[2011] UKFTT 275 (TC)

TC01137

Appeal number TC/2010/09428

VAT – Default surcharge – Reasonable excuse – Proportionality – Appeal dismissed

FIRST-TIER TRIBUNAL

TAX 

	MILL LANE ENGINEERING (ALDERSHOT) LIMITED	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

                         TRIBUNAL: Dr Christopher Staker (Tribunal Judge)
				 MS JANE SHILLAKER (Tribunal Member)

Sitting in public in Reading on 16 February 2011

Mr N May, director of the Appellant, for the Appellant

Ms G Orimoloye for the Respondents

DECISION

1.	This is an appeal against the imposition of a default surcharge under s.59 of the Value Added Tax Act 1994 (the “Act”) on late payment of VAT for the period 1 July 2008 to 30 September 2008 (“Quarter 09/08”).
2.	The amount of VAT due for the quarter, £178,181, was not an issue in dispute in this appeal.
3.	It was also not in dispute that the VAT payment for this period was not made in full by the applicable deadline.  The amount of £75,000 was received by HMRC by CHAPS on 12 November 2008, and the remainder by a combination of CHAPS payments on 18 and 24 November 2008.  
4.	Previously, HMRC had issued the Appellant with surcharge liability notices in respect of the periods 1 January 2008 to 31 March 2008 and 1 April 2008 to 30 June 2008.  The effect of this was that the default surcharge for Quarter 09/08 was calculated by HMRC as 5% of the VAT owed in that quarter.  
5.	On 14 November 2008, HMRC imposed a default surcharge of £8909.09, being 5% of the total amount of VAT due for Quarter 09/08.  On 19 August 2009, HMRC reduced the surcharge to £5159.09, on the basis that the amount received by HMRC on 12 November 2008 would be regarded as having been paid on time, so that the 5% surcharge would be charged only on the balance of the VAT owing for that quarter.
6.	It has not been suggested that the amount of the default surcharge has not been correctly calculated according to the terms of the applicable legislation.  The basis for the Appellant’s appeal is that the amount of the surcharge imposed is disproportionate and therefore contrary to European law.  The Appellant relies in particular on Enersys Holdings UK Limited v HMRC [2010] UKFTT (TC) (“Enersys”).  At the hearing, it appeared that a further issue was whether the Appellant had a reasonable excuse for the late payment.
The relevant legislation
7.	Section 59 of the Act states in relevant part as follows:
(1)	... 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—
... 
(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. 
... 
(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. 
... 
(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;
... 
(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.	Section 71(1) of the Act states in relevant part as follows:
(1)	For the purpose 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 a reasonable excuse; and
(b)	where reliance is placed 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.
The evidence and submissions of the parties
9.	At the hearing, the Appellant was represented by Mr May, the director of the Appellant.  HMRC was represented by Ms Orimoloye. 
10.	As a preliminary matter, the Tribunal had to determine whether to permit the Appellant to bring this appeal out of time.  Having heard both parties on the matter, the Tribunal decided that in all of the circumstances it would proceed to determine the appeal on the merits.  In particular, the Tribunal noted that HMRC did not in response to the Appellant’s notice of appeal raise any timely objection to the appeal being out of time, and that on the day of the hearing both parties had representation before the Tribunal prepared and ready to argue the merits of the appeal.  In the circumstance, the Tribunal considered that it was consistent with the interests of justice for the merits to be heard and determined.
11.	Mr May gave oral evidence, and stated amongst other matters the following.  
12.	The appellant is a company in the motor trade. It has a very high turnover to profitability ratio. Its turnover is approximately £23 million, and its profitability is about 0.5%.  It therefore collects huge amounts of VAT on behalf of HMRC in proportion to its actual profits.  On a £9000 transaction for the sale of a car, the Appellant makes only £115 profit after overheads and tax.  At the time, for corporation tax purposes, the Appellant was in fact making a loss.
13.	There are peaks and troughs in the trading year which correlate with the dates of changes in registration for new cars, in March and September every year. September is the highest period, in which the Appellant sells twice as much in one month as it would normally sell in three months. If there is the slightest hiccup in receiving finance from finance companies, that leaves problems settling VAT for that quarter.
14.	In Quarter 09/08, the Appellant knew in advance that it would not be able to pay the VAT on time.  Normally VAT is paid by direct debit.  The way that the banking system works is that if there are insufficient funds for the whole amount of a direct debit to be paid, the direct debit will be refused in its entirety.  Therefore, the Appellant contacted HMRC on 11 November 2008 to say that it would send £78,000 by CHAPS that day, with the balance to follow as soon as possible.  Direct debit payments of the VAT due are made by the Appellant on the 12th of the month in which they are paid.  Because of movements in the Appellant’s accounts, the Appellant is unable to know until very shortly beforehand whether there will be sufficient funds to cover a direct debit payment of the amount of VAT due.  For this reason, the Appellant was only able to contact HMRC on 11 November 2008 to say that the amount of VAT that was to be paid the following day could not be made in full.
15.	The Appellant argues that in all the circumstances, the imposition of a penalty of over £5,000 is disproportionate, in the same way that the default surcharge in Enersys was found to be disproportionate. 
16.	On behalf court HMRC, Ms Orimoloye submitted as follows. 
17.	A taxpayer cannot appeal simply on the basis that the taxpayer considers the penalty to be too severe.  
18.	The cases on disproportionality are, in addition to Enersys, Crane Ltd v HMRC [2010] UKFTT 378 (TC) (“Crane”) and Scotpackaging Ltd v HMRC [2010] UKFTT 504 (TC) (“Scotpackaging”).  In Enersys, the Tribunal did not conclude that the system of default surcharges was unfair or disproportionate, but found its application to be disproportionate in that specific case where the there was an exceptional amount of surcharge in circumstances where payment was only one day late.  In that case, at [44], the penalty was described as “grossly disproportionate when compared to the appellant’s financial circumstances”, in circumstances where it “represented almost 16% of its profits for the entire year; was equivalent to its earnings on turnover of more than £15 million, or about two months’ sales; and amounted to 44% of its corporation tax liability for the whole year”.  However, in that case at [69] it was said that “I am quite willing to accept—indeed experience of its operation tells me—that the default surcharge regime, by and large, produces a fair penalty, or at least one which is not obviously disproportionate to the offence”.  According to Enersys, it will therefore only be in the particular circumstances of a specific case that the penalty might be found to be “wholly disproportionate to the gravity of the offence”.
19.	The HMRC view is that the penalty should not be looked at not in the light of the whole annual profit but rather in the light of the relevant VAT quarter.  The taxpayer collects VAT on behalf of the HMRC. The Appellant has an annual turnover of £23 million. HMRC would expect the Appellant to contact HMRC beforehand if unable to pay on time. The HMRC position is that the Appellant did not contact HMRC beforehand. The legislative due date for payment was 31 October 2008.  The Appellant should therefore have contacted HMRC before that date.  The 10 day extension for payment by direct debit was a matter of HMRC concession.  A public information leaflet issued by HMRC emphasises the necessity to contact HMRC before the due date if a trader is unable to pay on time.
20.	HMRC therefore considers that the Appellant should have contacted HMRC by the latest on the day before the due date, and as 9 October 2008 was a Sunday, the Appellant should have contacted HMRC by 7 October 2008.  
21.	Mr May gave further evidence in response to questions from the Tribunal. The Tribunal noted that he had said that September was the Appellant’s peak period, and he was asked whether there was anything particular in Quarter 09/08 to make it different from a typical September quarter.  He responded that at the time he had had issues with the finance company that provides finance when the Appellant sells cars on credit. From June 2008 when the computer system was being switched, there were computer problems which delayed the clearing of direct debits.  The problems eventually became so bad that finance had to be done manually. The process in September was that signed hire purchase documents would be sent off by the Appellant to the finance company. If a car is sold on day 1, the finance agreement would be signed on day 1, and that would be the taxpoint for purposes of VAT. The Appellant gets the money from the finance company three days later. This is problematic when a vehicle is sold in one quarter, but the funds from the finance company are only received after the end of the quarter.  Due to the computer problems, the turnaround time for payment of finance had increased to 4 to 7 days.  At the time this was an absolute nightmare, and the Appellant was riding a roller coaster. It started in June or July 2008 and lasted to about February 2009. There had previously been problems in the March and June quarters of 2008 but these had been for different reasons.  Mr May drew attention to the letter from the Appellant to HMRC dated 18 November 2008 stating that “I realise that we were late paying, but we have made every effort to meet our commitments promptly”.
22.	The Tribunal considered that if the Appellant had further details and evidence to substantiate the contention that late payment was caused by an exceptional problem with financing arrangements, it may be that there would be an issue of reasonable excuse to be considered by the Tribunal.  In the circumstances, the Tribunal gave a direction granting each party 14 days to file with the Tribunal and serve on the other party any additional evidence and submissions on which they wish to rely in this appeal, and then a further 14 days to file any response to the filing of the other party.
23.	Both parties filed additional material pursuant to this direction.
24.	On behalf of the Appellant, the further submission consisted of an e-mail dated 8 March 2011, with three attachments.  The further submission stated that the three attachments “are a snapshot of a continuing very difficult circumstances of trying to keep a business trading and dealing with financial institutions that seem to ignore the real world and the difficulties SME’s have to contend with including our own Bankers, Barclays returning payments by mistake”.
25.	The first attachment is an e-mail dated 1 September 2008, which appears to be from the Appellant to the Appellant’s bank, relating to what is said to be an error on behalf of the bank in not carrying out instructions to make a transfer from the Appellant’s account to “Renault”.  
26.	The second attachment is an e-mail dated 23 September 2009, which appears to be from the Appellant to Renault.  Its precise significance is not easy to understand without explanation of its context, but it appears to relate to alleged difficulties in payments from the Appellant being made to Renault.  It says that RCI (presumably the finance company) “had accepted that there were faults and delays in their processing system” and that “due to non compatibility of a computer software programme they were having to process finance documents manually”.  It states that an agreement was reached between the Appellant and RCI “that there would be from time to time a set off of credits due that were delayed that allowed the return of the D40 and payment the next day when the credits due arrived”, and that “if these payments were controlled within a 24 hour period then no report of a returned D40 would be recorded”.
27.	The third attachment is a long letter dated 13 November 2009 from representatives of Yorkbury Management Limited, the Appellant’s parent company, to representatives of RCI.  The letter maintains that RCI had been asserting that the Appellant owed money to RCI under a cross-guarantee of indemnity, but that the Appellant and its parent company considered that the cross-guarantee had never been completed.  The letter stated that as a result of this disagreement, “RCI is placing restrictions upon its facilities to Mill Lane which are placing significant difficulties on its ability to trade” and that “RCI are making it very clear that facilities will return to normal once Mill Lane enters into a formal loan agreement to meet its obligations under the disputed Cross Guarantee”.  The letter states that “We would request in the strongest possible terms that RCI restores all facilities pending resolution of this dispute”.
28.	On behalf of the Respondents, the further submission consisted of a letter dated 4 April 2011.  The main points in this submission are as follows.
29.	In relation to the issue of reasonable excuse, HMRC submits as follows.  The Appellant runs a predominantly cash business and VAT is only declared at the point of sale.  HMRC expect that an inability to pay VAT should be an exception rather than the norm.  Where the reason for an insufficiency is unforeseen circumstances beyond the taxpayer’s control, there may be a reasonable excuse.  However, there does not appear to be any unexpected cash crisis which prevented the Appellant from paying the VAT by the due date.  Bank statements have not been provided to show how much funds were in the Appellant’s account at the time that the VAT was due or the efforts made to ensure that the VAT was paid by the due date.  In the circumstances, the failure to pay on time was due to a shortage of funds within the meaning of s.71(1)(a) of the Act, which is not a reasonable excuse.
30.	In relation to the issue of proportionality, HMRC submits as follows.  The default surcharge system is a civil penalty to encourage businesses to submit their returns and pay their VAT on time.  A penalty of 5%, £5.159 for a delay in paying £178,181, is not wholly outside the realms of what is necessary to achieve that object.  The Appellant had due warning, via surcharge liability notices, issued on earlier defaults in 03/08 and 06/08, of what the percentage penalty would be on the next occasion.  The insufficiency of funds was not brought on by late-paying clients as the Appellant runs a cash business, or by any other unexpected cash crisis.  The penalty does not fall within the category of exceptional penalties that are plainly and wholly unfair, as in Enersys, where there was a simple mistake over a due date.
Findings
31.	The Tribunal has considered the arguments and evidence in the case as a whole.
32.	The Appellant did not originally appeal on the ground of reasonable excuse under s.59(7)(b) of the Act.  The issue was raised in the circumstances referred to in paragraphs 21-22 above.  The Tribunal considers that the Appellant has been given a full and fair opportunity to advance any evidence or arguments in support of any possible claim of reasonable excuse.
33.	Section 71(1)(a) of the Act expressly provides that “an insufficiency of funds to pay any VAT due is not a reasonable excuse”.  If the Appellant seeks to rely on something more than an insufficiency of funds, such as unforeseen circumstances or events beyond the Appellant’s control (compare Steptoe v Revenue & Customs [1989] UKVAT V4283), the burden of proof is on the Appellant to establish the existence of such unforeseen circumstances and events, and also to establish that these circumstances and events were the cause of the late payment.
34.	At the hearing, Mr May indicated that at the time that the VAT payment was due, the Appellant had difficulties due to the fact that the finance company was having problems with its computer system, leading to delays in payments from the finance company to the Appellant.  The explanation given by Mr May was that the VAT liability arises on the day that a car is sold, so that in the case of a car sold on credit, if there is a delay in the purchase price being transferred to the Appellant from the finance company, the funds to pay the VAT come in only some time after the VAT liability arises.
35.	The second and third attachments to the Appellant’s further submissions do suggest that the Appellant was having ongoing difficulties with the finance company.  The second attachment supports the suggestion that the Appellant was experiencing delays in receiving funds from the finance company due to computer problems.  Without any further information, the second attachment suggests however that the delays in receiving payment were in the order of 24 hours.  The third attachment suggests that the Appellant was having problems with the finance company, although for quite different reasons, in November 2009.  It claims that the finance company was putting “severe financial and commercial pressure” on the Appellant, but does not give specific details.  Although the problems referred to appear to relate to events extending back as far as August 2008, it is not clear from this letter exactly how the circumstances to which it related impacted on the Appellant’s ability to pay its VAT liabilities in October 2008.
36.	The Tribunal considers that the evidence provided by the Appellant is insufficient to establish that the Appellant had a reasonable excuse for not paying on time the VAT for Quarter 09/08.
37.	The Tribunal has also considered the argument that the penalty was disproportionate.  In Enersys it was said at [69] by the Tribunal that “I am quite willing to accept—indeed experience of its operation tells me—that the default surcharge regime, by and large, produces a fair penalty, or at least one which is not obviously disproportionate to the offence”.  However, that case also stated that the penalty in an individual case may be discharged by the Tribunal where the default penalty regime leads to a penalty in that particular case that is “wholly disproportionate to the gravity of the offence” and “not merely harsh but plainly unfair”.
38.	The Tribunal has considered all of the evidence before it.  There was in fact little evidence presented by the Appellant in support of the claim that the penalty was disproportionate.  The Tribunal has considered what evidence there is, in particular the oral evidence of Mr May at the hearing that the appellant has a very high turnover to profitability ratio, such that the amount of the surcharge is very large when compared to the Appellant’s actual profits, and that for corporation tax purposes, the Appellant has made either a loss or modest profits.  
39.	However, on its consideration of all of the evidence and circumstances of the case as a whole, the Tribunal is not persuaded that the penalty is disproportionate.  For instance, in Crane, which involved a 2% surcharge, the Tribunal concluded that “Judged against the purpose of a regime which is intended to encourage the timely submission of VAT returns and payment of VAT and to penalise late submission, rather than to compensate the State for the interest cost of the late payment or to recover the funding benefit of late payment of the taxpayer, a penalty of £5000, even for one days’ delay, does not seem to us to be wholly outside the realms of what is necessary to achieve that object in this particular case”.  Every case must be decided on its own particular facts, so this is not to be regarded as a precedent that should be followed.  However, the Tribunal reaches the same conclusion in this case, involving a surcharge of 5%. 
Conclusion
40.	For the reasons above, the appeal is dismissed.
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.

Christopher Staker

TRIBUNAL JUDGE
RELEASE DATE: 27 APRIL 2011