[2011] UKFTT 168 (TC)

TC01037

Appeal number:  TC/2010/09331

VAT – default surcharge – whether reasonable excuse – no –
proportionality considered

FIRST-TIER TRIBUNAL

TAX 

	KAIZEN SEARCH LIMITED	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

			TRIBUNAL: 	Mrs B Mosedale (TRIBUNAL JUDGE)
					Mrs C S De Albuquerque (TRIBUNAL MEMBER)	

Sitting in public at Holborn Bars, 138 Holborn, London  on 7 February 2011

Mr C Jeffrey, Managing Director,  for the Appellant

Mr C Shea,  officer of HMRC,  for the Respondents

© CROWN COPYRIGHT 2011

DECISION

1.	Kaizen Search Limited (“the Company”) appeals against a default surcharge of £6,901.85 imposed on it in respect of its late payment of VAT for the VAT quarter 06/10.
2.	The surcharge was levied under s59 of the Value Added Tax Act 1994 (“VATA”) and the full provisions of that section are set out in the appendix to this Decision Notice.  
Facts
3.	The Company’s VAT default surcharge history is as follows:
Default No.	Period	VAT due & paid late	Rate of surcharge	Amount of surcharge	
1	09/09	£14,322.08	0%	Nil	
2	12/09	£308.08	2%	Nil	
3	03/10	£17,423.81	5%	£871.19	
4	06/10	£69,018.50	10%	£6,901.85	

4.	The Company did not appeal the earlier default surcharge (for period 3/10) nor did it contend that there was a reasonable excuse (within Section 59(7)(b)) for the first three earlier defaults.  It accepted it had paid late and was liable to a surcharge for 03/10.  It also accepted that it had taken 8 weeks to pay the VAT due for period 06/10 but contended that the penalty was excessive.  It did not contend that it had paid the VAT in any of these four periods at such a time that it would have been reasonable to expect HMRC to receive it on time (Section 59(7)(a)).
5.	Nevertheless, we considered whether the company had a reasonable excuse for any of the defaults as this would impact on the appropriate percentage penalty for period 06/10 if upheld.
6.	We find the facts to be as follows:
7.	The company faced two substantial problems in the years 2009-2010.  Firstly, it had cash flow problems and secondly there was a concern it had under-declared its VAT liabilities and might be facing a VAT assessment it could not pay.  
8.	At root of the cash flow problems was the economic recession.  The Company’s  receipts diminished while its main expense (staff salaries) remained unchanged.  Mr Jeffrey, the Managing Director, said the Company took a business decision to keep on its staff in the hope the economic position would improve, as indeed it has.  From the accounts produced to us for the Company for the year to 31 December 2009 (which included comparables for year to 31 December 2008) we find that the Company operated at a loss as its expenses (included its major expense of staff costs) exceeded its income.
9.	The Company entered into a time to pay arrangement with HMRC for its PAYE obligations.  Its cash-flow problems for period 06/10 were party caused by its need to meet its time to pay arrangement for PAYE.  The funds it had were used on paying staff salaries and PAYE obligations.
10.	But the immediate cause of its lack of cash in period 06/10 was that it had been successful in trading out of the recession and had taken on a big contract for BSkyB in mid-2010.  The terms of this contract allowed BSkyB 45 days to pay.  This meant that the Company (which did not operate cash accounting) had to pay the VAT on this contract before they received payment from BSkyB.  This meant that their liability for the 06/10 quarter was very large while at the same time they did not have the funds to pay it until some weeks after the due date.
11.	HMRC put it to Mr Jeffrey that he must have appreciated the effect of agreeing 45 day payment terms on cash flow when he entered into the contract.  Mr Jeffrey’s response was that it was not reasonable for HMRC to expect the Company to turn away profitable business.
12.	There had also been a VAT inspection of the Company which started in October 2009 and which was not resolved until August 2010.  This VAT inspection involved the company secretary, Ms Eda Poreci (who gave evidence), in a great deal of work as HMRC required the company to re-work its books for June 2006-June 2009 on a cash accounting basis.  On 14 May 2010 HMRC wrote to Ms Poreci saying that they considered that the Company had underpaid VAT of approximately £42,000 and would shortly raise a formal assessment to recover this amount.  On 29 June 2010 the VAT Inspector wrote to Ms Poreci revising the proposed assessment up to slightly over £51,000.  In the event the assessment that was raised on 22 September 2010 was for only £3,068.35 (which was paid).
13.	It was the Company’s case that the inspection had caused confusion, and, in particular at about the time the VAT return was due for quarter 06/10, the Company was uncertain if the VAT inspection was to result in an assessment for £51,000 or £3,000.  It would not have been able to pay the former.  HMRC accepted that the VAT inspection had involved Ms Poreci in a great deal of work but pointed out that the 06/10 period was outside the VAT inspection remit and so in their view no confusion should have arisen over how much VAT was due for 06/10.  Mr Shea also pointed out that the electronic return had been submitted on time for 06/10:  it was just the VAT that was paid late.
14.	The Company also considered that HMRC were in part to blame for the late payment in that Mr Jeffrey had attempted to negotiate a time to pay arrangement.  His evidence (which we accept) was that he rang the time to pay unit on 3 August and, as he was told the person he needed to speak to was not available, asked for HMRC to ring him back on this but they never did. 
15.	Miss Poreci attempted to speak to HMRC on 20 August but was unsuccessful because they would not speak to her as they did not hold a letter of authority for her from the Company.  She agreed Mr Jeffrey would ring back but as he was on holiday he was unable to call until his return on 27 August.  At this point a time to pay arrangement was discussed.  HMRC accept there was a time to pay arrangement from 31 August 2010. The VAT was paid in instalments and finally paid off completely 8 weeks after the due date.
16.	We find that Mr Jeffrey mentioned his concern about not receiving a call back on 3 August in a call to HMRC dated 21 September 2010 in which the HMRC officer to whom he spoke records that Mr Jeffrey was “really concerned” because he had not received a call back.
17.	Mr Jeffrey said that the main reason for the appeal was that they considered the penalty disproportionate to the offence.  For the previous 3 quarters the Company’s average VAT liability had been £10,000.  Mr Jeffrey considered a penalty of 10% of the VAT liability for 06/10 (which was nearly 7 times as high as the average of the previous 3 quarters) when they were only 8 weeks late paying was disproportionate.
Decision
18.	We find that the Company does not have a reasonable excuse for the defaults for 09/09, 12/09 and 03/10.  These were caused by cashflow problems caused by the economic recession meaning that its receipts dropped but its expenses did not.  It was a business decision to keep on staff rather than make them redundant with the result that the company did not cut its wages bill.  Shortage of funds by itself does not amount to a reasonable excuse as s71 VATA (set out in the appendix) provides that an insufficiency of funds to pay any VAT due by itself is not a reasonable excuse.  We consider that a sudden and unanticipated event causing a cash-flow problem might amount to a reasonable excuse but we were given no evidence of such an event.  In particular, Mr Jeffrey’s evidence was that the shortage of funds was caused by the business decision to keep staff on in face of the recession:  as the underlying cause of the shortage of funds this was neither sudden nor unanticipated.  
19.	While the Company is certainly not to be criticised for keeping on its staff, nevertheless a taxpayer is expected to act with reasonable foresight and due diligence and a proper regard for its duty to pay taxes on the due date.  When making a decision to continue to trade at a loss (albeit with retained profits), the Company ought to have factored in by some means or another a method by which it ought to have been able to pay its VAT on its due date.
20.	We find that the failure to pay the VAT on time for period 06/10 was also caused by a shortage of funds.  We do not accept that it was caused by any confusion over the VAT inspection.  Although we are sure the fear of a large assessment would have been the cause of much concern, we find that the Company was aware that the 06/10 return period was not affected by the inspection as it filed its return for that period by the due date.  The Company knew how much VAT was due for 06/10, it just did not pay it on the right date:  ultimately and after the due date it agreed a time to pay arrangement with HMRC.  Shortage of funds caused the late payment.
21.	Does that shortage of funds amount to a reasonable excuse?  We find it does not.  The immediate cause of the shortage was the contract with BSkyB which resulted in a liability to pay the VAT before their customer was due to pay the Company.  This was a foreseeable problem which the Company ought to have anticipated.  It should have arranged to borrow money or made some other arrangement to ensure that it did not default.
22.	We consider the failed attempt to arrange a time to pay agreement with HMRC before the due date.  The Company normally paid electronically and so would by concession from HMRC consider the due date of payment to be some 7 days after the actual due date of payment.  On this basis, its due date for payment would have been no later than 7 August (in practice 6 August as 7 August was a Saturday) and we find Mr Jeffrey rang HMRC to arrange a time to pay agreement on 3 August.  He knew that he had not successfully arranged time to pay as he was told the right person was not available and they would ring him back.  He was not called back.  But at the same time he did not attempt to make contact with HMRC again for another few weeks and not until after the due date (for electronic payments) of 7 August.  We do not consider that Mr Jeffrey had done enough before the due date to put a time to pay arrangement in place for 06/10.  HMRC should have rung back, but it is even more true that Mr Jeffrey should have chased them when he did not hear back.  Mr Jeffrey knew that the Company could not pay in time and should have made more of an effort to discuss this with HMRC in advance.  
23.	We do not find that the Company had a reasonable excuse for its late payment of the 06/10 period.
24.	Lastly, we consider proportionality.  Proportionality in relation to the default surcharge regime was considered in detail in the recent First-tier Tribunal decision of Enersys Holdings UK Ltd [2010] UKFTT 20 (TC) following full argument on both sides, the benefit of which we have not had in this case.  
25.	We agree with the Tribunal’s conclusion in Enersys that, as a matter of European law, national measures implementing the VAT regime, such as the default surcharge penalty regime for late payments of VAT, are required to be proportionate (Garage Molenheide BVBA and others v Belgium C-286/94 [1998] STC 126).  Further, the UK’s default surcharge regime is not by itself disproportionate but may, in exceptional cases, lead to the imposition of a penalty which is disproportionate.  Where an individual penalty is disproportionate, the Tribunal must discharge it, having no power to mitigate it.
26.	Is the penalty in this case disproportionate?  The first point to make is that whether a penalty is disproportionate cannot be judged (as the Company wishes to) by solely comparing it to the time-cost use of money:  the penalty is not intended to compensate the Government for being kept out of its money. It is not a substitute for an interest charge.  It is intended to deter non-compliance with the obligation to pay on the due date.  It is intended to be penal.
27.	Nevertheless, it can be disproportionate where (as per Simon Brown LJ in the case of International Transport Roth GmbH v Home Secretary [2003] QB 728) it is “not merely harsh but plainly unfair”.
28.	The default surcharge is a charged as a percentage of the tax unpaid on the due date.  It is ratcheted so that a first offence is 0%, a second offence 2%, a third offence 5% and a fourth offence 10%.  The late payment in this case was the Company’s fourth.  We do not find it plainly unfair that the rate for the penalty under appeal was 10% when seen in the light that the Company had had due warning with its three earlier offences and been warned (as we find it was) on each occasion what the percentage penalty would be on the next default.
29.	We note that in Enersys the conclusion that the default surcharge in that case was “wholly disproportionate to the gravity of the offence” (paragraph 69) shows that the Tribunal considered, as we do, that in deciding whether a penalty is disproportionate it is necessary to do what the default surcharge regime does not, which is consider:
•	The “gravity” of the default:  in particular to what extent the taxpayer was at fault;
•	How long the VAT was outstanding;
•	The amount of surcharge relative to the wealth of the defaulter.
30.	With regards the last point, we consider whether the fact that, as with Enersys, its VAT payment for the particular quarter was rather higher than usual could make it disproportionate.  As Mr Jeffreys put it, the average VAT due for the previous 3 quarters was approximately £10,000.  For quarter 06/10 it was nearly 7 times higher.  
31.	However, we are unable to conclude that this by itself makes the penalty disproportionate on the facts of this particular case.  In Enersys the cause of the late payment was a mistake unrelated to the amount of the VAT due and it was, in one way of looking, a matter of chance that the late payment arose in a quarter with a very high VAT liability.  This is not the case here.  The late payment of the VAT appears to be connected to the amount that was due:  as explained the large VAT liability was caused by the contract with BSkyB and the reason it was paid late (we find) was because of the long payment terms.  In this case the Company should have anticipated the penalty at which it was at risk was 10% of the tax due that quarter which it should have anticipated would be higher than average:  on this basis it is hard to see that the penalty was disproportionate.  
32.	Further, from the 2009 accounts mentioned above we also find that the quarter 06/10 was not out of line with the Company’s historic turnover, which again inclines us to the conclusion that it was not disproportionate.
33.	On the second point, Mr Jeffrey also made the case that he considered the penalty was high for a payment that was made only 8 weeks late.  We agree with the conclusion in Enersys that the fact that the default surcharge regime makes no allowance for how late a payment was made could lead to a disproportionate penalty.  We note that on the particular facts of that case, with a payment made only one day late, it was found to be disproportionate. 
34.	Even if we consider the payment as “late” only up and until the time to pay arrangement was entered into on 31 August, the payment was still made three weeks late:  it was due (if paid electronically) on 6 August.  Ignoring the time to pay arrangement, it was actually paid 8 weeks late.  This is not a case where the VAT was paid only slightly late, although we accept Mr Jeffries’ point that it was not exceptionally late either.  Bearing in mind that the default surcharge regime is intended to deter late payments, we do not consider that this penalty is plainly  disproportionate for a payment that was (on the best interpretation) 3 weeks’ late and, on a more conventional interpretation, 8 weeks’ late.
35.	On the first point, the “gravity” of the default, we note that the default did not arise because of a simple mistake over the due date as in Enersys..  As already mentioned, the Company knew the due date but did not have the funds to pay.  Nor did it make a great effort to ensure it had a time to pay arrangement in place on time, nor did we have any evidence that it had sought to meet its liability by another means (eg a bank loan).  We consider the “gravity” of the offence to be more serious than in Enersys although clearly far from the highest gravity as, we found, Mr Jeffrey had made some effort to discuss the position with HMRC in advance.  But for this reason too, we are not persuaded that the penalty is plainly out of proportion to the gravity of the offence when it is also borne in mind it was the 4th default in a row.
36.	In conclusion, although we agree that the penalty in this case is harsh, nevertheless we do not think the Appellant has made out its case that it is in that category of exceptional penalties that are plainly unfair.  We do not find it disproportionate in the sense meant by the European Court of Justice in Garage Molenheide and we do not discharge it.
37.	The appeal is dismissed.
38.	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.

TRIBUNAL JUDGE
RELEASE DATE: 14 MARCH 2011

The Value Added Tax Act 1994
S59 Default Surcharge

59 The default surcharge
(1)     Subject to subsection (1A) below If, by the last day on which a taxable person is required in accordance with regulations under this Act to furnish a return for a prescribed accounting period—

(a)     the Commissioners have not received that return, or

(b)     the Commissioners have received that return but have not received the amount of VAT shown on the return as payable by him in respect of that period,

then that person shall be regarded for the purposes of this section as being in default in respect of that period.

(1A)     A person shall not be regarded for the purposes of this section as being in default in respect of any prescribed accounting period if that period is one in respect of which he is required by virtue of any order under section 28 to make any payment on account of VAT.

(2)     Subject to subsections (9) and (10) below, subsection (4) below applies in any case where—

(a)     a taxable person is in default in respect of a prescribed accounting period; and

(b)     the Commissioners serve notice on the taxable person (a “surcharge liability notice”) specifying as a surcharge period for the purposes of this section a period ending on the first anniversary of the last day of the period referred to in paragraph (a) above and beginning, subject to subsection (3) below, on the date of the notice.

(3)     If a surcharge liability notice is served by reason of a default in respect of a prescribed accounting period and that period ends at or before the expiry of an existing surcharge period already notified to the taxable person concerned, the surcharge period specified in that notice shall be expressed as a continuation of the existing surcharge period and, accordingly, for the purposes of this section, that existing period and its extension shall be regarded as a single surcharge period.

(4)     Subject to subsections (7) to (10) below, if a taxable person on whom a surcharge liability notice has been served—

(a)     is in default in respect of a prescribed accounting period ending within the surcharge period specified in (or extended by) that notice, and

(b)     has outstanding VAT for that prescribed accounting period,

he shall be liable to a surcharge equal to whichever is the greater of the following, namely, the specified percentage of his outstanding VAT for that prescribed accounting period and £30.

(5)     Subject to subsections (7) to (10) below, the specified percentage referred to in subsection (4) above shall be determined in relation to a prescribed accounting period by reference to the number of such periods in respect of which the taxable person is in default during the surcharge period and for which he has outstanding VAT, so that—

(a)     in relation to the first such prescribed accounting period, the specified percentage is 2 per cent;

(b)     in relation to the second such period, the specified percentage is 5 per cent;

(c)     in relation to the third such period, the specified percentage is 10 per cent; and

(d)     in relation to each such period after the third, the specified percentage is 15 per cent.

(6)     For the purposes of subsections (4) and (5) above a person has outstanding VAT for a prescribed accounting period if some or all of the VAT for which he is liable in respect of that period has not been paid by the last day on which he is required (as mentioned in subsection (1) above) to make a return for that period; and the reference in subsection (4) above to a person's outstanding VAT for a prescribed accounting period is to so much of the VAT for which he is so liable as has not been paid by that day.

(7)     If a person who, apart from this subsection, would be liable to a surcharge under subsection (4) above satisfies the Commissioners or, on appeal, a tribunal that, in the case of a default which is material to the surcharge—

(a)     the return or, as the case may be, the VAT shown on the return was despatched at such a time and in such a manner that it was reasonable to expect that it would be received by the Commissioners within the appropriate time limit, or

(b)     there is a reasonable excuse for the return or VAT not having been so despatched,

he shall not be liable to the surcharge and for the purposes of the preceding provisions of this section he shall be treated as not having been in default in respect of the prescribed accounting period in question (and, accordingly, any surcharge liability notice the service of which depended upon that default shall be deemed not to have been served).

(8)     For the purposes of subsection (7) above, a default is material to a surcharge if—

(a)     it is the default which, by virtue of subsection (4) above, gives rise to the surcharge; or

(b)     it is a default which was taken into account in the service of the surcharge liability notice upon which the surcharge depends and the person concerned has not previously been liable to a surcharge in respect of a prescribed accounting period ending within the surcharge period specified in or extended by that notice.

(9)     In any case where—

(a)     the conduct by virtue of which a person is in default in respect of a prescribed accounting period is also conduct falling within section 69(1), and

(b)     by reason of that conduct, the person concerned is assessed to a penalty under that section,

the default shall be left out of account for the purposes of subsections (2) to (5) above.

(10) 	If the Commissioners, after consultation with the Treasury, so direct, a default in respect of a prescribed accounting period specified in the direction shall be left out of account for the purposes of subsections (2) to (5) above.

(11)     For the purposes of this section references to a thing's being done by any day include references to its being done on that day.

S71 Construction of sections 59 to 70

(1)	For the purposes of any provision of sections 59 to 70 which refers to a reasonable excuse for any conduct-
(a)	an insufficiency of funds to pay any VAT due is not  reasonable excuse; and
(b)	where reliance is place on any other person to perform any task, neither the fact of that reliance nor any dilatoriness or inaccuracy on the part of the person relied upon is a reasonable excuse.
(2)	…..