18868
DEFAULT SURCHARGES – two surcharges -  insufficiency of funds – sudden loss of one employee and a number of clients - whether a reasonable excuse – no – appeal dismissed – VATA 1994 Ss59(7)(b) and 71(1)(a)

LONDON TRIBUNAL CENTRE

	JUKKA & CO	Appellant

	- and -

	THE COMMISSIONERS OF CUSTOMS AND EXCISE	Respondents

			Tribunal:	DR A N BRICE (Chairman)
					MRS S EDMONDSON FCA

Sitting in public in London on 22 September 2004

Mr A W Culverhouse, of Messrs Culverhouse & Company, Accountants for the Appellant

Mr Philip Webb, Advocate instructed by the Solicitor for the Customs and Excise, for the Respondents

© CROWN COPYRIGHT 2004

DECISION

The appeal

1.	Jukka & Co (the Appellant) is a partnership of Mr J Etheridge and Mrs L Smith who are registered for value added tax in the name of the partnership. The Appellant appeals against two default surcharges, one of £1,119.83 for the accounting period ending on 30 April 2003 and the other of £1,417.22 for the accounting period ending on 31 July 2003. 

The legislation 

2.	Section 59 of the Value Added Tax Act 1994 (the 1994 Act) provides that where a value added tax return, or the tax due, is received late, the taxable person is in default. A surcharge is imposed for the second and subsequent defaults each surcharge being an increasing percentage of the tax paid late. However, section 59(7)(b) provides that a taxable person is not liable for a surcharge if he satisfies the Tribunal that there is a reasonable excuse for the return or tax being sent late. On the other hand section 71(1)(a) of the 1994 Act provides that an insufficiency of funds to pay any tax due is not a reasonable excuse. 

The issue 

3.	Thus the issue we had to determine was whether the Appellant had a reasonable excuse for each of the two defaults the subject of the appeal.

The evidence

4.	A bundle of documents was produced by Customs and Excise. Oral evidence was given on behalf of the Appellant by Mrs Smith and by Mr Culverhouse who also represented the Appellant at the hearing. 

The facts 

5.	From the evidence before us we find the following facts.

The Appellant and its business

6.	The Appellant operates a hair and beauty salon in Horsham, West Sussex. The business commenced in 1998. The salon has both male and female clients. The business employs six hair stylists and two beauty therapists.

7.	The Appellant accounts for value added tax on a cash basis. This means that the tax is included in the price paid by each client and the tax received is accounted for to Customs and Excise at the end of each accounting period. Input tax is claimed as goods are supplied. There are no account customers. 

8.	The Appellant was in default in the accounting periods ending on 31 July 2002, 31 October 2002, 31 January 2003, 30 April 2003, 31 July 2003, 31 October 2003 and 31 January 2004. The returns for those periods indicate the following:

Period ending 		Due date  		Date received	Amount of tax due 	Turnover

31 July 2002		31 August 2002		11 October 2002	£9,427.26	£64,660
31 October 2002		30 November 2002		14 January 2003	£9,024.33	£60,257
31 January 2003		28 February 2004		9 April 2003	£8,856.83	£59,334
30 April 2003		31 May 2003		5 August 2003	£7,465.56	£56,079
31 July 2003		31 August 2003		10 November 2003	£9,451.50	£65,905	
31 October 2003		30 November 2003		20 April 2004	£7,616.36	£58,024
31 January 2004		28 February 2004		4 June 2004	£9,029.08	£64,953

The events before the defaults the subject of the appeal

9.	In September 2001 an employee, Miss A, left the employment of the Appellant taking with her a number of the clients of the beauty therapist. Six of those clients were also clients of the hairdressing salon. Between September 2001 and September 2002 the Appellant employed two beauty therapists who each stayed for just six months. This time was not sufficient for either of them to build up a full client base. In September 2002 the Appellant employed a new beauty therapist, Miss B. She was also the salon manager.  

10.	In February 2003 Miss B left the employment of the Appellant taking with her all of the business’s beauty clients of which forty-eight were also clients of the hair dressing salon. The departure of Miss B was sudden. She gave notice at the last minute just before Mr Etheridge and Mrs Smith went on holiday, saying that she was in bad health and intended to spend six months recuperating in New Zealand. However, she did not go abroad and instead she set up a business with Miss A in premises which were about one mile away from the Appellant’s premises. The Appellant considered whether to take proceedings for breach of contract but in the end decided not to do so.

11.	Following the departure of Miss B the Appellant had to spend money advertising for new staff and new clients. The existing staff worked extra hours and the partners worked as hard as they could to maintain turnover.  In February 2003 the Appellant employed another full time beauty therapist and in March 2003 the Appellant employed a part-time beauty therapist. 

The Appellant’s financial position 

12.	In the accounting period ending on 30 April 2003 the Appellant banked £63,910.89 (of which £7,465.56 was the amount of value added tax due) and in the accounting period ending on 31 July 2003 the Appellant banked £74,827.89 (of which £9,451.50 was the amount of value added tax due). On 31 May 2003 (the due date for the accounting period ending on 30 April 2003) the Appellant’s bank account was overdrawn by £2,438.27 and on 31 August 2003 (the due date for the accounting period ending on 31 July 2003) the Appellant’s bank account was overdrawn by £2,497.42. On both dates the Appellant had an overdraft limit of £13,000. Thus, although the bank account was overdrawn on both due dates, the Appellant could have paid the tax in time by using its agreed overdraft. In August 2003 the partners of the Appellant took out an additional loan of £20,000 secured on their house. In 2004 the partners of the Appellant took out an additional loan of £20,000 secured on their house.

The arguments  

13.	For the Appellant Mr Culverhouse argued that the loss of Miss B was a catastrophe for the business which could not have been foreseen. The Appellant was faced with the extra expense of advertising for staff and clients and also experienced a drop in takings. It was left with the choice of either paying the wages of the remaining staff or paying the value added tax  The partners took very modest drawings from the business (£250 and £275 each week respectively). They had injected £40,000 into the business by way of re-mortgaging their home. The last return was on time and the tax was paid in full. The problem was now in the past. Mrs Smith accepted that the amount of tax due had been received but argued that the business did not have enough money to pay the tax as well as all the other expenses.

14.	For Customs and Excise Mr Webb argued that the Appellant had received the tax which it had to pay to Customs and Excise and then had used it in the business. He accepted that there had been a drop in turnover after the departure of Miss B and there had been additional advertising costs but all these were normal hazards of the trade and should not have affected the ability of the Appellant to pay the tax on time. He argued that the facts of this appeal could be distinguished from the facts in Commissioners of Customs and Excise v Steptoe [1992] STC 757as here there was no question of customers paying late.  

Reasons for decision  

15.	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. 

16.	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 s 33(2)(a) [now section 71(1)(a)] makes it plain that an insufficiency of funds cannot be so regarded. Insolvency is not enough."

17.	Secondly, it is necessary to distinguish the reason for late payment and the underlying cause or excuse 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 that the direct cause is the insufficiency of funds.

18.	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 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."

19.	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.

20.	Applying those principles to the facts of the present appeal we are not persuaded that the Appellant did not have sufficient funds to pay the tax; it could have paid the tax if it had used the overdraft facilities which were available to it. Secondly, we do not consider that the Appellant was deprived of the means to pay the tax by an adequate reason. 

22.	We accept that the decision of Miss B in February 2003 to cease her employment with the Appellant did cause a drop in turnover, from £59,334 in the accounting period ending on 31 January 2003 to £56,079 in the accounting period ending on 30 April 2003. However, we do not regard that as an unforeseeable or inescapable misfortune leading to an insufficiency of funds to pay the tax because the drop in turnover was not large, being 5.48%, and, in any event, in the following accounting period, which is also the subject of the appeal, turnover improved to £65,905, the highest level in the table set out in paragraph 8 above. Also, in April 2003 the drop in turnover would have been matched by a corresponding drop in the amount of tax due.

23.	Finally, of course, in this appeal the Appellant was paid the tax by its clients before it had to account for it to Customs and Excise. It was, therefore, hard put to it to persuade any Tribunal that it had a reasonable excuse for late payment and we are not persuaded.

Decision

24.	Our decision is that the Appellant did not have a reasonable excuse for each of the two defaults the subject of the appeal.

25.	That means that the appeal is dismissed.

DR A N BRICE

CHAIRMAN
RELEASE DATE: 6 December 2004

LON/2004/0972
29.11.04