VAT – Retail Schemes – Direct Calculation Scheme 1  Assessments – whether made to best judgment – s.73(1) VAT Act 1994

LONDON TRIBUNAL CENTRE

	AMJID RAFIQ and ASIF RAFIQ	Appellant
t/a Moniques

	- and -

	THE COMMISSIONERS OF CUSTOMS AND EXCISE	Respondents

				Tribunal:	Peter H Lawson (Chairman)
					 	Miss Angela West FCA

Sitting in public in Cardiff on 21 August 2003

Nigel Gibbon, Solicitor, for the Appellant

D J Bettoney, Senior Officer, for the Respondents

© CROWN COPYRIGHT 2003

DECISION

1.	This is an appeal by Mr Amjid Rafiq and Mr Asif Rafiq, trading in partnership as “Moniques” at 21 Oxford Street, Swansea SA1 3AQ, against two assessments of VAT, the first in the sum of £845 for the period 1 August 1998 to 30 April 2001, and the second in the sum of £11,511 for the period 1 November 1999 to 30 April 2002.  The Appellants were registered for VAT with effect from 1 May 1997.
2.	Mr Asif Rafiq, who lives at 81 Dolphin Street, Newport, Gwent, told us that he runs the shop and his brother is a silent partner and very rarely helps in the shop.  They have been in business four or five years, the shop having previously been run by their father.  Mr Asif Rafiq provided us with photographs of the interior and exterior of the shop.
3.	Mr Rafiq said that he purchases his stock from wholesalers in Stevenson Square in Manchester.  There were racks full of samples and he purchases some items there.
4.	Ladies’ and children’s warehouses are different.  There are over 30 ladies’ fashion shops in Swansea.  There is one similar shop opposite his and another next door to the left of his shop, and another to the right.  There is a shop called Peacocks opposite his shop.  The other shops are very similar to his.  There is a shop called “New Looks” which offers “Buy 1, Get 1 Free”, i.e. half price stock.  Mr Rafiq said he could not afford to do this himself; people tend to gravitate to well-known shops such as multiples who purchase direct from manufacturers, rather than wholesalers, so that they can pick up the quantity they want at the prices they want.
5.	Asked what he does to compete he said that he needed to match, or beat, the prices offered by competitors.
6.	Children’s clothes are different and there is little competition.  The items offered are “a lot more basic”, e.g. tracksuits, and there is not so much risk with these.
7.	As to adult clothes, he buys 6-8 garments one week and changes the style the next week.  Styles can change five times in the summer or autumn periods.  Fashion changes very quickly.  Swansea can be two weeks behind Cardiff.
8.	Supposing he buys a garment for £5, including VAT, he tries to sell it for £10.  He relies on his experience as to what the market will bear.  He send staff round to other shops to check prices.  If items do not sell, he keeps them for two or three weeks and then halves the price – that way, at least he gets the cost back.  He charges full pounds and does not include pence at all.  He has no space to keep unsold stock.  Out of 10 styles, perhaps 2 might sell at 100% mark-up.  He has “sales” almost every month for adult clothing and about half the stock would be in the sale.  Children’s clothes are not reduced in the same way.  The adult stock goes down more often and more quickly than children’s.
9.	In reply to questions by Mr Bettoney, Mr Rafiq said he understood zero rating and standard rating for VAT purposes.  The supplier tells him which is which.  He tells his accountant how much he has marked up the stock he sells.  He sends all his figures to his accountant.
10.	His staff are aged 16 or 17 and may be in their first jobs.  He has to train them and they make a lot of mistakes.  It is time consuming to write out bills and retail customers do not like to wait.  He has not kept till rolls but he has kept a written record of sales.  There was no record which showed the Daily Gross Takings (“DGT”).
11.	In reply to further questions from Mr Bettoney, Mr Rafiq said that about one half of the goods in the shop would be in a sale at any one time.  Not all the goods would be offered at half-price; some might be at a 75% mark-up, some less, some at less than cost.  In reply to Mr Bettoney, Mr Rafiq agreed that he could have worked out the mark-up on standard rated goods.  This would be 37.5%.  Some zero rated items sell at 100% mark-up.  Roughly 20% - 30% of the sales were zero rated.
12.	Asked what records he gives to his accountant, Mr Rafiq said that he records his sales in writing each day in a book, and compares the book with his till.  He sends his sales information, his purchase invoices, his wages records and his receipts for outgoings such as petrol, to his accountant.
13.	The officer who visited the Appellants on 14 June 2001 and 9 October 2001 was Mr Malcolm King, a senior officer based at Swansea, who has 31 years experience with the Commissioners.  Before we relate his evidence we will refer to the Direct Calculation Scheme 1 which is described in Notice 77/5 and published in a booklet of which the latest issue is that dated March 2002.
14.	As retailers, the Appellants do not issue invoices for each sale as and when made.  They sell garments that are designed for young children and not suitable for older people, and which are, therefore, considered to be zero rated under Schedule 8 Group 16 Item 1, in addition to other garments which are standard rated.
15.	The basis for the Direct Calculation method, which is used to establish the amount of output tax due, is that the Appellants should calculate the total expected selling price (“ESP”) of the goods for each VAT quarter which forms the minor part of their sales (in this case the zero rated goods) and subtract this total from their total sales to give the amount of sales subject to the standard rate of VAT.
16.	In this case, Mr King compared the buying and selling process of a selection of zero rated garments with the help of Mr Asif Rafiq and found that the mark-ups on sales lay in the range 71.4% to 113.3%, and that the range on standard rated goods was similar.
17.	Mr King made further checks on the mark-ups that had been used in the Scheme for each of the VAT periods as follows:
10/98 and 01/99 – 75%
04/99 and 07/99 – 80%
10/99 – 200%
01/00 – 80%
04/00 – 80%
07/00 – 90%
10/00 – 70%
01/01 – 70%
04/01 – 70%
18.	In none of these cases was there any indication as to where these percentages had been obtained.
19.	Using the figures for the first four periods listed above, Mr King established that the resulting calculated mark-up for the year on standard rated goods was 35.77% and the overall mark-up was 45.8%.  For the next four periods he arrived at mark-ups of 22.19% for standard rated goods and an overall mark-up of 33.88%.  For the three periods up to 04/01 Mr King calculated the mark-ups on standard rated goods was 29.41% and the overall mark-up was 35.7%.
20.	Mr King made a further visit on 9 October 2001, when he carried out a further weighted mark-up exercise with the assistance of Mr Asif Rafiq and the zero rated goods which resulted in an overall mark-up of 75.3%.  He applied this overall figure to the previous figures and calculated that this would leave the following amounts for standard rate:  
year to 31 July 1999 – 36.4%
year to 31 July 2000 – 23.8%
1 August 2000 – 30 April 2001 – 28.5%
21.	Mr King noted that, because the Appellants had not kept the required record of supplies as and when they were made, for example by means of a till roll, he considered that the takings used for the retail scheme were incorrect because they were understated.  He considered that this invalidated the retail scheme used and took steps to assess the amounts of tax correctly due by means of a mark-up exercise on the standard rated goods.  Because Mr King considered that the amounts of output tax were underdeclared by virtue of the incorrect use of the retail scheme, the Commissioners made the assessments for VAT which have been set out above.
22.	In their Notice of Appeal dated 18 December 2001, the Appellants claimed that the Commissioners had not used best judgment and by amended grounds of appeal dated 15 April 2002, that the assessment was not made to best judgment and was void because the Commissioners had used an unlawful basis to calculate the assessment; the Notice of Appeal accepted that the Appellant used an unlawful retail scheme but submitted that the Commissioners cannot build an assessment on the same basis.  Alternatively, it was claimed that if the Tribunal found that the Commissioners used best judgment, then the assessments were excessive.  On another basis, a small amount of VAT might be shown to be due but that was always the situation where a retail scheme had been used.  If it was found that the assessment was based on an unlawful retail scheme and another basis should have been used, then the Appellants would argue that the appeal should be allowed and the Commissioners needed to start again.
23.	In their Statement of Case the Commissioners did not claim that the Appellants had used an “unlawful” retail scheme but that they had not complied with the requirements for the use of such schemes, in particular as to the percentages to be used and the requirements to maintain a record of supplies as and when they were made.  The Commissioners accepted that, where a retail scheme is correctly used, the amount of VAT calculated by such a scheme may not equal that which would be due were an accurate record made of every sale but that, in that case, no further tax would be due.
24.	In his interview with Mr Rafiq on 14 June 2001, Mr Rafiq told Mr King that he tried to keep a garment or style for a month; after a month he would reduce the price by 35%; if it was not selling he would reduce the price by 50%, and if it was still not selling he would reduce it to £2.99.  (This appears to be an exception to what Mr Rafiq said about “whole pounds” in para 8 above).  Mr Rafiq said that the mark-up policy was the same for standard rated and zero rated clothing.
25.	Mr King reported that a 40%-50% margin equates to a mark-up of 81.81%; a 40% margin equates to 66.66% and so on.  Overall, the mark-ups varied from 66.66% to 113.33%.
26.	With adult clothing the mark-up varied between 66% and 130%.  A mark-up of 64.69% was equivalent to 49% after taking out the VAT.  The assessment made by Mr King was based on a 75.29% mark-up which was equal to 49% on standard rated clothing.
27.	Mr Gibbon asked Mr King whether the percentages he was quoting were for items selling at the full price.  This figure represented an 84.64% mark-up and this came down to 75.3% after allowing for VAT.  
28.	Mr Gibbon asked Mr King whether the samples used showed that the Appellant was not achieving 100% mark-up and Mr King confirmed that in the six items which he sampled, none of the mark-ups reached 100%.  The mark-up appeared to be 85% on zero rated items and 64% on standard rated items.  Because the standard rated items included a mark-up which included VAT, the achieved mark-up was less for standard rated items.  This was taken into account in the assessment.
29.	In practice, Mr Rafiq does not achieve his 100% target.
30.	Mr Gibbon suggested to Mr King that as the zero rated sales produced different mark-up results, he should have done a standard rated mark-up exercise separately.
31.	Was Mr Rafiq, Mr Gibbon asked Mr King, talking about overall mark-up or including reductions?  Mr King said he did not ask about the prices after clothes went on the “rails”; he assumed that Mr Rafiq would know what “mark-up policy” meant.  He wrote to Mr Rafiq asking for an explanation but received no reply.
32.	Mr Gibbon suggested that clothing goods for young people and adults are basically the same lines, and the difference is in the sizes.  Between 25%-30% of the sales is young persons’ clothing.  Mr King disagreed that there cannot be young persons’ clothing throughout the same as adults.  Mr King replied that there was no way of knowing what is discounted and there is no reason to believe that the discounted items would be greater in number.  The policy was the same for both.
33.	Mr Gibbon asked why the sampling was throwing out different results but Mr King said that this was brought into the calculation at the time.  He confirmed that he had no reason to doubt that Mr Rafiq’s evidence was true.  There was nothing said at the time of the visit to show that the discounting was greater in the children’s wear.  Taking six items of standard rated adult clothing, he arrived at an average mark-up of 64.69%.
34.	In respect of “the first assessment” the Appellant did not contest the element relating to scale charges.
35.	Mr Gibbon submitted that the Commissioners had no grounds upon which to raise any assessment in respect of an alleged failure to operate the direct calculation retail scheme properly because the mark-up utilised by the Commissioners for the minority goods (i.e. zero rated goods) at 75.29% was within the range of mark-ups (predominantly 70%-80%) which were utilised by the Appellant over the period in question and the Commissioners therefore had no grounds to consider in respect of this issue that the Appellant’s returns were incomplete or incorrect as required by section 73(1) VAT Act 1994.
36.	In respect of “the second assessments” the Appellant’s case was that the Commissioners had not used best judgment in raising the assessments under appeal for the following reasons:
37.	In calculating the amount of output tax alleged to have been underdeclared the Commissioners had utilised a full weighted mark-up on zero rated purchases (i.e. 75.29%) and had applied the results thereof to standard rated purchases, resulting in an apparent underdeclaration of output tax;
38.	The Commissioners had not produced, nor were they able to produce, cogent evidence to demonstrate to the Tribunal that it is fair, reasonable or appropriate to apply the results of the mark-up exercise on zero rated purchases to standard rated purchases; further, the Commissioners had failed to take into account that it is statistically and mathematically incorrect to apply the results of a survey of one population to another population.
39.	Further, the available evidence suggested that it was wholly inappropriate for the results of the exercise on zero rated purchases to be applied to standard rated purchases for the following reasons:
(a)	On 14 June 2001 the assessing officer examined a sample of 6 zero rated lines and discovered that the achieved mark-ups lay in the range of 71.4% to 113.3%;
(b)	On the same day the officer examined a sample of 6 standard rated lines and discovered that the achieved mark-ups lay in the range of 46.91% to 71.62%;
(c)	The fully weighted mark-up exercise on zero rated goods indicated that  zero rated mark-ups lay in the range – 15.15% to +150%, with a weighted average of 75.29%.
(d)	From the results obtained at (a) – (c) above, Mr Gibbon submitted that there is no reason to suppose that there is sufficient correlation between the mark-ups achieved on zero rated goods with those achieved on standard rated goods that it can be assumed, as the Commissioners had assumed, that the results of the mark-up on zero rated goods can legitimately be applied to standard rated goods.
40.	Given the difference in the range of mark-ups as between zero and standard rated goods, the officer should, Mr Gibbon submitted, in order to use his best judgment, have undertaken a fully weighted mark-up exercise on standard rated goods which he would have been able to do from the information available to him at the time he elected to undertake such a mark-up on the zero rated goods.  his decision to use the results of the mark-up exercise on zero rated goods was not the use of best judgment because statistically it is not permitted to apply the results of analysis of one population to another separate and distinct population.
41.	In any event, Mr Gibbon submitted, the second assessments were excessive because no allowance had been given for sales and discounts which are more prevalent in respect of adult clothing than children’s clothing.
42.	Mr Bettoney, for the Commissioners, said that the appeal raised a comparatively narrow point, namely was the assessment made to best judgment?  He referred to the Tribunal Decision in Nemonthron Restaurants Limited [Decision No. 18123] and, in particular, paragraph 46 of that Decision which reads as follows:

”Since Curry Inn the judgment in Rahman (trading as Khayam Restaurant) v Customs and Excise Commissioners (No 2) [2003] STC 150 has been given.  From that judgment we derive two further principles, namely that the fact that a different methodology might lead to a different result does not compel the conclusion that the methodology which had been adopted was not to best judgment; and that in the usual case the tribunal should concentrate on the question as to what amount of tax was due because, if that were close to the amount of the assessment, it might be a sterile exercise to consider whether Customs and Excise had exercised best judgment in making the assessment.”
43.	There were two assessments in this case, and the issue in both was the level of zero rating.  The obligation is on the trader to get his returns right.  A stock taker could have done the necessary work.  As matters stood, all that can be said is that the overall mark-up must be between 94.3% and 64.69%, but the assessment uses 49%.  There is no hard evidence, he said, to support the Appellant’s contentions, and he should have kept records of his sales.  He has a sophisticated till but throws away the paper produced by it.  Mr Bettoney submitted that the assessment was made to best judgment.
44.	Mr Gibbon said, as to the first assessment, there was no reason to believe (until now) that the figures were wrong.  The figure of 74.3% was arbitrary.  They were close to the figures used in 2001, he said, in one case.  There was nothing on which to found an assessment.  Section 73 of the VAT Act deals with inaccurate returns.  The officer had no reason to believe that they were inaccurate.
45.	As to the second assessment, this was a jump into best judgment.  Did Mr King have sufficient information?  Mr Gibbon submitted that Mr King should have known that it was not right to use zero rated mark-ups to arrive at standard rated tax levels.  The information before him should have told him that they were not the same after adjustment for VAT.  Therefore, his assessment lacked best judgment.  The key answer relied on by Mr King, when Mr Rafiq was asked what his mark-up policy was, was that it was the same for children and adults.  The difficulty is that adult clothing was much more heavily discounted.  You would have expected to see something in the way of a weighted mark-up exercise to deal with this.  With several hundred garments on display, Mr King had enough pointers to show that whatever Mr Rafiq said was not correct.  He should, in best judgment, have done something else.  In particular, he should not have relied on the zero rated mark-up exercises.  It is not enough to say that 49% is less than 65% after allowing for discounts.
46.	The question was whether the Commissioners had made their assessment to the best of their judgment.  Possibly a fully weighted mark-up exercise would have produced a different answer, we do not know.  The question was, was it reasonable or appropriate to use one set of figures to arrive at an underdeclaration of a different sample or set?  Mr Gibbon said it was not appropriate and they would be left with nothing to base an assessment on.  The case fell into the rare category of the wholly unreasonable.  The assessment should, Mr Gibbon said, be discharged.
47.	We have carefully considered the submissions made by both parties.  Our conclusion is that in principle Mr Gibbon was correct in stating (para 39(d) that, for the reasons given by him, there was no sufficient correlation between the mark-ups achieved on zero rated goods and those achieved on standard rated goods to justify a conclusion that the results of the mark-up exercise on zero rated goods could legitimately be applied to standard rated goods.
48.	In essence, the Appellant carries on two distinct businesses, but the VAT Act, and indeed business practice, do not treat them as distinct.  The Appellants, the Commissioners accepted, are not dishonest, but their problems have arisen from their failure to keep adequate records and to operate the Retail Scheme correctly.

This case is different from the Nemonthron case referred to by Mr Bettoney because the dispute is not so much one of arithmetic as of method (see para 37 above).
49.	The appeal is allowed with costs.  If there is any difficulty in agreeing the amount of the Appellants’ costs they may apply to the Tribunal for directions.

CHAIRMAN

RELEASED:

LON/