Whether mistaken payments by the taxpayer's customers were corporation tax receipts arising or accruing from trade and thus subject to corporation tax

The appeal

The case consisted of an appeal by Pertemps Recruitment Partnership Ltd (“Pertemps”) from a decision of the First-Tier Tribunal.

The issue raised by the appeal was whether sums paid by Pertemps’ customers to Pertemps by mistake formed part of the “profits or gains arising or accruing from [Pertemps’] trade” within section 18(1)(a)(ii) of ICTA 1988, so as to be subject to corporation tax.

The facts

Pertemps carries on business as a recruitment agency providing either temporary or permanent workers to its customers. Customers are divided into two groups, “contract” customers and “A-Z” customers. Contract customers enter into negotiated long-term contracts with Pertemps for the supply of temporary and/or permanent workers. A-Z customers engage Pertemps to provide workers on its standard terms of business.

Relationships with A-Z customers are often “one off” and last for a short period of time. Customers are invoiced on a regular basis and are contacted promptly by Pertemps’ credit control department if an invoice is not paid on time.

Pertemps keeps a full history of all payments received. If a customer can show that it has made an overpayment in error, Pertemps will refund the overpayment, even if the payment has been transferred to a balance sheet account or has been released to the profit and loss account.

Over the five years in issue, the total unreconciled payments amounted to £1,624,000. Pertemps were not able to explain why customers make payments in error, but they appeared to fall into three categories.

Firstly some customers make payments against invoices in circumstances where the invoice has been reversed by a credit note. Secondly, some customers pay invoices twice, in some cases mistaking a credit note for an invoice. Thirdly, in one case during the sample period considered by the First-Tier Tribunal the payment could not be linked in any way to an underlying supply.

The First-Tier decision

All of the sample payments examined by the First-Tier Tribunal were made by persons who had a customer relationship with Pertemps, and in every case the payment was made by reference to a Pertemps invoice (real or, in one case, imagined).

The First-Tier Tribunal had found that:

1. each of the overpayments which were the subject of this appeal was made by a customer under a mistaken belief that it owed money to Pertemps for services Pertemps had supplied to it;
2. the payments derived from the business rela-tionship that Pertemps had with its customers;
3. the payments were of sums of money to which, on receipt, Pertemps was not entitled;
4. Pertemps does not carry on any specific activity which might be said to earn or encourage these payments;
5. given the scale on which Pertemps operates, it is inevitable that mistakes will occur from time to time, and therefore the receipt of mistaken payments is an unavoidable incident of Pertemps’ trade.

The First-Tier Tribunal also considered the legal status of the mistaken payments as follows:

1. Money paid by a customer to Pertemps by mistake is not a debt owing to the customer. This is not affected by the fact that, as a matter of good accounting practice, prior to release of the mistaken payment to its profit and loss account, Pertemps shows the mistaken payment in its sales ledger and balance sheet account as a liability owed to the customer.
2. Nor does Pertemps hold the money on trust for the customer or otherwise receive the money in a fiduciary capacity. Thus the customer has no proprietary claim in respect of the money.
3. Since the money is paid by the customer under a mistake, the customer has a common law personal claim against Pertemps for restitution of the money.
4. As a consequence of (i)-(iii), money paid by mistake to Pertemps by customers belongs to Pertemps unless and until the customer makes a successful claim in restitution against Pertemps, or such a claim is settled by agreement.

The appeal arguments

In the course of this appeal, Pertemps contended that in reaching its decision the First-Tier Tribunal had erred in law.

It submitted that (i) a receipt is to be judged once and for all at the time of receipt and (ii) a payment cannot be a trading receipt unless the trader has a legal entitlement to receive it at that time, save perhaps in exceptional circumstances which do not apply here.

The decision of the Upper-Tier Tribunal

The case of Morley v Tattersall 1938 22 TC 51 was central to Pertemps’ submissions. Tattersall was the well-known firm of horse auctioneers which auctioned horses as agent for the vendors. They received the purchase prices paid by the purchasers on behalf of their clients, and deducted their commission and expenses. It was a term of their contracts with their clients that no money would be paid to the client without a written demand from the client.

For various reasons, clients from time to time did not call for payment of their money, and so Tattersall held unclaimed balances to the credit of the clients. Many of those balances remained unclaimed for a considerable number of years.

Tattersall did not include the unclaimed balances in its profit and loss account which was made up each year. Provision was made in the partnership agreement, however, for annual transfers of unclaimed balances to the credit of the partners. Despite this, the Crown contended that the unclaimed balances became trading receipts when distributed to the partners.

Counsel for Pertemps in the course of the appeal thus submitted that Morley v Tattersall was authority for the proposition that the nature of a receipt was fixed once and for all when it was received: receipts either are or are not trading receipts at the time that they are received, and their nature cannot change after receipt.

Counsel for Pertemps also argued that Morley v Tattersall was also authority for the proposition that in general a receipt is not a trading receipt unless the trader has a legal entitlement to receive the money, since it is that entitlement which connects the receipt to the trade. Pertemps had no legal entitlement to the mistaken payments, and therefore the mistaken payments were not connected to Pertemps’ trade and were not trading receipts.

HMRC submitted that the decision in a number of cases demonstrated that a payment which was subject to a contingent obligation to repay could be a trading receipt. HMRC also argued that Commissioner of Income Tax v Savundranayagam (1957) 67 TC 239 established that a receipt obtained by a trader in circumstances such that the payer had a claim for restitution of the money did not prevent it from being a trading receipt.

Pertemps’ arguments were not accepted by the Upper-Tier Tribunal for the following reasons. Firstly, as counsel for HMRC had pointed out, there was no requirement in section 18(1)(a)(ii) of ICTA that the trader be legally entitled to the receipts making up the profits. Secondly, there was no such requirement in Morley v Tattersall. Whilst it was held in the case that the money was the client's money, and it follows from this that Tattersall was thus not legally entitled to it; it does not follow that legal entitlement is a sine qua non for a trading receipt. Thirdly, the Upper-Tier Tribunal considered that the review of various cases, and in particular Commissioner v Savundranayagam, Simpson v Reynolds and IRC v Falkirk, demonstrated that legal entitlement is not a prerequisite.

Fourthly and most fundamentally, the Upper-Tier Tribunal held that the fact that a payment is made in circumstances such that the payer has a restitutionary claim to repayment of that sum does not mean that the recipient is not legally entitled to receive it.

On the contrary, the recipient is legally entitled to receive and keep the money unless and until a claim for repayment is made.

In addition to the “legal entitlement to receive” argument, counsel for Pertemps also advanced what the Tribunal viewed as a contradictory argument, namely that Morley v Tattersall was based on the Court of Appeal's conclusion that the money belonged to the clients in a business sense, rather than in a legal sense. Similarly, it was argued in this case that the mistaken payments belonged to Pertemps’ clients in a business sense, albeit not in a legal sense, and thus were not trading receipts of Pertemps.

In support of this argument, counsel for Pertemps pointed out that the development of the law of restitution in recent years meant that the remedies available in respect of a common law restitutionary claim were converging with those which were available in respect of a proprietary claim, as illustrated by the decision of the House of Lords in Sempra Metals Ltd v Inland Revenue Commissioners [2007] UKHL 34, [2008] 1 AC 561 that the court has jurisdiction to award compound interest where a claim was made for restitution of the time value of money paid under a mistake.

The Tribunal rejected this argument.

By contrast, the Pertemps case was distinguished from the position in Morley v Tattersall as the mistaken payments were the property of Pertemps, albeit that the customers have a claim for restitution.

Finally counsel for Pertemps argued that the purpose of the mistaken payments in the present case was not such as to make them trading receipts. The Upper-Tier Tribunal disagreed and found that on the facts found by the First-Tier Tribunal, the mistaken payments derived from the business relationship between Pertemps and its customers, were made by the customers in the belief that they owed money to Pertemps for services supplied by Pertemps and were an unavoidable incident of Pertemps’ trade.

Having regard not only to the nature of the payments (money which upon receipt became Pertemps’), but also their purpose (money paid for the reasons just stated), the Tribunal had been entitled to conclude that they were trading receipts.

Although the Upper-Tier Tribunal cited the foregoing as being sufficient to dispose of the appeal, counsel for HMRC raised a further point. It was submitted that the best guide to the true profits or losses of a trader is to apply the accepted principles of commercial accountancy. In support of this HMRC relied upon the dictums of Sir Thomas Bingham MR, Nolan LJ and Sir Christopher Slade, in Gallagher v Jones [1993] STC 537 at 555:

• “... the central issue is at root a very short one. The object is to determine, as accurately as possible, the profits or losses of the taxpayers’ businesses for the accounting periods in question. Subject to any express or implied statutory rule, of which there is none here, the ordinary way in which to ascertain the profits or losses of a business is to apply accepted principles of commercial accountancy.”

On this basis, it was argued that, since Pertemps' profits as stated in its accounts included the mistaken payments, and those accounts gave a true and fair view and were in accordance with generally accepted accounting principles, the mistaken payments were properly to be regarded as trading receipts.

Commenting on HMRC's argument, the Upper-Tier stated that this point lent additional support to the Tribunal's decision, but was not conclusive on its own. For all the reasons previously stated, the appeal was dismissed.