20019
VAT – default surcharge – instruction to pay given to bank but payment not made until day after due date – whether reasonable excuse for default – yes – but part payment of amount due only – appeal therefore dismissed – whether calculation of surcharge should take account of part for which reasonable excuse existed

LONDON TRIBUNAL CENTRE

	CRIME NOVEL FILMS (UK) LIMITED	
		Appellant

	- and -

	THE COMMISSIONERS FOR 
	HER MAJESTY’S REVENUE AND CUSTOMS	
			Respondents

		Tribunal:	Malcolm Gammie CBE QC (Chairman)
				Sheila Wong Chong FRICS

Sitting in private in London on 25th October 2006

Mr Sefton Potter, Accountant, for the Appellant

Mrs Pauline Crinnion, advocate, for the Commissioners

© CROWN COPYRIGHT 2007

DECISION

Introduction

1. This is an appeal against a decision of the Respondents of 21 July 2006 on review with respect to a Default Surcharge originally imposed by Notice dated 12 May 2006 arising from the late payment of VAT for period 03/06.  The Appellant company had initially been late in submitting its VAT return for the period 03/05 even though the return (when made) showed that there had been no input or output tax paid or collected.  For the period 12/05 the Appellant company submitted its return in good time but was late in paying the tax due of £153,215.36.  The late payment on this occasion was due to cash flow difficulties (which do not provide a reasonable excuse) and the rate of surcharge for period 03/06 was accordingly 5 per cent.  

2. The return for the period 03/06 was again submitted in good time and showed tax due of £1,026,556.45.  The Surcharge Liability Notice assessed the amount of surcharge payable by the Appellant company as 5% of £873,305.09 or £43,665.25.  Mrs Crinnion for the Respondents told us that the surcharge figure should be £51,327.82 (5% of £1,026,556.45).  The discrepancy had arisen because the Respondents’ computer had allocated the amount paid late in respect of the period 12/05 against the tax shown as due for the period 03/06.  

3. The Appellant was represented at the appeal by its accountant, Mr Sefton Potter, who also gave evidence as a former director of the Appellant, and was cross-examined by Mrs Crinnion.  From the file of documents produced by the Respondents and Mr Potter’s account we find the facts as set out below.  Given the circumstances in which the default arose and the serious consequences that we were told would befall the Appellant company if the default were to stand, we did not give our decision immediately but have taken time to consider the matter.  

The facts

4. Crime Novel Films Ltd (“the Appellant”) is a co-producer of a film with Cattleya S.p.A and Babe SARL under an agreement of 6 August 2004.  We did not see a copy of the co-production agreement although a letter of the same date relating to production expenses was included in the bundle of documents.  There were at least three other parties to the arrangements for financing the film: The Aquarius Film Company No 10 LLP, The Aquarius Film Company No 11 LLP and The Aquarius Film Company No 12 LLP (the “Aquarius LLPs”).  We did not see any of the agreements relating to these companies.  However, in a letter of 1 March 2006 to the Respondents in relation to the default in period 12/05 Mr Potter stated as follows—

	“However, the situation remains that we are unable to pay our outstanding debt of £153,215.36 at the present time as we are waiting to receive VAT from The Aquarius Film Company No 10 LLP, The Aquarius Film Company No 11 LLP and The Aquarius Film Company No 12 LLP.

	We understand that the above LLPs have requested monthly VAT accounting and therefore anticipate that they should receive a repayment shortly.  On receipt of these funds the LLPs can pay Aquarius Film Management Limited who will then be able to clear their VAT debt.

	This is our only source of money and we trust in the light of the above that you reconsider your decision relating to our proposal for Time to Pay.”

5. Subsequent correspondence indicates that the Aquarius LLPs raised finance from investors equal to the net cost of production.  The Appellant would invoice the LLPs for the cost plus VAT and the Aquarius LLPs would pay the VAT once they had reclaimed it.  The Respondents accepted that this split procedure was standard practice in the film industry but refused time to pay for the period 12/05 on the basis that the Appellant and the Aquarius LLPs were separate entities and the Respondents were under no obligation to await the outcome of inter-company transactions before starting recovery action.  The Respondents considered that because the procedure was standard practice the VAT element should have been taken into consideration and any shortfall provided from normal commercial sources.  In the event, once the Aquarius LLPs had been repaid the VAT, the Appellant discharged its outstanding VAT liability for period 12/05.

6. We accordingly turn to period 03/06 for which the Appellant’s return showed VAT due of £1,026,556.45.  The Appellant paid its VAT electronically and accordingly payment for the period 03/06 was due by the extended date of 7 May 2006.  As that date was a Sunday, the payment had to be received into the Respondents’ account on the previous bank working day, Friday 5 May 2006.  The Appellant’s VAT return was made in time, being received by the Respondents on 24 April 2006.

7. The individual ordinarily responsible for the Appellant’s VAT affairs became ill early in April and at the relevant time in May had not returned to work.  The Appellant sought to excuse the default by reference to this individual’s illness.  However, we think that this only contributed indirectly to the default and alone is not an adequate excuse.  We accept that the Appellant’s VAT affairs may have been disrupted by staff illness and, possibly, by the resignation at the end of March of the director responsible for the Appellant’s financial affairs.  Nevertheless, there was time enough between the occurrence of these events and the beginning of May to make alternative arrangements.

8. Indeed, alternative arrangements were made.  As an indication of this, the Appellant’s VAT return was prepared and submitted in good time.  As it had been prepared and signed by the individual who was absent through illness this had obviously been done well in advance, reflecting the straight forward nature of the Appellant’s VAT affairs.  All that was required to be done was the relatively simple clerical task of dating the return and posting it in time, which was done.  Thereafter, the only outstanding task was to authorise payment by the relevant date.

9. This task was delegated to a junior member of staff.  The only relevance of staff illness, therefore, was that the process of instructing the bank to pay the VAT in time fell to this junior member of staff rather than to the more senior individual who would normally have dealt with it.  The junior member does not appear to have been completely unfamiliar with the Appellant’s VAT affairs, having e-mailed the Respondents on 18 April 2006 to confirm that the outstanding VAT liability for period 12/05 had been paid by bank transfer.

10. The process that she had to follow on the relevant day for period 03/06 (Friday, 5 May 2006) was to send an instruction by fax to the Appellant’s bank to make the payment.  To achieve this, she had to input a code and the relevant account data into an electronic device that the Appellant held and the device then produced encrypted account details and a security code that could be sent securely to the Appellant’s bank to process.

11. The junior staff member did all this and despatched the fax on Friday 5 May 2006 but the bank failed to make the payment that day.  The Appellant apparently became aware of this fact on the Friday but too late to repeat the instruction and as a result the payment was only made on 8 May 2006.  We did not see any documentary evidence of the payment instruction given on 5 May 2006 but we accept Mr Potter’s evidence that the instruction was given.  Unfortunately, the junior member of staff involved had left the Appellant’s employment and did not give evidence.  In a letter of 26 May 2006 to the Respondents signed on behalf of the Appellant by the junior staff member concerned it was explained that—

	“We gave instruction to our bank on 7 May 2006 (sic) for a same day transfer.  This instruction was not processed by the bank in error.  We could not have foreseen the circumstances that led to the delay in your receipt of the payment.  As soon as we became aware of the error, we immediately gave another instruction to pay.”

12. Both parties accepted that the reference in this letter should have been to 5 May rather than to 7 May 2006.  Mr Potter explained (and we accept) that the further instruction to pay was given on 5 May but after the time at which the Appellant’s bank was able to transfer funds that day to the Respondents.  The Appellant had been unsuccessful in seeking to persuade its bank to provide an explanation as to why it never acted on the first instructions given on 5 May 2006.  Apparently the bank does not keep appropriate records to enable it to say one way or the other why this was so.

Our decision on the late payment

13. Accepting (as we do) that the bank was instructed to make payment on 5 May 2006, there are several plausible explanations for the failure to carry out that instruction on that day.  One is that the junior member of staff concerned failed to input the correct data so that the encrypted information and security code that the machine produced could not be recognised or acted upon by the bank.  (We have assumed that the machine did not malfunction in the absence of any evidence to suggest that this might have occurred).  Another explanation is that the bank neglected to act on the instructions that it had been given (or perhaps to query in time the incorrect instructions it had received).  Underlying the first of these reasons is the possibility that the Appellant’s failure was due to the junior staff member’s carelessness or lack of attention, from a lack of familiarity with the encryption machine or from a simple mistake in entering the data.  This might not have occurred had the more senior member of staff been available to perform the task but it is only in this peripheral way that her illness has any bearing on the matter.

14. It is unfortunate that the junior staff member was no longer available to give evidence so that we could hear first hand from her what happened on that Friday and form an opinion of her abilities.  Certainly she was capable of inadvertent or careless error, as her letter of 26 May 2006 illustrates.  Having heard from Mr Potter and having considered the matter at length, however, we are prepared to conclude that the error occurred at the bank in failing to carry out the Appellant’s instruction or in failing to query the first instruction in time for the Appellant to confirm that instruction and for the payment to be made on 5 May 2006.

The failure to pay VAT due in full

15. It follows from the last paragraph that in ordinary circumstances we would allow the Appellant’s appeal.  However, we noted in the course of the hearing that the payment instruction given on 5 May 2006 was for £761,600 only, as against a VAT liability shown on its return for period 03/06 of £1,026,556.45.  The discrepancy related again to VAT due to be repaid to the Aquarius LLPs.  If any steps had been taken to speed repayment (see paragraph 4 above), they evidently proved insufficient to avoid the same problem that had arisen in period 12/05.  

16. From the papers before us, it appears that the repayment in question due to the Aquarius LLPs also related to the period 03/06.   The Aquarius LLPs evidently submitted their returns on time and were due to be repaid just over £300,000 VAT.  The process of repayment may have started around the beginning of May 2006 but the Aquarius LLPs did not receive the money and pass it on to the Appellant until after 5 May 2006.

16. This Tribunal has previously accepted that the failure by a taxpayer to receive an anticipated tax repayment on a timely basis can constitute a reasonable excuse.  In the present case, the repayment was due to third parties rather than directly to the Appellant and it was those third parties who owed the Appellant the sum equivalent to the VAT.  In the circumstances of the case, however, where the Aquarius LLPs were parties to the same series of transactions under which the Appellant’s VAT liability arose, this does not seem important.  We understand that where repayment traders elect for monthly accounting repayments are normally made within three weeks from the date of submission of the VAT return and in any event usually within 30 days of submission.  Our problem in this case is that we have no evidence that the repayment to the Aquarius LLPs for period 03/06 was unduly delayed.  

17. Furthermore, this was not the first time on which this problem had arisen from the mistiming of VAT payments and repayments.  The Appellant was fully aware of the consequences of the mistiming and appears to have done nothing to deal with it.  It paid what it could on 5 May 2006 and presumably accepted with equanimity that the balance would be paid in due course once the Respondents had repaid the Aquarius LLPs.  There was nothing in the papers or Mr Potter’s evidence to suggest either that the Appellant had sought any temporary financial accommodation to bridge the gap or that it had pressed the Respondents through the Aquarius LLPs to speed repayment.  

18. Accordingly, we do not think that the Appellant’s failure to discharge the balance of its VAT liability because the Respondents had not repaid VAT to the Aquarius LLPs constitutes a reasonable excuse for the Appellant.  Mr Potter did not suggest the contrary but this is possibly because in dealing with the issue of the late bank payment neither party appears to have recognised the issue that part payment involves but which we felt bound to raise with them at the hearing.  Nevertheless, there was no evidence upon which we could conclude that the Appellant had a reasonable excuse for the unpaid balance.  We must therefore dismiss the Appellant’s appeal.  Nevertheless, there remains the question of how the Appellant’s default surcharge should be calculated in these circumstances.

The relevant legislation

19. Section 59 of the Value Added Tax Act 1994 provides that—

	(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 the 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.

20. Section 59(2) and (3) provide for the service in the circumstances specified in subsection (1) above of a surcharge liability notice specifying or extending the period during which the taxable person is at risk of the default surcharge.  Section 59(4) then provides that—

	“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.”

21. Section 59(5) sets out the specified percentage (5% in the Appellant’s case) and then subsection (6) provides that—

	“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.”

22. Regulation 40(2) of the Value Added Tax Regulations 1995 (SI 1995/2518) provide that the VAT shall be paid not later than the last day on which the person in question is required to make the return for the period to which the VAT relates.  By Regulation 40(3) this does not apply where the Respondents allow or otherwise direct.  In particular, a direction may allow additional time for payment that is made electronically.  Regulation 40(5) provides that later payment so allowed does not of itself constitute a default for the purposes of section 59.

23. Returning to section 59, subsection (7) provides for those cases where there is a reasonable excuse for the VAT shown on the return not having been despatched to the Respondents.  In those circumstances, a taxable person—

	“ 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).”

24. It seems to us, however, that subsection (7) cannot apply to the Appellant.  While we have found that it has a reasonable excuse in relation to £761,600 of the VAT due, that was only part of the VAT shown on the return for period 03/06 and the Appellant has no reasonable excuse in relation to the balance that was due.  This is perhaps unsurprising as a reasonable excuse for non-payment of part of the VAT due ought not to absolve a taxable person of the default for the period in relation to the balance.

25. As we have noted the surcharge liability notice for period 03/06 incorrectly calculated the surcharge liability by reducing the outstanding VAT for that period by the amount paid in respect of the period 12/05.  Given our conclusion in relation to the failure to pay £761,600 (for which there was a reasonable excuse), we would expect the surcharge to be calculated on the balance due of £264,956.45.  This is not, however, what section 59(6) envisages.  This provides that a person’s outstanding VAT for the purpose of calculating the surcharge is so much of the VAT for which he is liable in respect of the period “as has not been paid by that day”, i.e. the last day on which he is required to make a return for the period (see above).

26. At the hearing Mrs Crinnion was unable to tell us what the Respondents’ practice was in these circumstances.  Having regard to the terms of the legislation we find it impossible to say that an amount unpaid on the due date should be deemed to have been paid and excluded from the calculation of surcharge if the taxpayer had a reasonable excuse for its non-payment.  It appears that a reasonable excuse under section 59(7) is an all or nothing matter.  This leads to the situation that a person who has a reasonable excuse for the entire tax is excused the default entirely while one who has a reasonable excuse for non-payment of all but a £1 is not excused the default (which is appropriate) but then suffers a surcharge liability calculated by reference to the entire tax due for the period (which seems completely disproportionate).  It is certainly true that many taxpayers who suffer a default surcharge by a day or so complain that its amount is out of all proportion to the failure involved.  In the present circumstances, however, we think that the fairer result would be to treat £761,600 as having been paid by the due date and calculate the surcharge on the balance due but unpaid.

Conclusion

27. Our conclusion is that the Appellant had a reasonable excuse for its failure to pay £761,600 on the due date but as that only represented three quarters of the VAT shown on the return (and there was no reasonable excuse for non-payment of the balance), the Appellant’s appeal must be dismissed.  Fairness would seem to dictate that the resulting surcharge should be based not on the VAT shown as due in the return for the period but on the amount of VAT that would have remained unpaid on the due date had the bank acted upon the Appellant’s instruction to pay £761,600 on 5 May 2006.  This requires us to decide, however, that the expression “outstanding VAT” excludes both what has been paid and what would have been paid taking account of the taxpayer’s reasonable excuse.  This seems to us, however, to read more into section 59(6) than the legislative language permits. 

28. We have therefore concluded that we have no power to direct that the calculation of the default surcharge take account of the £761,600 paid after the due date on 8 May 2006.  In this respect, Regulation 40 would only provide relief if this were a situation in which the Respondents otherwise allow payment of the tax after the usual due date.  We must therefore leave the calculation of the surcharge in this case to the good offices of the Respondents having regard to what is fair and proportionate in the circumstances.

MALCOLM GAMMIE QC
CHAIRMAN
RELEASED:  16 February  2007

LON/06/0837