20362

VAT – DEFAULT SURCHARGE – principal client failed to make stage payments the value of which constituted 90 per cent of the Appellant’s value of supplies during the relevant quarter – the Appellant could not have reasonably foreseen that the client would renege on her agreement to make stage payments – the steps taken by the Appellant were those of a prudent business person aware of its responsibilities to pay VAT on time – reasonable excuse – Appeal allowed. 

MANCHESTER TRIBUNAL CENTRE

	PERCHWORTH CONSTRUCTION SERVICES LIMITED  	Appellant

	- and -

	HER MAJESTY’S REVENUE and CUSTOMS	Respondents

			Tribunal: MICHAEL TILDESLEY OBE	 (Chairman)

Sitting in public in North Shields on 8 August 2007

Don Brown, company manager for the Appellant 

Matthew West, counsel instructed by the Acting Solicitor for HM Revenue & Customs, for the Respondents

© CROWN COPYRIGHT 2007

DECISION
The Appeal
1.	The Appellant was appealing against a default surcharge in the sum of £2,090.75 issued on 13 April 2007.
The Dispute
2.	The Appellant was a construction company established in 1996 employing 13 members of staff with an annual turnover of about £600,000. The Appellant’s main source of business was the construction of new houses and house extensions for private clients. The Appellant, however, was shifting its business towards carrying out refurbishment work and maintenance contracts for local authorities which were more reliable payers than private clients.
3.	The Appellant did not pay the VAT due in the sum of £13,938.36 for the period ending 28 February 2007 by the required date of 31 March 2007. This resulted in the Appellant incurring a default surcharge at the rate of 15 per cent in the sum of £2,090.75. The Appellant’s VAT return was dated 28 March 2007 but not received by the Respondents until 2 April 2007. The Appellant paid the outstanding VAT four weeks after the due date. 
4.	The dispute concerned whether the Appellant had a reasonable excuse for not making the VAT payment by the due date. During the VAT period in question the Appellant was principally engaged in one building project which involved the renovation of an existing building into a two bedroom cottage. The customer reneged on her agreement to make stage payments which meant that the Appellant did not have the funds to pay the VAT due by 31 March 2007. The stage payments formed the main source of the Appellant’s income during the period ending 28 February 2007.  The Respondents contended that the Appellant’s cash flow difficulties did not amount to a reasonable excuse because the legislation specifically precluded insufficiency of funds from being a reasonable excuse.  Further the Respondents considered that the value of the stage payments was not significant enough to make the non-payment a reasonable excuse. 
5.	Although the Appellant’s cash flow difficulties cannot in law amount to a reasonable excuse, the underlying cause of those difficulties may in certain circumstances constitute a reasonable excuse.  The issues for determination were whether the non-receipt of the stage payments for the two bedroom cottage was the underlying cause of the Appellant’s problems and if so whether it met the criteria for a reasonable excuse. 
The Hearing
6.	Mr Brown gave evidence upon oath for the Appellant. The Respondents submitted a bundle of documents.
7.	I announced my decision to allow the Appeal at the end of the hearing. The Respondents requested the decision to be recorded in writing in accordance with rule 30 of the Tribunal Rules 1986.
The Facts
8.	I found the following facts:
(1)	The Appellant had a poor VAT compliance record, having 12 surcharge liability notices and or default surcharges since 30 September 2002. The Appellant left its VAT accounting and reporting to a local accountant who failed to advise the Appellant about the liability notices and surcharges. The Appellant at the time was unaware of its poor compliance record. The Appellant has since dispensed with the services of the accountant and introduced controls for its VAT reporting.
(2)	During the last three and half years the Appellant had been involved in litigation against a client who refused to pay for a new build. The litigation almost sent the Appellant into liquidation, as the client’s legal representatives took measures to stall the proceedings, which originally were forecast to last 12 months. In October 2006 the Appellant was successful with its action to recover the monies due from the client. However, the Appellant was only awarded 70 per cent of its legal costs which effectively meant that it had suffered a loss.
(3)	The protracted legal proceedings created severe financial pressures for the Appellant whose survival was dependent upon the overdraft facilities granted by its bank.
(4)	  On 1 November 2006 the Appellant secured a contract to renovate an existing building within the grounds of a house into a two bedroom cottage. The contract was for £128,000 exclusive of VAT which was due to be completed in March 2007. The client agreed to make stage payments. The agreement was documented.  The client made her first payment in November 2006 but missed her payments for December 2006, January, February and March 2007. The Appellant considered it took all reasonable steps to ensure that its client honoured her agreement to make stage payments. The client gave various excuses for not making the payments. The Appellant formed the view that the client knew what she was doing, and that it was a deliberate act by her to avoid making the stage payments. 
(5)	The Appellant decided to complete the building project even though it was not being paid. Based on its recent litigation experience the Appellant concluded that its position would be much stronger to recover the contract price in full if it finished the building. 
(6)	The consequence of continuing with the building project was that the Appellant was effectively starved of its primary source of income for the months of December 2006, January and February 2007. Mr Brown after close questioning confirmed upon oath that the contract constituted 90 per cent of the Appellant’s work during that three month period.
(7)	The Appellant’s VAT return for the period ending 02/07 revealed that its total value of sales during the period was £129,364 whilst its total value of purchases was £94,478.  The Appellant’s quarterly salary bill was in the region of £30,000.
(8)	The Appellant was unable to obtain at short notice other contracts to cover the shortfall occasioned by the client’s refusal to make stage payments.  In December 2006 the Appellant secured an extension to its overdraft facility to £70,000 by offering its premises as collateral. By February 2007 the Appellant exceeded its overdraft facility by £5,000.
(9)	 In view of its experiences with private clients, in particular their reluctance to meet their financial obligations on time, the Appellant decided to shift its business focus from private client work to building and maintenance contracts for local authorities which were more reliable payers. 
(10)	The Appellant contacted the Respondents about its failure to pay the VAT after it received the surcharge assessment dated 13 April 2007. The Appellant paid the outstanding VAT as soon as it received the monies from the private client which was some four weeks after the due date.
The Reasons
9.	Section 59 of the VAT Act 1994 requires the Appellant to furnish VAT returns and pay the outstanding VAT within one month of the relevant accounting period. The Appellant failed to pay the VAT due within one month of the accounting period ending 28 February 2007. 
10.	The Appellant can avoid the default surcharges if it can satisfy the Tribunal on a balance of probabilities that it had a reasonable excuse for not furnishing the VAT payments on time. Insufficiency of funds in itself cannot in law amount to a reasonable excuse (section 71(1)(a) of the VAT Act 1994). 
11.	The Appellant did not have sufficient funds to meet its VAT liabilities for the period in question. The Appellant, however, considered that it had a reasonable excuse because its principal client for the disputed period had defaulted on her stage payments which represented the source of the VAT due. The Respondents relied on a letter dated 16 May 2007 from Mr Brown, the company manager for the Appellant where he stated that the value of the stage payments was £47,964 to undermine the Appellant’s case. In the Respondents’ opinion the Appellant was citing insufficiency of funds as its reason for the default which could not in law amount to a reasonable excuse.
12.	Customs and Excise Commissioners v J B Steptoe [1992] STC 757 is the leading authority on reasonable excuse in the context of insufficiency of funds. Steptoe  established that insufficiency of funds could never of itself constitute a reasonable excuse, but the cause of that insufficiency, the underlying cause of the taxpayer’s default, might do so. Nolan LJ, however, considered at page 773 that such circumstances would be rare:
“ …the cases in which a trader with insufficient funds to the pay the tax can successfully  invoke the defence of reasonable excuse must be rare. That is because the scheme of collection which I have outlined involves at the outset the trader receiving (or at least being entitled to receive) from his customers the amount of tax which he must subsequently pay over to the commissioners. There is nothing in law to prevent him from mixing his money with the rest of the funds of his business and using it for normal business expenses (including the payment of input tax), and  no doubt he has every commercial incentive to do so. The tax which he has collected represents in substance, an interest free loan from the commissioners. But by using it in his business he puts it at risk. If by doing so he loses it, and so cannot hand it over to the commissioners when the date of payment arrives, he would normally be hard to put to it to invoke section 19(6)(b). In other words he will be hard put to it to persuade the commissioners or the tribunal that he had a reasonable excuse for venturing and thus losing money destined for the Exchequer of which he was the temporary custodian”.
13.	Lord Donaldson of Lymington MR at page 775 went onto explore when underlying causes of insufficiency of funds which led to a default were to be regarded as a reasonable excuse or not. He said:
“ …. if the exercise of reasonable foresight and of 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 on which such foresight, diligence and regard would have overcome the insufficiency of funds”.
14.	Thus in order for the Appellant to satisfy me that it had a reasonable excuse for not paying its VAT on time, the Appellant would have to establish the underlying cause of the insufficiency of funds. Further, it would have to show that the consequences that flow from the underlying cause were significant for its cashflow  and  could not by avoided by the exercise of reasonable foresight and due diligence on its  part, whilst having at the same time proper regard for the fact that the VAT would be due on a particular date.
15.	After questioning Mr Brown upon oath in some depth I was satisfied that the value of the Appellant’s supplies to its client who defaulted on the stage payments formed 90 per cent of its total supplies during the quarter ending on 28 February 2007. I preferred Mr Brown’s evidence upon oath to the statement of value of £47,964 in his letter dated 16  May 2007, which would have amounted to about 30 per cent of the value of its supplies during the disputed quarter. 
16.	In view of my finding that the client’s default constituted 90 per cent of the value of the Appellant’s supplies during the relevant quarter, I am satisfied that the client’s failure to make the stage payments had a significant negative impact on the Appellant’ cashflow and was the cause of the Appellant’s default with its VAT payment for the 28 February 2007 quarter.  
17.	The Appellant ensured that the agreement regarding stage payments was fully understood by its client and documented before entering into the contract to carry out the refurbishment. In those circumstances I find that the Appellant could not have reasonably anticipated that the client would renege on the agreement. 
18.	Once the Appellant became aware that the client would not make the stage payments, it negotiated an extension of its facility with its bank and decided to complete the job which reduced the risk of a protracted dispute with the client about meeting the full contract price. The enhanced overdraft facility was insufficient to pay the VAT due for the quarter ending 28 February 2007. The Appellant could not obtain a further extension as it had already given its property as collateral for the December 2006 extension.  The step of completing the job improved the Appellant’s chances of recovering the money lost and meeting its VAT liability on the supply, albeit late. Although the Appellant should have warned the Respondents earlier about its cash flow difficulties, it did pay the VAT due as soon as it received the funds from the contract. In all the circumstances I am satisfied that the steps taken by the Appellant were those of a prudent business person conscious of its responsibilities to pay the VAT by the due date.
Decision
19.	 I find that 
(1)	The unpaid stage payments constituted 90 per cent of the value of the Appellant’s supplies during the relevant quarter and were the cause of the Appellant’s default with its VAT payment for the 28 February 2007 quarter.
(2)	 The Appellant could not have reasonably anticipated that the client would renege on her agreement to make stage payments.
(3)	 The steps taken by the Appellant were those of a prudent business person conscious of its responsibilities to pay the VAT by the due date. 
20.	I hold that the Appellant has a reasonable excuse for its default with the VAT payment for the quarter ending 28 February 2007. I, therefore, allow the Appeal and make no order for costs.

                                 MICHAEL TILDESLEY OBE
CHAIRMAN
RELEASE DATE: 12 September 2007
MAN/07/0716