This case centered on whether, under Section 56 FA 2009, a company had a reasonable excuse for late payment of PAYE due to worker absenteeism which had a knock-on effect on cash flow as a result of delays in work performed for customers of the company.

Background

ID Machinery Ltd is a privately owned company specialising in the sale of new and used equipment for the paper converting industry. An important part of the business is the purchase, stocking and rebuilding of used machinery in the fabrication of paper and cardboard products for the packaging industry. The company began trading in 1971. Given the present economic climate trading was difficult.

The company appealed against a decision of HMRC which charged penalties for failure to pay PAYE on time. In total there were nine defaults in the period between March 2011 and March 2012 totalling over £134,000 with a default penalty of 3% of that amount charged pursuant to paragraph 6 of Schedule 56 Finance Act 2009. Each payment was between 15 and 37 days late.

The company was in financial difficulties and as a result HMRC were involved in monitoring their payments. In addition the company also contacted the Business Payment Support Service (BPSS) of HMRC for advice and help, their request for deferral of payment was turned down. Because of the company's past history of late payment, HMRC felt that it was not a one-off situation.

In their Notice of Appeal, the company made the following points. Since 2007, the business had suffered financially which meant changes to the way it was run. This included implementation of a staff reduction policy by way of redundancies, pay freezes across the workforce, reduction of salaries for management and directors, closure of storage facilities and aggressive negotiation with suppliers. The business continued to employ 18 people with a reduced workforce.

The company contended that it had strived to make regular PAYE payments despite falling behind in the years between 2007 and 2011. Despite the request for assistance for time to pay (arrangements being refused), the company had managed still to make payments to HMRC.

The company questioned HMRC's review letter which stated “the Company's cash flow problems are not beyond those expected in the course of business in difficult economic circumstances”. They argued that they had survived two recessions prior to the present one and had always made arrangements to deal with the economic climate and to survive, having made similar arrangements in their present circumstances.

The company felt that the penalty imposed was disproportionate to the offence committed and submitted its main argument based on the “Bradford Factor”. This is a human resources management tool which is used to measure worker absenteeism. It calculates a score for each employee's absence in a year. The higher the score, the more disruptive the employee's absence to the Company.

In the 2011/12 the company had 352 days of absence by workers which they argued caused significant disruption to the business. The effect was to cause repair work to machines to be significantly delayed and therefore payments by customers to be delayed.

The repair work is highly specialised with engineers specifically recruited from different parts of the country. As such, they cannot easily be replaced if absent. The fact that an engineer with a particular expertise would be absent from work is very disruptive and impacted on the timeline for completion of the customer contract which in turn impacted on cash flow.

The company therefore argued that the lateness in paying HMRC was due in a significant way to worker absenteeism in a specialised industry with specialised workers. This caused the company to be continually late in making their payments in 2011/12 period. Their cash flow difficulties were largely cause by worker absenteeism. The company argued that was a reasonable excuse which they had made clear to HMRC on several occasions.

It was HMRC's view that the company was a ‘customer’ bad debt. The company had a long history of non-compliance and HMRC records showed that they had paid late since 2007. The problem was therefore on-going and did not just relate to 2011/2012, the company was alerted during that year about late payments via eleven legal warning demands.

HMRC further argued that insufficiency of funds is not a reasonable excuse unless it can be attributed to events which are outside the control of the taxpayer and that there was no reasonable excuse in this case. In fact, the company's past history suggested that paying PAYE late was “the normal rather than a one off situation”.

HMRC further argued that the company has been in business since 1971 and should be aware of their obligations as tax payers meet their compliance. They had received several warnings regarding penalty defaults and late payments, were aware of the penalty regime and were put on notification regarding the implications.

Decision

Upholding the company's appeal, the First Tier Tribunal stated that whilst the relevant legislation states that insufficiency of funds does not constitute a reasonable excuse, the cause of that insufficiency, which is to say the underlying cause of the default, might do so.

That concept was tested in the case of JB Steptoe [CA July 1992, [1992] STC 757]. In that case, the Appellant was an electrical contractor whose main customer was a local council which counted for a significant part of his income. There was a delay in the Council making payments which caused acute cash flow difficulties for the Appellant. This meant that returns and payments were late. The Tribunal agreed that he had suffered unforeseeable and unavoidable misfortune and granted his appeal.

In that decision, a distinction was drawn between a shortage of funds and a reasonable excuse where there were a series of unforeseen circumstances which led to the shortage of funds.

The question which therefore had to be asked was “Did those unforeseen circumstances lead to the shortage of funds?” In other words could the trader have reasonably foreseen the insufficiency of funds or were they faced with a more immediate cash crisis arising from events which were outside of their control.

In looking at this issue, the court also looked at the efforts made by the business concerned to deal with the issues arising and the steps taken in obtaining alternative finance to deal with the cash flow difficulties. In looking at the question of whether illness amounts to a reasonable excuse a critical factor is whether there has been illness of key employees.

The FTT held that the company operated in a specialised industry with specialised workers. They receive payment from their customers on completion of their contract work. If employees are ill, this would delay their payments and it would delay the completion of the work. It would not be easy to find employees to replace these key specialist workers as there were very few companies operating in this sector with these specialised machines. Furthermore, it would be difficult to make adequate provision for the absence of these key workers in advance.

In this case, the Appellants had acted sensibly and had taken significant steps in the present economic climate and over the years to reduce their workforce, take pay reductions and freezes and to streamline the business to be a viable economic proposition in difficult times.

In addition, the company continued to trade and to pay all its tax bills and had in fact approached HMRC's BPSS to deal with debt management and time to pay arrangements.

The question for the Tribunal was whether the Appellants had a reasonable excuse for their late payments. The Tribunal found that, taken as a whole, the company acted in a reasonable manner, sought advice and were honest and upfront with their financial difficulties. They took reasonable steps to deal with these difficulties and to inform HMRC.

The absenteeism of key workers had a knock on effect on the cash flow and resulted in customers not paying for completed work on time, which in turn created cash flow problems. This was a reasonable excuse and it was the Tribunal's view that a reasonable competent businessman would have defaulted in making payments when faced with the same or a similar predicament.

The company did exercise due diligence and had proper regard to their tax obligations. They were not presently in default. The appeal was upheld for these reasons.

The full text of the case is available at http://www.financeandtaxtribunals.gov.uk/judgmentfiles/j7102/TC02590.pdf