstances under paragraph 11 is flawed. This was one of the principal reasons for requesting additional submissions. The Tribunal amended the Notice of Appeal with the consent of HMRC to enlarge its jurisdiction to deal with all matters specified in paragraph 15. Further the Tribunal directed the Appellants to advise HMRC if they were pleading special circumstances for a special reduction, which they did. HMRC decided there were no special circumstances  to justify a special reduction.
11.	The Appellants accepted the following matters:
(1)	Their VAT return submitted for 06/06 quarter contained an inaccuracy which amounted to an inflated claim to repayment of tax.
(2)	The inaccuracy was careless. The Appellants did not exercise reasonable care when completing the 06/06 VAT return.
(3)	The Appellants were liable to a 30 per cent penalty of the potential lost revenue for their careless action, which was ₤10,125 (₤33,750 x 30 per cent).
(4)	HMRC applied the maximum reduction from 30 per cent to 15 per cent for a prompted disclosure permitted under the legislation which resulted in a penalty of   ₤5,062 (₤33,750 x 15 per cent). 
(5)	The Appellant did not pursue the option of suspending the penalty. The Appellants agreed with HMRC’s assessment that suspension would serve no useful purpose because the Appellants’ usual business did not involve the purchase of real property and this was a one-off error in respect of an isolated property transaction.
12.	The sole issue in dispute was whether there were special circumstances to justify a special reduction in the amount of penalty imposed. The Appellants submitted that this was an unduly large transaction for the business and that there was no likelihood of a real loss of VAT to HMRC. The transaction related to the purchase of a property on which a binding contract was entered into in the quarter 06/06 with completion in the following quarter. The Appellants believed that the tax point for the transaction was when the binding contracts were exchanged. In those circumstances there was no likelihood that they would make a claim for the VAT on the balance of the purchase monies in the subsequent quarter. A penalty of ₤5,062 was unduly harsh for an isolated transgression arising from the Appellants’ misinterpretation of a technical matter.
13.	HMRC contended that the special reduction provision in paragraph 11 of schedule 24 allowed it to reduce a penalty when HMRC thinks it is right because of special circumstances. The measures in the preceding paragraphs 4 to 10 of schedule 24 ensure that proportionality within the framework of the intended purpose of the legislation is maintained. Special circumstances only apply to circumstances for which a reduction cannot be given under any of the other provisions in schedule 24. In order to maintain the credibility of paragraph 11 its use must be restricted to special circumstances that could not have been anticipated when the legislation was drafted. It is not possible to provide specific examples of when a special reduction might occur because of the unforeseeable nature of the special circumstances. They are likely to be very low risk events resulting in an outcome that means the person was unable to submit an accurate return or document.
14.	HMRC submitted that the Appellants had put forward no special circumstances. The size of the Appellants’ transaction was not relevant because the underlying Appellants’ behaviour that led to the inaccuracy determined the maximum and minimum statutory penalty percentage rates. The setting of maximum and minimum rates based on conduct ensured that penalties were constant, and not determined by the nature of the transaction. The issue of dealing with a large and unusual transaction would only be relevant in deciding whether the error was careless or deliberate. HMRC had given the maximum discount for the Appellants’ conduct. Thus this was the level of the penalty that was intended by the legislation to influence behaviour. A lesser penalty would not achieve this purpose and should not be changed. 
15.	HMRC dismissed as speculation the Appellants’ submission regarding the incorrect application of the tax point merely advancing the input tax claim by three months. Equally HMRC considered there were no facts to support the Appellants’ contention of no danger of an overall tax loss to HMRC. 
16.	 Further HMRC submitted there were specific provisions in schedule 24 that if circumstances were different would direct HMRC to determine that the behaviour was not careless or treat the potential lost revenue as delayed tax or suspend a careless penalty. None of these circumstances applied in the Appellants’ case, which meant that the Appellants’ penalty had been correctly calculated. Finally the Appellants’ penalty was for their failure to take reasonable care which resulted in an inaccurate return. The circumstances of the Appellants’ error represented the norm under which a schedule 24 penalty was imposed and by definition did not constitute special circumstances to justify a special reduction. 
17.	  The Tribunal may either affirm HMRC’s decision or substitutes its own decision on the amount of the penalty. If it substitutes its own decision, the Tribunal may rely on special circumstances (paragraph 11) –
a.	to the same extent as HMRC (which may mean applying the same percentage reduction as HMRC to a different starting point), or
b.	to a different extent, but only if the Tribunal thinks that HMRC’s decision in respect of the application of paragraph 11 was flawed.
18.	In this Appeal the Appellants were asking the Tribunal to apply its jurisdiction under b) above in which case the Tribunal is required to find that HMRC’s application of paragraph 11 was flawed. In the Tribunal’s view a) above did not apply because it would to relate to the starting point of the potential tax loss ((₤33,750), which in this case was not in dispute. 
19.	The Tribunal agrees with HMRC’s basic proposition that special circumstances should be interpreted in the context of schedule 24 as a whole. The Tribunal, however, considers that HMRC’s construction of special circumstances within that overall context was flawed. Also the Tribunal considers that HMRC did not actively consider whether the grounds put forward by the Appellant constituted special circumstances. The Tribunal’s impression of HMRC’s rationale was that it was constrained by its inaccurate construction of the overall statutory context, which meant that it did not stand back and ask itself whether the circumstances were special. It does not, however, follow from the fact that the Tribunal decides that HMRC’s application of paragraph 11 was flawed that special circumstances applied to the Appellants’ case.  
20.	The Tribunal’s construction of special circumstances having regard to the overall context of schedule 24 consists of the following propositions: 
(1)	The schedule draws a distinction between deliberate and careless errors  in respect of the objectives for the penalty regime. The schedule imposes lower penalties for careless errors but also enables the tax payer to put matters right by suspending the penalty. The power of suspension is not available in the case of penalties for deliberate errors.
(2)	The maximum penalty for careless and deliberate errors and the reduction for disclosure are tax-geared, in that they are calculated by applying a fixed percentage to the potential tax loss. The use of fixed percentages ensures a consistent approach to the calculation of penalties.
(3)	 The reduction in penalty under paragraph 9 is restricted to the tax payer’ conduct on disclosure. The reduction does not take into account the entirety of the tax payer’s conduct. 
(4)	The use of the power to suspend on conditions either part or whole of the penalty for a maximum period of two years is appropriate when there is a likelihood of repetition of the same or similar careless error. The power to suspend provides an incentive for the tax payer to exercise proper care with his future tax affairs. 
21.	 The Tribunal disagrees with HMRC’s assertion that the application of a maximum penalty and a reduction for disclosure calculated by means of prescribed percentages of the potential tax loss produces a proportionate penalty for careless errors.  On the Tribunal’s construction, the interaction of these factors ensures a consistent approach but not necessarily a proportionate one for the imposition of penalties. The schedule 24 penalty regime without a provision for special circumstances does not distinguish between different categories of failures to take reasonable care and disregards aspects of the tax payer’s conduct unconnected with disclosure. Further the tax-geared element may produce an unduly harsh monetary penalty which has no relationship to the tax payer’s culpability. In this respect the Tribunal considers that the provision for special circumstances enables consideration of all circumstances of the individual case except those matters specifically excluded by paragraph 11 so as to ensure that the penalty is proportionate to the tax payer’s contravention.
22.	The Tribunal finds in relation to the Appellants that
(1)	The penalty was invoked for a careless error on the Appellants’ part when completing the 06/06 VAT return.
(2)	The maximum penalty for the Appellants’ careless error was ₤10,125 (30 per cent of the potential loss revenue of ₤33,750). 
(3)	 The Appellants received the maximum discount for their prompted disclosure which reduced the penalty to ₤5,062 (15 per cent of the potential loss revenue of ₤33,750).
(4)	The Appellants’ failure consisted of a technical error which was a misinterpretation of the tax point for a property transaction. The Appellants incorrectly assumed that the tax point for the whole transaction was when binding contracts were exchanged. This resulted in a claim for the entire input tax on the deal rather than a staggered claim at the exchange of contracts and completion of the transaction. The Appellants did not take advice on the correct tax point.
(5)	The effect of the error was to advance the tax point for the transaction. The Tribunal finds that there was no real likelihood of a tax loss to HMRC. In view of their misunderstanding of the tax point, the Tribunal is satisfied that the Appellants would not have submitted a duplicate claim for the input tax on the balance of the purchase monies in the subsequent VAT quarter. Thus the error would be self correcting by not making a claim in the subsequent quarter. Further the transaction was subject to a binding contract which meant that there was legal obligation to complete the deal. 
(6)	The transaction was a one-off. The Appellants’ principal business was in furniture not in property deals. The error was, therefore, unlikely to be repeated which ruled out the option of suspending the penalty.
(7)	The size of the monetary was aggravated by the unusually large value of the transaction.
23.	The Tribunal is satisfied that the one-off nature of the transaction, and its unusually large value together with no real likelihood of tax loss constituted special circumstances for reducing the penalty.  The combination of these factors produced a disproportionate monetary penalty in relation to the contravention and the Appellants’ culpability. The Tribunal, however, considers that the Appellants should not escape entirely the consequences of their carelessness which could have been avoided had they taken advice on the VAT consequences of a transaction with which they were not familiar. The Tribunal considers in all the circumstances that the penalty should be reduced by 50 per cent, namely the penalty should be fixed at 7.5 per cent of the potential loss revenue. 
Decision
24.	The Tribunal determines a penalty of ₤2,531 ((7.5 per cent of the potential loss revenue of ₤33,750). The Appeal is, therefore, allowed in part.
25.	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.

                                   MICHAEL TILDESLEY OBE
TRIBUNAL JUDGE
RELEASE DATE:  4 FEBRUARY 2011