The case involved whether payment of VAT through cheque instead of online constituted an actual default on the part of the taxpayer and whether or not the taxpayer had a reasonable excuse for the default. The Tribunal was also required to decide whether the 15 per cent surcharge was disproportionate.

Background

The taxpayer company appealed against HMRC's imposition of £8,433.37 of a surcharge penalty for the VAT period 31 December 2010 following its payment by cheque.

The business of the company was that it contracted academics from Oxford and Cambridge to produce research in various fields; it was also involved in academic tuition. The business started with a simple website and, in four years, expanded to a turnover of £1.5m. Initially the company's accounting system was non-existent and the accounts, VAT and Pay As You Earn fell into substantial arrears giving rise to surcharges for six tax periods from June 2008. Following these defaults, the surcharge was determined at the rate of 15 per cent, the last two of which were also surcharged at 15 per cent.

On 10 January 2010, HMRC issued a mandation letter to the taxpayer requiring it to submit returns and pay VAT electronically. Thereafter the taxpayer paid VAT electronically on time for the period March 2010. VAT for the period June 2010 was paid in 11 instalments electronically. Before the return for the period September 2010, the company set up a direct debit mandate and the VAT for that period was paid by direct debit, payment being collected by HMRC on 10 November.

The electronic return for the period December 2010 was made on 31 January 2011 and showed £56,222.48 as payable; the due date thereon was stated as 7 February 2011. Before payment for this period was made, the Chief Executive of the company called HMRC advising them to cancel direct debit.

Consequently, the taxpayer paid VAT on 3 February 2011 by posting a cheque, which cleared their account on 9 February 2011. HMRC's schedule of defaults showed the payment by cheque as being made on 7 February. A surcharge at the rate of 15 per cent was then imposed for this default.

The taxpayer argued that the VAT cheque was banked and cleared by HMRC before they would have received it by direct debit. If there was delay, it was because of HMRC's false construction/application of the legislation. They argued that HMRC relied on tertiary legislation, the rules under which were unfair, irrational, and unreasonable for those paying by cheque, considering the differential deadlines.

The taxpayer also maintained that the penalty was disproportionate to the offence and should be discharged, further alleging that the default was innocent. The taxpayer also contended that the penalty of £8,433.37 was disproportionate as it represented 41 per cent of the gross profit for the period.

HMRC argued that under regulation 25(1) of the Value Added Tax Regulations 1995, the default date for returns was the end of the following month, i.e. 31 January for a 31 December VAT period. Whilst they had the power to allow additional time for electronic returns, in the taxpayer's case, the additional time was irrelevant because the payment was not made electronically. HMRC argued that there was no option to pay by cheque and therefore their having treated payment as being received on 7 February was immaterial because the tax was due by 31 January.

HMRC further stated that there was no reasonable excuse. The taxpayer was aware of the need to pay on time, in particular because of the earlier surcharges. The direct debit had been cancelled after the last due date for payment by cheque therefore payment by cheque was a deliberate decision. The payment had not been despatched at such a time and in such a manner that it was reasonable to expect it would be received within the time frame under the Value Added Tax Act 1994, s. 59(7), because payment by cheque was not permitted.

HMRC also submitted that the history of the taxpayer's previous defaults was relevant to the 15 per cent surcharge. Although the default was not intentional, the decision to change to paying by cheque was deliberate. The surcharge was not excessive in absolute terms and its context was the need for compliance in paying on time. The amount of the surcharge progressively arose from persistent defaults and consequently resulted in progressively higher penalties.

Decision

The First-tier Tribunal dismissed the taxpayer's appeal. Under the 1996 Regulations, payment by cheque made in contravention of the requirement to pay electronically is treated as made on the day when the cheque clears to the controller's account, which, under regulation 40(2C), is the second business day following the date of its receipt.

The Tribunal found that the cheque was posted on 3 February, the day after the taxpayer's Chief Executive called HMRC to change the direct debit payment method. Assuming it was sent by first class post in a pre-paid envelope provided by HMRC and arrived on the next day, the second business day following receipt was Tuesday 8 February. This was later than 7 February, the date shown on the electronic return form.

Given that regulation 40(2C) VAT Regulations 1995 was mandatory, the fact that HMRC recorded the payment as received on 7 February was irrelevant. The Tribunal concluded that the taxpayer was in default by one day and found that the immediate cause of the default was the decision by the Chief Executive to cancel the direct debit and pay by cheque instead.

Regardless of whether the Chief Executive who cancelled the direct debit knew of the requirement to pay by electronic means, the taxpayer had been issued with a mandation letter and had been paying electronically. Therefore the Chief Executive's ignorance was not a reasonable excuse.

The Tribunal also considered that the uncertainty of the due date might have been confusing to the taxpayer, which could have given rise to a reasonable excuse. However, there was nothing to suggest that the taxpayer was misled in any way. Whether the due date was in law 31 January or 7 February, a cheque posted on 3 February could not have cleared to HMRC's account by 7 February, as was required. Furthermore, the taxpayer was not entitled to assume that the extra time allowed for payment by direct debit applied when the direct debit was cancelled.

As to the issue of proportionality of the penalty, the Tribunal held that the amount of penalty was high in absolute terms as it was 15 per cent of the VAT due, the maximum percentage. However it was the arrears which arose from previous defaults and surcharges which gave rise to the 15 per cent rate. The arrears showed that the defaults in previous periods had not been remedied. The Tribunal did say that if it had the power to mitigate the penalty, this would have been a case where it would have done so.

However, that did not answer the question whether the present case was one where the penalty was so unfair as to be incompatible with the principle of proportionality. An element of harshness was necessary to make a penalty dissuasive (the case of Enersys Holdings UK Ltd being considered). In this case, the Tribunal held that although the surcharge was heavy, it was not so unfair.

The taxpayer's appeal was dismissed in full.

The full text of the case is available at http://www.financeandtaxtribunals.gov.uk/judgmentfiles/j6375/TC01954.pdf