20012

Default surcharge - reasonable excuse - water leak at hotel causing flood and loss of business - found that there was a reasonable excuse for the first three periods after the flood but not for periods thereafter - default surcharge rates therefore reduced in relation to periods under appeal - application of section 59(7) and (8) VATA: when a default is material to a surcharge - no adjustment in relation to other periods

LONDON TRIBUNAL CENTRE

	THE CEDAR HOUSE HOTEL COMPANY LIMITED	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

			Tribunal:	CHARLES HELLIER (Chairman)
					GEORGE MILES

Sitting in public in Bristol on 23 November 2006.

Sarah Crocker, Managing Director of the Appellant

Jonathan Holl instructed by the Acting Solicitor for HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2007

APPEAL

1.	This is an appeal against a default surcharge of £5,001.44 in respect of the VAT period ending 31 December 2005 (the “12/05” period) and being 15% of the VAT paid late in that period. The Appellant did not appeal against lower surcharges for 06/05 and 09/05.
2.	At the end of the hearing we announced our decision orally. Mr Holl asked us to set out our reasons fully.
3.	We found the following facts from the oral evidence of Ms Crocker and the documents before us:
The Facts
(1)	The Appellant company acquired the Stonehouse Court Hotel in May 2004. It is a hotel with 36 bedrooms, conference and reception facilities, a restaurant seating up to 150 people and gardens. It overlooks the Cotswolds. 
(2)	Before and after the hotel was acquired it derived the majority of its income from weddings and conferences in equal measure. Christmas parties also contribute significantly. Many of its customers are local businesses in the Stroud Valley.
(3)	The hotel was acquired by the Appellant as a going concern and with knowledge of the previous turnover of the business. For the period up to September 2004 the business performed in line with forecasts.
(4)	The Appellant engaged builders to carry out building works. During the execution of those works a flood occurred on 26 September 2004. The flood wiped out the hotel’s telephone system. The telephone system was replaced in early November 2004 six weeks after the flood. In the meantime a temporary system was rigged up but it was unreliable as a result of damage to the wiring.
(5)	The effective absence of a reliable telephone system in this period had serious consequences for the business. First it meant that customers were unable to ring up to book events at the hotel. Second reports that it was impossible to contact the hotel gave rise to a local conclusion that the hotel had closed. Neither of these consequences had any immediate consequence for the business, but both affected the business of the hotel in 2006.
(6)	Christmas events were generally booked in October, and late September and October were usually good months for summer wedding bookings. Companies tended to book about 3 months in advance. As a result the December 2005 turnover was substantially reduced and events, conferencing, weddings and banking revenues for 2006 were as Ms Crocker put it knocked for six. The break with existing customers and the belief that the hotel had closed meant that booking and revenues were affected for at least 12 months after the flood - so for most of 2006.
(7)	The following table indicates the differences in the income of the business for the 10 months after the flood with that in the preceding year:
£’000s	Before Flood	After Flood	(reduction)	
November	79	62	(17)	
December	139	93	(46)	
January	61	51	(10)	
February	80	49	(31)	
March	101	66	(35)	
April	73	74	1	
May	105	101	(4)	
June	108	99	9	
July	123	90	(33)	
August	83	73	(9)	
September	105	85	(20)	
October	98	92	6	

(8)	The reductions in income were substantial. It seems to us that those in December to March can clearly put down to the flood as can at least part of July’s £33,000 reduction (July being a good wedding month). We doubt whether more than half the August and September reductions could be attributed to the flood.
(9)	The Appellant made an insurance claim in respect of the damage and loss of revenues occasioned by the flood. It received an early payment of £10,300 (the cost of the new telephone system was £12,000) and payments of £40k and £50k respectively in February and March 2005. On a very broad brush basis this means that by the end of March 2005 (6 months after the flood) its total cash receipts for that 6 month period were some £60,000 less than expected. (We note that a further loss of profits claim was made in August 2006 but for reasons unconnected with the determination of the magnitude of the loss or its cause it was the subject of some dispute with the insurer).
(10)  The Appellant is generally paid by its customers before or when they use its facilities: wedding parties pay in advance, guests at the end of their stay. Some corporate customers take 30 days credit. The Appellant has had no bad debts relevant to this appeal.
(11)  The Appellant communicated weekly with its bankers. After the flood the bank agreed to extend its overdraft facility from £100k to £150k. Deficits in expenditure income (see table above) in the autumn of 2005 meant that by December 2005 the overdraft had reached £198k. At that stage the bank refused to extend it further.
(12) The Appellant’s business has fairly substantial overhead costs. Payroll and other fixed overhead expenses amount to some £90k per month. It made redundancies following the downturn in business laying off both people who had been recently recruited and those who had been inherited from the previous owner. We accept Ms Crocker’s evidence that the Appellant cut back as far as it could do so and yet still ran a hotel business. Other costs were cut too. The programme of replacing furnishings (which had started on acquisition of the business was stopped).
(13) The Appellant submitted its VAT return 3 days late for the quarter 12/04. It is possible that it was submitted late for 03/05 but there was no clear evidence before us on that question and we make no finding that it was late. It failed to pay its VAT on time for each of the quarters 12/04, 03/05, 06/05, 09/05, and 12/05. The Respondents agreed to instalment arrangements for the payment of the VAT for the 06/05 quarter. The arrangements made clear that they did not absolve the Appellant from the surcharge effect of late payment.
(14)  The Respondents served Surcharge Liability Notices (or extension notice) on the Appellant in respect of each of the quarters 12/04 to 12/05. Notwithstanding that in the 03/05 quarter a surcharge of 2% would have been exigible the Respondents did not claim the surcharge. Surcharges of 5% and 10% were claimed in respect of 06/05 and 09/05. The Appellant did not appeal against those surcharges deciding to stomach them as business was beginning to look up.
(15) Ms Crocker’s father lent the Appellant the funds to pay the VAT for the 12/05 return.
(16) The Appellant’s business income stabilised in the summer of 2005 and was back on the rails by the end of the year.
The Respondents’ arguments
4.	Mr Holl accepted that the flood was sudden and its effect unexpected. He pointed out that the worst effect for the Appellant’s turnover was in periods 12/04 and 03/05. By January 2006 he said the business was in better shape and any excuse had disappeared. He also submitted that the Appellant did not have a reasonable excuse in relation to 06/05.
The Statutory Provisions
5.	Section 59 VATA 1994 provides a system of default surcharges when taxpayers deliver a VAT return late or pay VAT late.  The relevant provisions of section 59 are the following:-
(1)	“Subject to subsection (1A) below If, by the last date 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.

(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 service 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.

(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.”)

6.	Thus a default begins a twelve month period in which the taxpayer can be put on notice that any further default will give rise to a surcharge, if there is a further default then the at risk period can be extended by further notice and so on. And the rate of the surcharge starts low but works its way up to 15% for the fourth and subsequent defaults in a period.
7.	It will be seen that a surcharge period is triggered and can be extended by default. Subsection (7) provides a form of defence in relation to a surcharge; if the taxpayer can show inter alia that he had a reasonable excuse for what would otherwise have been a default, the default is, if it is “material”, treated as not having occurred.
8.	Sub-section (7) relates to a default which is “material” to the surcharge. Sub-section (8) explains when a default is material. It is “material” if (a)  it is the default which triggers the surcharge under appeal (that is in (8)(a)), or (b) two conditions are satisfied: first that it relates to the surcharge liability notice upon which the surcharge depends, and second that it must also be the case that the taxpayer has not previously been liable to a surcharge in respect of a period ending within the period specified in or extended by that notice (sub-section (8)(b)).
9.	This second condition in sub-section (8)(b) in sub-section (a)(b) appears to mean that even if a taxpayer had a reasonable excuse for a default in a period, that default can still support the surcharge liability notice issued in respect of it by reference to which a surcharge liability may be assessed if the taxpayer was actually liable to a surcharge within the relevant period following that notice - whether or not he appealed against it. We deal with the application of sub-section (8)(b) in paragraph 18 below.
10.	Section 71 VATA 1994 limits the conduct which can give rise to a reasonable excuse defence.  It provides that:
“(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 upon the part of the person relied upon is a reasonable excuse.”

11.	The application of this section was considered by the Court of Appeal in Customs and Excise Commissioners v Steptoe [1992] STC 757 which affirmed that the effect of section 71 was not to prevent the reason for an insufficiency of funds from being a reasonable excuse: its effect was to prevent the mere insufficiency of funds from constituting a reasonable excuse.  Nevertheless not any reason will suffice: it has to be one which would be recognised as giving rise to a reasonable excuse, and broadly that is a question of whether the cash flow problem was reasonably avoidable.  And the question of whether reasonable foresight, due diligence, and a proper regard for the tax being due could have avoided the default will be relevant.
12.	It is also clear for the cases that whereas an unfortunate event or circumstance may give rise to a reasonable excuse in relation to one quarter, its ability to support a reasonable excuse in later quarters may be more limited because by then it would generally be reasonable to expect the taxpayer to have made arrangements to cope with the need to pay the tax: an excuse will be exhausted by the date on which reasonable foresight due diligence and a proper regard for the fact that VAT will be due would have overcome the insufficiency of funds.
Our findings
13.	We find that the taxpayer had a reasonable excuse for its failure to pay VAT on time for the periods 12/04 and 03/05. We also find that the taxpayer had a reasonable excuse for the late delivery of its VAT return for 12/04 and if relevant for 03/05.
14.	12/04 was the period immediately after the flood occurred.  Christmas bookings were lost and the cash receipts substantially reduced.  The circumstances and result of the flood were not in this period reasonably avoidable, and it is clear that these circumstances were the reason for defaults.
15.	In the period 03/05 cash takings were also substantially reduced. That reduction could not reasonably have been avoided. We do not believe that it would have been reasonable to have shed more staff in that period and it is clear that the company took steps to acquire what finance it could from its bankers.  The effects of the flood in the period were not reasonably avoidable and were the reason for default.
16.	 At the hearing we indicated that we thought that by June the excuse afforded by the flood had evaporated. Further consideration has caused us to change our view. The cash flow effect of the flood was still substantial at the end of June even though the Appellant was taking reasonable steps to reduce it and avoid its consequences. Although the Appellant’s income in April, May and June had returned to normal and it had received the insurance payment in June, its receipts were some £60,000 down for the 6 month period ended in March and it was up to its borrowing limits. The unavoidable effects of the flow were still being felt in June and July. As a result we find that there was a reasonable excuse for the 06/05 VAT payment default.
17.	 However, we feel confident that there was no reasonable excuse for 09/05 and 12/05. We accept that takings were down in 09/05 (by £62k) and that the overdraft was above its limit by the end of December 2005; but by May 2005 its business was stabilising and the possibility of this outcome would have been foreseen. Whilst it is often difficult to escape from the foreseeable, we think that by this time it was reasonable to expect the Appellant to have taken steps to enable it to pay the VAT on time despite the lingering effects of the flood. We therefore accept Mr Holl’s submission that there was no reasonable excuse for the 12/05 period.
18.	The consequences of these findings are:-
(i)	for the purposes of section 59, the taxpayer was not in default for the periods 12/04, 03/05and 06/05.  The default surcharge notices issued in respect of and for the 12 months following the end of each of each of those periods are therefore deemed not to have been served (see  paragraph 19 below);

(ii)	for the purposes of section 59, the taxpayer was in default for the period 09/05. This was therefore a period in respect of which a default surcharge notice could be properly issued.  The notice served by reference to this period is headed “Surcharge Liability Notice Extension” but also bears rubric indicating that if no surcharge period had been previously notified the period starting on 11 October 2005 and ending on 30 September 2006 is specified as a surcharge period.  It seems to us that this notice satisfies, in relation to that period the requirements of section 59(3) and therefore that a surcharge period began to run as the result of that notice;

(iii)	thus a surcharge liability period was created from 11 October 2005 to 30 September 2006;

(iv)	in that period the taxpayer defaulted in respect of 12/05;

(v)	the appropriate surcharge in respect of the period 12/05, being the period in which the first default took place after the service of the notice,  is 2% of the late paid tax;

(vi)	that means that the surcharge for 12/05 should be 2% x 33,342.99 = £666.84  rather than 15% x 33,342.44 = £5,001.44.

19.	We referred in paragraph 8 above to the requirements of section 59(8)(b). The 12/04, 03/05 and 06/05 defaults are to be ignored in relation to the 12/05 default only if they are “material” to that surcharge. They will be material if the conditions in 59(8)(b) are satisfied:
(i)	the first condition in that paragraph is clearly satisfied: the surcharge for 12/05 depends upon surcharge liability notices generated by the 12/04 default, and if the 12/04 default is to be ignored the 03/05 default, and if that default is to be ignored as well, the 06/05 default;

(ii)	the second condition in relation to any default is that the person has not previously been liable to any surcharge in respect of the period specified in or extended by the notice upon which the surcharge depends. This requires the surcharges made on the Appellant to be taken in turn:

	(a)	the 06/05 surcharge. This surcharge would be the first surcharge in the period relevant to the 12/04 notice. There was no previous surcharge liability: the condition is satisfied. Therefore the 12/04 notice is, as respect this surcharge deemed not to have been served. The same result then applies to the 03/05 notice. Thus both the 12/04 and the 03/05 defaults are material to the 06/05 surcharge. The consequence of that is that the 06/05 surcharge liability must be deemed not to have been incurred.

	(b)	the 09/05 surcharge. This would, on the assumption that the taxpayer is to be taken as liable to a surcharge in respect of 06/05, have been the second surcharge in the period commenced and extended by the 12/04 or 03/05 notices. But sub-section (7) deems the 12/04 and 03/05 notices not to have been served in relation to the 06/05 default: so that default must be regarded as one in respect of which no surcharge arose. As a result the 09/05 default must be treated as one which in respect of which in the relevant period there had been no previous surcharge liability. As a result the 09/05 default is material in relation to the 12/04 and 03/05 defaults, and for the purposes of that 09/05 default the 12/04 and 03/05 notices must be deemed not to have been served. What about the notice that was served in respect of the period 06/05? But again the 06/05 default will be material to the 09/05 default because the notice served as a result of it would be the only notice on which the 09/05 surcharge depended and there would, since the service of that notice have been no previous default. Thus as a result of sub-section (7) the 06/05 notice will be treated as not having been served. Thus for the purposes of the 12/05 liability a surcharge liability should not be taken as having arising in 09/05

	(c)	the 12/05 surcharge. This would have been the third surcharge in the period commenced and extended by the 12/04, 03/05 and 06/05 notices. But sub-section (7) deems the 12/04 03/05 and 06/05 notices not to have been served in relation to the 09/05 default because in relation to each such default the 12/05 default is material. Thus the 12/05 default is to be surcharged only by reference to the 09/05 default.

20.	We note that another consequence of our finding would be that, if there had also been before us appeals in relation to the surcharges levied for 06/05 and 09/05, the surcharge for those periods would have been reduced to nil (from 5%) and to 2% of the late VAT (from 10%).
21.	However appeals in respect of those periods were not before us, and in this appeal we cannot make any determination in respect of those periods.  The default surcharge made and paid in respect of those periods is thus unaltered by this appeal and this decision.
22.	We considered whether, if an application was made to appeal out of time against the surcharge made in respect of those periods we would grant it.  We would not for the following reasons.
23.	Sarah Crocker is in our opinion a very competent and able manager.  She understood the operation, risks and scale of the taxpayer’s business very clearly.  She took professional advice when required.  It was clear that a decision had been taken (whether formally or implicitly, it does not matter which) not to appeal against the surcharges of £1,582 for 06/05 and £1,847 for 09/05.  It was not until 12/05 when the charge racked up to £5,001 that, given the size of the operation and the calls on her time and that of others, it was worthwhile making an appeal.  That is a perfectly respectable commercial approach, but it would not be one which in our view would provide a reason for this tribunal to exercise its discretion to extend the time limit for the making of an appeal.
24.	Finally we note that the fact that no appeal was made in relation to 03/05. 06/05 cannot create an irrebutable presumption that there was no reasonable excuse in those periods relevant to this appeal. In any event there could not have been an appeal in relation to 03/05 since no surcharge was assessed. Had there been appeals and had the tribunal held that there was no reasonable excuse in relation to those periods, that finding would at the very least been highly persuasive if not binding upon us. But in the absence of any decision on the issue there is no assumption statutory or otherwise that the issue has been determined one way or the other.
Conclusion
25.	We allow the appeal to the extent of a reduction in the default surcharge for £5,001.44 to £666.84.

CHARLES HELLIER

CHAIRMAN
RELEASE DATE:  8  February  2007

LON/2006/0582