[Home] [Databases] [World Law] [Multidatabase Search] [Help] [Feedback]
	United Kingdom VAT & Duties Tribunals Decisions
You are here: BAILII >> Databases >> United Kingdom VAT & Duties Tribunals Decisions >> CMS Peripherals Ltd v Revenue and Customs [2005] UKVAT V19234 (8 August 2005) URL: http://www.bailii.org/uk/cases/UKVAT/2005/V19234.html Cite as: [2005] UKVAT V19234

[New search] [Printable RTF version] [Help]

19234

VALUE ADDED TAX - three default surcharge – finance director of Appellant perpetrated large scale and complex fraud against the Appellant – the effect of the fraud was to reduce the cash flow of the Appellant and to reduce its profits - whether the Appellant had a reasonable excuse for each of the defaults – yes - appeal allowed – VATA 1994 Ss 59A(8)(a)(ii) and 71(1)

LONDON TRIBUNAL CENTRE

CMS PERIPHERALS LIMITED

Appellant

- and -

HM REVENUE AND CUSTOMS

Respondents

Tribunal: DR A N BRICE (Chairman)

MISS S C O'NEILL

Sitting in London on 20 July 2005

Mario Angiolini of Counsel, instructed by Messrs Baker Tilly VAT Consultants, for the Appellant

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

© CROWN COPYRIGHT 2005


 


DECISION

The appeal

1. CMS Peripherals Limited (the Appellant) appeals against three default surcharges. The Appellant is a payment on account trader which means that it has to make monthly payments. At the end of the second and third month of each accounting quarter it has to make a payment on account of tax and one month after the end of the accounting quarter it has to render a return and make a balancing payment.
2. The first default occurred in the accounting period ending on 31 December 2001. A payment on account was due on 30 November 2001 and was paid on 12 December 2001. The surcharge was at the rate of 5% and amounted to £12,247. The second default occurred in the accounting period ending on 31 December 2002. The balancing payment was due on 31 January 2003 and was paid on 4 February 2003. The surcharge was at the rate of 10% and amounted to £163,059. The third default occurred in the accounting period ending on 31 March 2003. A payment on account was due on 28 February 2003 and was paid on 6 March 2003. The surcharge was at the rate of 15% and amounted to £45,320. Thus the amount at issue in the appeal was £220,626.

The legislation

3. Section 28 of the Value Added Tax Act 1994 (the 1994 Act) provides that the Treasury may make an order providing that a taxable person of a description specified in the order shall be under a duty to make payments on account of any tax he may become liable to pay, of amounts and at times determined in the order. Under the provisions of section 28 the Treasury has made the VAT (Payments on Account) Order 1993 SI 1993 No. 2001. That Order provides that a taxable person, who in any year has to pay more than £2M in value added tax, is under a duty to make payments on account. The Appellant is such a taxable person.
4. Section 59A of the 1994 Act provides that where a payment on account has not been received on the due date the taxable person is in default. A surcharge is payable in respect of each default, the amount being a specified percentage of the aggregate value of defaults for each accounting period. The percentage is 2% for the first accounting period of default; 5% for the second; 10% for the third and 15% for subsequent accounting periods. However, section 59A(8)(a)(ii) provides that a taxable person is not liable for a surcharge if he satisfies the Tribunal that he has a reasonable excuse for the payments of tax not being sent in time. Section 71(1) provides:

"71(1) For the purpose of any provision of sections 59 to 70 which refers to a reasonable excuse for any conduct-

(a) an insufficiency of funds to pay any VAT due is not a reasonable excuse; and

(b) where reliance is placed on any other person to perform any task, neither the fact of that reliance, nor any dilatoriness or inaccuracy on the part of the person relied upon, is a reasonable excuse."

The issue

5. Thus the main issue for determination in the appeal was whether the Appellant had a reasonable excuse in each accounting quarter for the payment of tax not being received on time.
6. The Appellant also raised at the hearing an alternative issue which was whether the default surcharge regime, where there was no power to mitigate the amount of the penalty, was disproportionate and so a breach of Community law. This was an unexpected argument and Mr Holl, for the Respondents, was not ready to deal with it. It was therefore agreed that, if the Appellant were unsuccessful on the main issue in the appeal, either party would have liberty to apply to the Tribunal for another hearing to hear arguments on the alternative issue.

The evidence

7. A large bundle of documents was produced by the Appellant and a smaller bundle by the Respondents. The bundle of documents produced by the Appellant contained an affidavit of Mr Frank Salmon, the Managing Director of the Appellant. This affidavit had been made on behalf of the Appellant on 18 September 2003 for the purpose of obtaining a freezing injunction from the High Court. The Respondents accepted that its contents were true. Witness statements containing evidence on behalf of the Appellant and given by Mr Christopher James Lewis Argent, the United Kingdom Financial Controller of the Appellant; Mr Michael Gerard Callaghan, who is now the Managing Director of CMS Peripherals Ireland; and Ms Christine Ann Warner, the Human Resources Officer of the Appellant, were not objected to by the Respondents and were read at the hearing.

The facts

8. From the evidence before us we find the following facts.
9. The Appellant is registered as a company in the United Kingdom but is part of an Irish based group of companies. Mr Frank Salmon is the majority shareholder of the group. The Appellant is in the business of supplying data storage products to businesses. The Appellant buys in products from a wide variety of sources and its business customers, therefore, can obtain all, or most, of their data storage needs from the Appellant. The Appellant's annual turnover averaged about £70M over the relevant period and it had an annual gross profit of just over £5M after cost of sales and before the deduction of staff and other administrative costs. Thus the gross margin after costs of sales (8-9%) is low.

The finance director and her responsibilities

10. On 18 October 1999 the Appellant employed a new finance director. She had overall responsibility for finance, stock control, and warehouse functions. She was solely responsible for all matters relating to tax and value added tax and she was responsible for authorising all payments of value added tax. Her initial salary was £60,000 per annum which, with share options, bonus and commissions, resulted in an overall package of £90,000. The finance director was a member of the board of directors; there were three other directors.
11. At the relevant time the Appellant had two main banks, namely, Barclays Bank plc and Allied Irish Bank plc. At Barclays Bank the Appellant had three main accounts in sterling, euros and US dollars respectively. The account at the Allied Irish Bank was used for foreign exchange transactions and balances were rarely kept on this account. In the course of its business it was necessary for the Appellant to buy substantial amounts of euros and US dollars as many of its suppliers were located in Europe or the United States of America. The finance director was one of the nominated signatories on the bank mandates with both banks. In accordance with the bank mandate with the Allied Irish Bank, the finance director had authority on her own to give instructions to carry out foreign exchange transactions. Also, the finance director had authority, with one other signatory, to give authority to the Allied Irish Bank to effect payments to third parties.
12. During her employment with the Appellant the finance director assumed complete control for financial matters. The unchallenged evidence of Mr Salmon was that she did not like any of her methods to be questioned. The unchallenged evidence of Ms Warner was that the finance director did not always disclose issues and problems in her department to the rest of the board of directors which meant that, at the relevant time, the board were not fully aware of the availability of funds and, because the finance director did not always have financial information to present to the board, meetings were conducted without written reports showing complete figures for each month. The finance department normally had three or four members of staff. Between January 2001 and November 2001 there was no staff turnover in that department but from November 2001 to April 2003 seven members of staff left. Their main reasons for leaving were that they were either unhappy in their role or because they had performance issues. At the date of the hearing there were no members of staff in the finance department who had been there during the events which are the subject of this appeal.

The doubts about the finance director

13. From about 2001 Mr Salmon started to have some doubts about the competency of the finance director and in September 2002 he began to look for her replacement. In February 2003 Mr Callaghan became the Finance Director for the group; the finance director remained the finance director in England but reported to Mr Callaghan. The first suggestion made by the finance director to the board that there was a problem with the value added tax payments was made in an email dated 18 June 2003 sent by the finance director to Mr Salmon and Mr Callaghan referring to the January 2003 return. On 27 June 2003 the finance director was made redundant; thereafter she continued to work for the Appellant for one day each week until 29 August 2003.
14. On 22 August 2003 Mr Callaghan discovered some irregularities in cheque payments. These were put to the finance director who had an explanation which later turned out to be incorrect. On 29 August 2003, in a general conversation, a representative of the Allied Irish Bank plc mentioned in passing the Appellant's foreign exchange business in New Zealand dollars. As the Appellant did no business in New Zealand dollars alarm bells rang. Investigations were carried out by the Appellant and fraudulent transactions were discovered.

The details of the fraudulent transactions

15. The investigations discovered that the fraudulent transactions began in about October 2001. Typically the Allied Irish Bank was asked to purchase a substantial number of US dollars funded from the account of the Appellant and this part of the transaction would be genuine; however, as part of the same transaction, the bank would be asked to purchase a much smaller amount of New Zealand dollars and the beneficiary of that transaction was the father of the finance director. Later the father of the finance director would send her payments of similar amounts. In the Appellant's bank statements only the total payment for the foreign currency transaction was shown; the individual purchases of currencies in each transaction were not identified. The receipt of the US dollars was shown in the Appellant's bank statements but in the nominal ledger the exchange rate shown was lower than that actually achieved by the Allied Irish Bank. The finance director used the difference between the actual cost of the US dollars, and the inflated cost as recorded in the nominal ledger, to fund the purchase of the New Zealand dollars. There was no mention in the Appellant's records of the purchase of the New Zealand dollars. In order to effect these transactions the finance director had to forge signatures and destroy confirmations from the Allied Irish Bank.
16. In addition to the New Zealand dollar frauds, other frauds were also discovered. Some payments out of the Appellant's bank account had been diverted to accounts held by the finance director and/or her husband and some cheques which were purportedly made out to suppliers of the Appellant also found their way into the bank account of the finance director and/or her husband. The finance director also purchased assets for her own benefit using the money of the Appellant.

The action taken by the Appellant

17. On 18 September 2003, when it had begun to establish the scale of the frauds, the Appellant applied to the High Court which granted a freezing injunction against the finance director. Initially the freezing injunction was in respect of assets up to £890,000 but this was extended to £1.18M on 30 October 2003. The finance director did not challenge the injunction and it remains in force.
18. In July 2004 the Appellant obtained summary judgment against the finance director in the amount of £991,853.73 plus interest of £168,923.65 and costs. The difference between the ultimate value of the fraudulent transactions (nearly £1.4M) and the claim was to ensure that the Appellant got a quick summary judgment. The Appellant has taken steps to enforce this judgment; some of the finance director's assets have been transferred to the Appellant and others are due to be transferred. In May 2005 a settlement with the finance director's husband was agreed.

The effect of the frauds

19. The frauds began on 22 February 2001 and ended on 23 June 2003. Altogether the amount lost to the Appellant, which the Appellant identified, was £1,374,161.52. There were also other unconfirmed transactions. The effect of the frauds was to reduce the Appellant's cash position throughout the period of the fraudulent activities. All the fraudulent payments were made without the knowledge of the rest of the board of directors. As a result of the frauds there was less money in the Appellant's bank accounts than there should have been.
20. The frauds also affected the profits of the Appellant. The adjusted profit or loss on ordinary activities before tax was:

Year ending

31 August 2001 (14 months) £1,061,631.

31 August 2002 (£971,896)

31 August 2003 £31,902

31 August 2004 £776,817

21. Of course, not all of the reduction in profit between 2001 and 2002 was due to the perpetration of the frauds; during that year the Appellant saw a downturn in its business which was reflected in a reduction in annual revenue and in the gross margin which meant that the Appellant could not cover its selling, distribution and administrative expenses.

The effect of the frauds on the defaults

22. The first default occurred in the accounting period ending on 31 December 2001. A payment on account was due on 30 November 2001 and was paid on 12 December 2001. The tax due on 30 November 2001 was £249,949. On 29 November 2001 the company had an overdraft of £413,264.64 which was well in excess of its agreed limit of £250,000. On 30 November 2001 a payment of £600,000 was made into the account by the bank in respect of an invoicing discount facility to cover the unauthorised overdraft; payments out were made the same day and at the end of the day the balance was £9,936.38. As at 30 November 2001 the cumulative amount then extracted by the finance director was £603,187.33
23. The second default occurred in the accounting period ending on 31 December 2002. The balancing payment was due on 31 January 2003 and was paid on Tuesday 4 February 2003. The amount of tax due on Friday 31 January 2003 was £1,630,591.29. On that date the bank account opened with a debit of £72,661.46, A number of payments were paid in that day but they were not cleared until 4 February 2003. One such payment was a cheque from the Appellant's largest customer for the amount of £1,492,768.68. The balance shown at the end of 31 January was £1,765,107.22. As at 31 January 2003 the cumulative amount then extracted by the finance director was £1,054,252.31.
24. The third default occurred in the accounting period ending on 31 March 2003. A payment on account was due on 28 February 2003 and was paid on 6 March 2003. The amount of tax due on 28 February 2003 was £302,000. The bank statements show that on that date there was a debit balance of £6,198.73. On that date the cumulative total of money extracted by the finance director amounted to £1,157,439.77. After the third default there have been no further defaults by the Appellant.
25. On 25 August 2003 Messrs Baker Tilly, on behalf of the Appellant, asked for a re-consideration of the surcharges for the second and third defaults claiming that they were due to the high turnover of staff in the finance department; the losses recently made by the company and the late payment by the Appellant's largest customer.

The arguments

26. For the Appellant Mr Angiolini argued that there was a reasonable excuse for all three defaults. He accepted that an insufficiency to pay the tax due was not a reasonable excuse but cited Customs and Excise Commissioners v Salevon Limited [1989] STC 907 for the principle that the wrongful act of an employee could be a reasonable excuse. The frauds had not been detected by the auditors. As far as the second default was concerned Mr Angiolini also relied upon Customs and Excise Commissioners v Steptoe [1992] STC 757 for the principle that a very late payment by the Appellant's largest customer, at the same time as the frauds were being perpetrated by the finance director, added to the underlying cause of the insufficiency of funds and also amounted to a reasonable excuse. Mr Angiolini also referred us to a number of Tribunal decisions and remarked that he had not found any such decision where the dishonesty of a director, partner or employee had not been found to be a reasonable excuse for a default.
27. For the Respondents Mr Holl argued that the Appellant was a very large and sophisticated trader unlike many of the traders mentioned in the Tribunal decisions. Defalcations of £1.4M over two years were small when compared with annual turnover of £70M. It was also relevant that the Appellant had to make monthly payments (that is, twelve each year) and from 1 October 2000 to 31 March 2003 there were only five defaults which meant that the finance director had been more compliant than non-compliant. Also, many of the extractions had occurred in accounting quarters where there had been no defaults. As far as the late payment from the Appellant's largest customer was concerned, Mr Holl argued that this had to be considered within the context of the Appellant's total turnover; in Steptoe the late payment amounted to 90% of the trader's turnover. As far as the second default was concerned there was about £1.76M in the bank account and an overdraft of £250,000 on the due day –the money was there to pay the tax. Mr Holl also criticised the quality of the evidence on behalf of the Appellant which, he argued, left some gaps which had not been filled.

Reasons for decision

28. In considering the arguments of the parties we begin with the terms of the legislation. Although section 59A(8)(a)(ii) 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 Salevon and also in Steptoe. Those authorities established four main principles.
29. First, that 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 s 33(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 in plain that an insufficiency of funds cannot be so regarded. Insolvency is not enough."

30. Secondly, that 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.
31. Thirdly, that 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."

32. Finally, that 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 HM Revenue and Customs. 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.
33. Applying those principles to the facts of the present appeal we are of the view that the Appellant was deprived of the means to pay the value added tax by the wrongful acts of the finance director. The real cause of the defaults was the dishonest acts of the finance director which resulted in a negative cash flow position. This was an unforeseeable and inescapable misfortune and so was a reasonable excuse for all the defaults.
34. Mr Holl argued that the Appellant was a very large and sophisticated trader and that defalcations of £1.4M over two years were small when compared with annual turnover of £75M. We do not agree that the Appellant was a sophisticated trader. Its financial management processes and financial reporting at the relevant time were poor for a business of this size and its gross margins were low. In any event, the defalcations did not reduce the turnover but did reduce the Appellant's profits and the cash flow position; the defalcations meant that, over the period of two years, the cash position of the Appellant was £1.4M less than it should have been. We accept that in many months payments were made but they are not the subject of this appeal
35. As far as the second default is concerned there was about £1.76M in the bank account and an overdraft of £250,000 on the due date but the unchallenged evidence was that most of the amount shown as credited to the account consisted of uncleared funds which were not cleared until 4 February when the value added tax payment was made. Turning to what was claimed to be a late payment from the Appellant's largest customer, we agree with Mr Holl that this needs to be considered within the context of the Appellant's total turnover and we would not have found this late payment to be a reasonable excuse for the second default. Further, we did not receive sufficient evidence about this payment; we were not, for example, told how long it had been outstanding and to what extent it could not be regarded as a normal hazard of trade.
36. All the evidence on behalf of the Appellant was unchallenged and any gaps are explicable by the fact that there is now no-one who worked in the finance department of the Appellant in 2001 to 2003 who is still there.

Decision

37. Our decision on the main issue in the appeal is that the Appellant did have a reasonable excuse for each default.
38. That means that the appeal is allowed and that we do not need to hear further argument on the issue of proportionality.

DR A N BRICE

CHAIRMAN

RELEASE DATE: 8 August 2005

Tribunal Decisions relied on in argument but not mentioned in the Decision:

Dove Services (Manchester) Limited v The Commissioners of Customs and Excise (1990) Tribunal Decision 5510

Fat Sams American Food and Beverage Company Limited v The Commissioners of Customs and Excise (1991) Tribunal Decision 5785

Mr A G Hurlstone v The Commissioners of Customs and Excise (1991) Tribunal Decision 6167

Swift Catering Servicess Limited v The Commissioners of Customs and Excise (1991) Tribunal Decision 6740

Primboon Limited v The Commissioners of Customs and Excise (1992) Tribunal Decision 7757

Reflex Synthesisers Controllers Limited v The Commissioners of Customs and Excise (1992) Tribunal Decision 8815

Stocken & Lambert v The Commissioners of Customs and Excise(1993) Tribunal Decision 10572

M M Carew & Son Marble Company Limited v The Commissioners of Customs and Excise (1993) Tribunal Decision 11681

Prime Agency Recruitment Limited v The Commissioners of Customs and Excise (2002) Tribunal Decision 18043

Greengate Furniture Limited v The Commissioners of Customs and Excise (2003) Tribunal Decision 18280

LON/2004/0067

39. 08.05