19924

DEFAULT SURCHARGE –reasonable excuse – insufficiency of funds – loss of one stylist – problem of communication with bank – appeal dismissed – VATA 1994 Ss 59 and 71(1)(a)   

LONDON TRIBUNAL CENTRE

SMILE HAIR LIMITED
Appellant

 - and -   	

THE COMMISSIONERS FOR HER MAJESTY’S 
REVENUE AND CUSTOMS 
Respondents

Tribunal: DR A N BRICE (Chairman)
 MRS E M MACLEOD CIPM

Sitting in London on 29 November 2006

There was no appearance by or on behalf of the Appellant

Mr P Webb, of the Office of the Acting Solicitor for HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2006
 
DECISION

The appeal
1.	Smile Hair Limited (the Appellant) appeals against a default surcharge penalty amounting to £561.99 and imposed by Her Majesty’s Revenue and Customs (Customs). The penalty was in respect of the accounting period ending on 30 April 2006. The tax and the return were due on 31 May 2006; the return was received on 7 June 2006 and the tax due of £11,239.87 was received on 20 June 2006.  

The legislation 
2.	Section 59(1) of the Value Added Tax Act 1994 (the 1994 Act) provides that, where a return or the tax due is not received in time, the taxable person is in default. Section 59(4) provides that a penalty is imposed for the second and subsequent defaults in a series and the amount of the penalty is a percentage of the tax paid late. This was the third default in a series and the percentage was 5%. Section 59(7)(b) provides that if a taxable person satisfies the tribunal that there was a reasonable excuse for the late sending of the return or the tax he is not liable for the surcharge. Section 71(1)(a) provides that an insufficiency of funds to pay any VAT due is not a reasonable excuse. 

The issue
3.	What we had to decide was whether the Appellant had a reasonable excuse for the late sending of the return and the tax which were due on 31 May 2006. 

Hearing in the absence of the Appellant
4.	When the appeal was called on for hearing there was no appearance by or on behalf of the Appellant. The Notice of Appeal had been lodged by Mr P A Moores, a director of the Appellant and the Tribunal had not been given any reason for his non-attendance at the hearing. Mr Webb, for Customs, told us that he had spoken to Mr Moores the previous day and that Mr Moores had then said that he would not attend.  Accordingly, we heard the appeal in the absence of the Appellant under Rule 26(2).  Rule 26(3) provides that the Tribunal may set aside a decision given in the absence of a party if that party applies to the Tribunal centre within fourteen days after the date when the Decision is released.  

The evidence
5.	The Respondents produced a bundle of documents. This included a number of letters from the Appellant.  

The facts
6.	From the evidence before us we find the following facts.

7.	The Appellant was first registered for value added tax in January 1989 under the name of New Concept Hair Team Limited trading from premises at High Street, Ascot, Berkshire. The Appellant supplies hairdressing and other beauty treatment. The name of the Appellant was changed to Smile Hair Limited on 25 October 2005.  

Previous late payments
8.	Although the default the subject of this appeal was the third in a series there were a number of defaults in previous years. In July 2001 Mr Moores wrote to Customs to say that cash flow had reduced during the previous payment period and he would like to pay the tax due on 31 July 2001 by three stage payments on 15 August, 15 September and 15 October 2001. This proposal was accepted by Customs who stated that the arrangement did not prevent or cancel the recording of defaults or liability to surcharge. However, the return for the period ending on 31 July 2001 was not sent and on 29 April 2002 Customs issued an assessment in the sum of £2,764.07 and a surcharge of £240. The return was actually sent on 16 May 2002 after which the assessments to tax and to a surcharge were withdrawn. 

9.	Two years later, on 2 September 2003, Mr Moores wrote to Customs to say that the business had suffered a severe downturn in turnover of almost 50%. This was because there were staff on maternity leave, because of holidays of staff and clients, and because a new salon had opened opposite run by a former employee who had targeted the Appellant’s clients. Two staff were to be made redundant; directors’ drawings were to be reduced; and a bonus scheme was to be introduced to increase turnover. Mr Moores proposed payment by three instalments. The arrangement was accepted by Customs who stated that the arrangement did not prevent or cancel the recording of defaults or liability to surcharge. The last instalment appeared to be paid after the agreed date.

10.	Customs also agreed to accept payment by instalments in March 2004.. 

11.	The return and tax for the accounting period ending on 31 July 2004 should have been received on 7 September 2004 by electronic transfer but the payment was not received until 8 September. On 23 September 2004 the Appellant appealed to Customs against a surcharge of £729.46 imposed because the electronic transfer was received one day late. Mr Moores said that he did not pay on time because he had a lot of cheques to pay in, and those cheques would not have cleared on time. On 2 November 2004 Customs agreed to cancel the default.   

Current late payments
12.	With that background in mind we come to the series of defaults of which the default under appeal was the third. In the accounting period ending on 31 October 2005 the due date was 30 November 2005 and the tax and return were received on 20 December 2005. That was the first default and a surcharge liability notice was issued on 16 December 2006.  In the accounting period ending on 31 January 2006 the due date was 28 February 2006. The return was received on 8 March 2006; about half the tax was received on 8 March 2006 and the rest on 24 March 2006. That was the second default The amount of the default surcharge penalty should have been 2% of the tax paid late. However, no penalty was imposed. 

13.	In the accounting period ending on 30 April  2006 the due date was 31 May 2006. The return was received on 7 June 2006. A cheque for the full amount of tax due (£11,239.87) was sent with the return but was returned by the Appellant’s bank because of an insufficiency of funds amounting to £528.  At that time the Appellant was changing banks and the bank manager of the new bank was not able to contact Mr Moores at the appropriate time to arrange an overdraft. The tax was eventually received by Customs on 20 June 2006. That was the third default and is the default the subject of the appeal. The amount of the default surcharge penalty was 5% of the tax paid late.  An overdraft was in fact agreed on 29 June 2006. 

The correspondence after the surcharge
14.	Because the Appellant was not represented at the hearing we read its correspondence with Customs in order to identify the arguments which would have been put on behalf of the Appellant if it had been represented. After receiving notice of the default surcharge penalty Mr Moores wrote to Customs on 5 July 2006 saying that the Appellant had cash flow problems and two staff had to be made redundant. This time Customs did not cancel the surcharge. 

15.	Mr Moores wrote more fully to Customs on 4 November 2006 to say that there were two reasons for the late delivery of the return. The first was the unexpected loss of a senior stylist in March when all her clients stopped coming into the salon. Turnover dropped causing a problem with cash flow. Three staff had since left. The second reason was because the bank had returned the cheque without speaking to Mr Moores. With the letter of 4 November 2006 Mr Moores sent some documents. One was a trading and profit and loss account for the Appellant for the year ending on 31 January 2005. This showed an increase in sales to £317,618 from a level of £295,733 the previous year. It also showed a net profit of £14,797 up from a loss of £20,727 the previous year.  

16.	On 9 November 2006 Customs wrote to the Appellant to say that it had not established a reasonable excuse for the default. They had examined the Appellant’s turnover from January 2005 to April 2006, as stated on the returns, which was:

Period ending on  		2005		2006
31 January			£81,808	£81,550
30 April			£83,637	£80,400
31 July				£85,621
	31 October			£85,387

17.	Customs went on to say that although there was some reduction in turnover in the relevant period (ending on 30 April 2006) there was no evidence of a significant decline in sales during the quarter under appeal. Further, the Appellant accounted for tax under the cash accounting scheme and so only had to pay tax when it had been received. Also any problems arising from the loss of a senior stylist in mid-March could have been resolved by the due date of 31 May 2006. Although there were insufficient funds to pay all the tax due some could have been paid on time and the directors should have contacted the bank prior to the due date to negotiate an overdraft facility. 

18.	 Mr Moores replied on 14 November 2006 to say that there had been a significant decline in turnover which was down £3,237 from the turnover in April 2005.  He said that he had called Customs’ helpline and gained the impression that the amount of tax had to be paid in full and he was not told that if he paid as much as he could then that would reduce the surcharge. He intended to be present at the hearing of the appeal and to bring an Observer from the Civil Service Union.

19.	Customs replied on 21 November 2006 to say that they could find no evidence that the National Advice Service had given a false impression and the published notices were quite clear that the surcharge was calculated on the amount of tax not paid on time and so it was in the interests of taxable persons to pay as much as they could by the due date. In the bundle of documents produced to us there were records of twelve conversations between representatives of the Appellant (not always Mr Moores) and Customs on different dates since 2003. One conversation, on 20 February 2004, recorded that the caller (D Moores, director) said that the Appellant could not afford to pay the tax due on the January 2004 return. The caller was advised to submit the return with the correct figures and also advised to send as much payment as possible. There was a record of a telephone conversation with Mr Moores on 5 June 2006 when he said that he would be late in paying the tax due with the return for the period ending on 30 April 2006 and that the Appellant owed tax of approximately £11,000.  Customs explained that the Appellant would receive a 5% surcharge liability notice extension but as 5% of £11,000 was not over £400 there would be no financial penalty. In fact 5% of £11,000 is over £400 and so there was a financial penalty. However, by 5 June 2006, at the date of that call, the due date of 31 May 2006 had passed and so any advice to pay as much as possible would not have made any difference.

The arguments 
20.	In the absence of the Appellant we took its arguments to be as stated in the correspondence with Customs as summarised above, namely, cash flow problems, the unexpected loss of a senior stylist in the relevant accounting period, and the change of bank which led to the cheque being reurned. We also referred to the grounds of appeal set out in the Notice of Appeal which were;

“We were in no position to pay. We tried to pay in cheques a.s.a.p. The directors have not taken any money or expenses since refit They have put £10,000 in to keep company going – but no money now available. Company now on knife edge – whether it survives or fails severe staff cuts being made.”

21.	For Customs Mr Webb argued that as the Appellant was on the cash accounting system, and only paid value added tax on the amount it actually received from customers, any decrease in the level of sales would lead to a similar decrease in the amount of tax due. He relied upon section 71(1)(a) of the 1994 Act which provided that an insufficiency of funds to pay any tax due was not a reasonable excuse. 

Reasons for decision
Legal principles
22.	In considering the arguments of the parties we begin with the terms of the legislation. Although section 59(7)(b) of the 1994 Act provides that there is no liability for a surcharge if there is a reasonable excuse, section 71(1)(a) provides that an insufficiency of funds to pay any tax due is not a reasonable excuse. The ambit of section 71(1)(a) (which was then section 33(2)(a) of the Finance Act 1985) was considered in Commissioners of Customs and Excise v Salevon [1989] STC 907 and also in Commissioners of Customs and Excise v Steptoe [1992] STC 757. Those decisions established four main principles. 

23.	First, section 71(1)(a) makes it clear that an insufficiency of funds is not a reasonable excuse for late payment. As Nolan J (as he then was) said in Salevon:

"Suppose a trader was able to demonstrate as a matter of fact that when the time for payment came he was, at least temporarily, bereft of funds and unable to borrow what was needed; that might be regarded in the absence of s33(2)(a) [now section 71(1)(a)] as a reasonable excuse for non-payment. The law does not as a general rule require the impossible. But s 33(2)(a) [now section 71(1)(a)] makes in plain that an insufficiency of funds cannot be so regarded. Insolvency is not enough."

24.	Secondly, it is necessary to distinguish the reason for late payment and the underlying cause for late payment. Even though the reason for the failure to pay on time is an insufficiency of funds, the underlying cause could, depending on the facts, be a reasonable excuse. Although a trader who lacks the money to pay his tax by reason of culpable default would not have a reasonable excuse, a trader who is deprived of the means to pay his tax for some adequate reason might well have a reasonable excuse for late payment notwithstanding that the direct cause is the insufficiency of funds.

25.	Thirdly, it is for the tribunal to decide whether the underlying cause constitutes a reasonable excuse. The wrongful act of another person, or some unforeseeable or inescapable misfortune, leading to an insufficiency of funds, could well be a reasonable excuse but there are limits on what could be regarded as a reasonable excuse. The test was outlined by Lord Donaldson in Steptoe in the following way:

"If the exercise of reasonable foresight and due diligence and a proper regard for the fact that the tax would become due on a particular date would not have avoided the insufficiency of funds which led to the default, then the taxpayer may well have a reasonable excuse for non-payment; but that excuse will be exhausted by the date upon which such foresight, diligence and regard would have overcome the insufficiency of funds."

26.	Finally, the cases in which a trader on the cash accounting scheme with insufficient funds to pay the tax can successfully invoke the defence of reasonable excuse are rare because such a trader receives from its customers the amount of tax which must be paid to Customs.  If the trader uses that money in its business and loses it, and so cannot hand it over when the date for payment arrives, the trader will normally be hard put to it to persuade the tribunal that there is a reasonable excuse for late payment.
   
The legal principles applied to the facts
27.	Applying those principles to the facts of the present appeal it is clear that an insufficiency of funds to pay the tax due cannot be a reasonable excuse. We have looked for the underlying cause for the insufficiency of funds which the Appellant argued was due to the loss of a senior stylist. However, the turnover figures do not support this. In the period during which the stylist left turnover was £80,400 which was not significantly less than turnover in the previous period (when the stylist was still there) of  £81,550. 

28.	In the light of the facts we have found we conclude that the Appellant was frequently short of cash. This occurred in July 2001, September 2003, March 2004, July 2004, November 2005 and February 2006. There was no evidence of any unforeseeable or inescapable misfortune in the period ending on 30 April 2006. We are of the view that the exercise of reasonable foresight and due diligence and a proper regard for the fact that the tax would become due on 31 May 2006 would have avoided the insufficiency of funds. In particular, the exercise of reasonable foresight and due diligence would have led the Appellant to have arranged an overdraft with its new bank before the due date and not after.

29.	We are confirmed in our views by the fact that the Appellant accounted for tax under the cash accounting scheme and so received the tax from its customers before it had to be paid to Customs. It appears that the Appellant used that money in its business, and lost it, and so was unable to hand it over to Customs on the due date for payment. That has not persuaded us that there was a reasonable excuse for late payment. 

Decision
30.	Our decision is that the Appellant did not have a reasonable excuse for the late sending of the return and the tax which were due on 31 May 2006. 

31.	That means that the appeal is dismissed. 

DR A N  BRICE

CHAIRMAN

RELEASE DATE: 7  December 2006

LON/2006/0891
06.12.06