20539

DEFAULT SURCHARGE – insufficiency of funds – whether reasonable excuse – no – Appellant asked for extra time to pay tax “without a surcharge penalty” and Customs granted the extra time  - whether  wording of Customs’ letter constituted a reasonable excuse for late payment – yes – appeal allowed  - VATA 1994 Ss59(7)(b) and 71(1)(a) 

LONDON TRIBUNAL CENTRE

ALLEGRA STATEGIES LIMITED 
Appellant

 - and -   	

THE COMMISSIONERS FOR HER MAJESTY’S 
REVENUE AND CUSTOMS 
Respondents

Tribunal: DR A N BRICE
 MRS R A WATTS DAVIES MHCIMA FCIPD 

Sitting in London on 28 November 2007

Mr Jeffrey Young, the Managing Director of the Appellant, for the Appellant 

Mr Jonathan Holl, Advocate in the Office of the Solicitor of HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2008

DECISION

The appeal
1.	Allegra Strategies Limited (the Appellant) appeals against a default surcharge penalty of £1,151.67 The penalty was imposed by the Commissioners for Her Majesty’s Revenue and Customs (Customs) because the tax due for the accounting period ending on 30 September 2006 was not received by the due date which was 31 October 2006. 

The legislation
2.	Section 59 of the Value Added Tax Act 1994 provides that where a value added tax return, or the tax due, is not received by Customs in time the taxable person is in default. A surcharge is imposed for the second and subsequent defaults. However, section 59(7)(b) provides that a taxable person is not liable to a surcharge if he satisfies the Tribunal that there is a reasonable excuse for the delay. Section 71(1)(a) provides that an insufficiency of funds to pay any tax due is not a reasonable excuse.  

The evidence
3.	A bundle of documents was produced by Customs. We heard oral evidence from Mr Jeffrey Young, the Managing Director of the Appellant, who also represented the Appellant at the hearing. We found Mr Young to be a reliable witness and accept his evidence. 

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

The Appellant and its business
5.	The Appellant was established in 1998 and is a research consultancy. It publishes reports on various market sectors. It has a number of major retail clients. In 2005 it suffered a bad debt of £40,000 owed to it by a large retailer. At about the same time the re-structuring of another large retailer meant that the Appellant’s turnover was reduced. It was difficult to keep the Appellant going and Mr Young put his own money into the business. 

The return and tax due on 31 January 2006 
6.	In the accounting period ending on 31 December 2005 tax of £14,395 was due on 31 January 2006. It was not received by Customs until 9 February 2006. A surcharge liability notice was issued on 17 February 2006 and stated on the reverse:

“An agreement with your local debt management unit to defer payment does not prevent you being surcharged for defaulting.”  

7.	No pnalty was imposed as that was the first default. On 6 February 2006 the Appellant entered into a time to pay agreement with Customs under which it agreed to pay other outstanding tax of £9,729 by twenty-four monthly instalments.    

The return and tax due on 30 April 2006 
8	In the accounting period ending on 30 March 2006 the tax and return were  due on 30 April 2006. The return was received by Customs on 2 May and the tax was received by Customs on 12 May 2006. A surcharge of £642.79 was imposed at the rate of 2% of the tax paid late. 

9	On 4 May 2006 Mr Young wrote to Customs asking to pay another  outstanding liability of £15,455.64 by twelve monthly payments. The letter referred to the bad debt of £40,000 and the fact that in both 2004 and 2005 the Appellant’s accounts showed losses of £19,250 and £48,400 respectively. Also, turnover had declined from £837,000 in 2004 to £652,900 in 2005. The letter went on to say that the Appellant had recently had cash flow difficulties and had had to effect emergency loan arrangements. Customs did not accept the proposal for a twelve-month arrangement but said that they would consider an arrangement over six months subject to appropriate financial documents being provided. The documents were provided by the Appellant on 22 May 2006 and the Appellant accepted the six-month arrangement. 

10 	On 25 May 2006 Customs formally accepted the arrangement under which the outstanding tax would be paid in six monthly instalments. The letter stated that acceptance of that arrangement did not prevent or cancel the recording of defaults, liability to surcharge and interest where applicable. 

11.	On 21 September 2006 the Appellant wrote again to Customs about the delay in payment of the monthly instalment which was due. The letter recorded that Customs had agreed that the August payment could be made in September but asked for another month. The reasons given for the financial difficulties were exactly the same as those in the letter of 4 May 2006.  

The return and tax due on 31 October 2006  
12.	In the accounting period ending on 30 September 2006 the tax was due on 31 October 2006. On 19 October the Appellant wrote to Customs to ask for thirty  additional days to pay the tax. The letter stated that the Appellant had been informed on previous occasions that it could have avoided penalty surcharges by contacting Customs in advance and hoped that that would be the case in that instance. The letter went on to say that the Appellant had cash flow difficulties as a result of the late payment of invoices by some large clients. Nearly £200,000 worth of invoices were outstanding of which £60,632.50 related to the quarter ending in September 2006. The letter went on to say:

“We will obviously submit our Q3 VAT return on time. Would you therefore be kind enough to allow us 30 additional [days] grace to pay the outstanding amount without a surcharge penalty?”

13.	The return was received by Customs on 20 October 2006. It showed that during that accounting period the Appellant had turnover of £166,464 and tax of £23,033.54 was due. On 26 October 2006 Customs replied to the Appellant’s letter of 19 October and said:

“In response to your letter dated 19/10/06 please be advised that after careful consideration I am granting you extra time to pay the above debt within the next 30 days.

You must be willing to adhere to the arrangement plan and I must remind you that if you default on this arrangement this case will be transferred to our legal team with no further warning. 

Default surcharge is a civil penalty to encourage businesses to submit and make payments in time. This will be added onto your account automatically if you have been late with payment or submitting your return previously. “

14.	A surcharge was notified to the Appellant on 17 November 2006. The tax was received by Customs on 24 November 2006. 

The arguments
15.	For the Appellant Mr Young argued that he had understood Customs’ letter of 26 October 2006 to mean that if he defaulted on the arrangement to pay the tax within the thirty days allowed there would be a surcharge but he had not defaulted. He also argued that the Appellant did not have the funds to pay the tax because of late payment by its customers. For Customs Mr Holl referred to section 71(1)(a) of the 1994 Act and argued that an insufficiency of funds to pay the tax was not a reasonable excuse. He cited Commissioners of Customs and Excise v Steptoe [1992] STC 757 and argued that the facts of this appeal were not the same as the facts in Steptoe. Turning to the latter of 26 October 2006 Mr Holl accepted that there was a lack of clarity but argued that the letter did not extend the due date and drew attention to the wording on the reverse of the surcharge liability notice and to the statement in the letter of 25 May 2006. 

Reasons for decision
16.	We first consider whether the insufficiency of funds to pay the tax was a reasonable excuse and then consider the effect of Customs’ letter of 26 October 2006.

The insufficiency of funds 
17.	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  Steptoe. Those decisions established four main principles. 

18.	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 s33(2)(a) [now section 71(1)(a)] makes in plain that an insufficiency of funds cannot be so regarded. Insolvency is not enough."

19.	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 the insufficiency of funds.

20.	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 at 770d 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."

21.	Finally, the cases in which a trader with insufficient funds to pay the tax can successfully invoke the defence of reasonable excuse are rare because traders receive from their customers the amount of tax which must be paid to Customs and Excise . If they use that money in their business and lose it, and so cannot hand it over when the date for payment arrives, they will normally be hard put to it to persuade the tribunal  that there is a reasonable excuse for late payment.

22.	Applying those principles to the facts of this appeal we recall that the Appellant said, in its letter of 19 October 2006, that nearly £200,000 worth of invoices were outstanding of which £60,632.50 related to the quarter ending in September 2006. The annual turnover of the Appellant was in the region of £650,000  The turnover in the relevant accounting period was £166,464. If £60,000 of that were outstanding then over £100,000 was received. The tax due was £23,033.54. In Steptoe 95% of the work done by the taxpayer was done for one customer who paid eight weeks late and  Nolan LJ at 769e thought that a finding of a reasonable excuse was “on the borderline of sustainability as a matter of law”. In this appeal most of the tax due had been received by the Appellant before the due date. Also the Appellant’s cash flow problems were not recent. The bad debt had occurred in 2005 (and we understand that bad debt relief had been claimed) and the other cash flow problems also occurred from 2005 onwards. It seems to us therefore that the insufficiency of funds in the accounting period ending on 30 September 2006 was not in the nature of an unforeseeable or inescapable misfortune and that the exercise of reasonable foresight and due diligence should have overcome the insufficiency of funds. 

23.	We conclude that the insufficiency of funds due to late payment by customers was not a reasonable excuse.    

Customs’ letter of 26 October 2006
24.	We turn to consider Customs’ letter of 26 October 2006 which was written in response to the Appellant’s letter of 19 October 2006. The latter specifically asked for  “30 additional [days] grace to pay the outstanding amount without a surcharge penalty” [We have added the emphasis.] Customs’ letter of 26 October 2006 is ambiguous and could be read in the way in which it was read by Mr Young to mean that if the Appellant defaulted on the arrangement to pay in thirty days a surcharge would be imposed.  We are of the view that any general statements in the surcharge liability notice of 17 February 2006, or in the time to pay agreement of 25 May 2006, are not relevant in deciding the meaning of the letter of 26 October 2006 which was dealing with a specific and not a general request. 

25.	We do not have to decide what the letter of 26 October 2006 actually meant but we do have to decide whether the contents of the letter mean that Appellant had a reasonable excuse for the delay in making the payment due on 31 October 2006. We accept that Mr Young genuinely thought that he had an extra thirty days during which no penalty would be imposed and arranged to pay the tax accordingly. That means that the Appellant had a reasonable excuse for paying the tax after the due date.    

26.	We conclude that Customs’ letter of 26 October 2006 does constitute a reasonable excuse for the late payment.

Decision     
27.	Our decision is that the Appellant did have a reasonable excuse paying the tax due on 31 October 2007 in November 2007. 

28.	That means that the appeal is allowed. 

DR NUALA BRICE

CHAIRMAN

RELEASE DATE: 21 January 2008

LON/2007/1357
15/01/08