Businesses struggling to meet VAT and other tax liabilities should take heart from a recent tax case which suggests that the Courts may accept that a lack of funds can be a reasonable excuse for late payment of tax, according to Smith & Williamson. However, this shortfall must be due to events outside the taxpayer’s control. [Mutch v HMRC (TC 232)]
“In practice, therefore, a business would have to demonstrate a strong track record of good financial management. They would need to have met tax deadlines in the past, and show that cash flow problems had arisen due to circumstances beyond their control, having been caused, for example, through fraud or a sudden credit problem,” advised Richard Mannion, national tax director at Smith & Williamson, the accountancy and financial services group.
“While Time to Pay agreements should remain the first port-of-call for struggling businesses to negotiate a delay in critical tax deadlines, these cases provide further scope for discussions with the taxman and so are worth noting.”
“HMRC has been notorious for its apparently unsympathetic interpretation of the ‘reasonable excuse’ rule in payment of taxes so the fact that this approach has been overturned not once, but twice, in recent weeks by the First Tier Tax Tribunal indicates an important change. I am hopeful that the taxman will, going forward, take a more understanding approach to late payment although people will naturally need firm evidence to support their case,” concluded Mannion.
The recent tax case of Mutch has considered whether taxpayers could cite the recession as a factor when claiming they had a “reasonable excuse” for failing to pay their taxes on time.
The case potentially has relevance to well-run but struggling businesses across all sectors, however, the concept of reasonable excuse could prove particularly helpful for businesses with a VAT payment problem or to those in the construction industry.
In terms of VAT, if a business is late or misses a VAT payment without a reasonable excuse, they become subject to an escalating penalty.
Those working in the construction industry can lose their entitlement to receive gross payments of their invoices if they fail to pay their taxes on time - unless they can show a reasonable excuse for the delays. Loss of gross payment status means that all subsequent payments from contractors have to be paid over net of withholding tax, amounting to 20 per cent for registered subcontractors. Loss of gross payment can therefore be a fatal blow to a business that is already struggling to pay its bills.
HMRC have been notorious for their unsympathetic interpretation of the reasonable excuse rule, but their unsympathetic approach has been overturned by the First Tier Tax Tribunal twice in recent weeks. In the case of Mutch, the taxpayer had built up his carpentry business to meet the needs of the local house builders, but the business had been overtaken by the recession and the immediate and devastating impact on the demand for new houses.
The Judge referred to two VAT cases (‘Salevon’ at the High Court, September 1989, and ‘Steptoe’ at the Court of Appeal, July 1992) where the test of reasonable excuse was considered. He said that the precedent laid down by the Courts was that you should ask whether the taxpayer had exercised reasonable foresight and due diligence in the knowledge that the tax would become due on the particular dates, but those efforts could not have avoided the insufficiency of funds which led to the failures.
Applying those tests the Judge found that the way that Mutch reacted to the recession was ‘fair and business-like’ and he had met the required standards.
The recent tribunal decisions serve as a useful reminder of the way that the reasonable excuse rules should be operated by HMRC:
· They should exercise judgement, considering what a reasonable competent businessman (taken for comparison purposes) in a similar situation would have done;
· They need to consider whether that reasonable competent businessman would have defaulted when faced by the same or similar predicament.
“These cases have arguably shown up HMRC’s lack of understanding of just how catastrophic the recession has been for particular types of business and the decisions serve as a rebuke to their more usual unsympathetic approach. I hope that those in charge at HMRC will take the decisions on board and ensure that their staff follows the steps clearly laid down by the courts,” said Mannion
“The reported cases underline the fact that an insufficiency of funds can be a reasonable excuse if attributable to events outside the taxpayer’s control. This could be the case where the business has a strong track record of good financial management, having met tax deadlines in the past, but cash flow problems had arisen due to circumstances beyond their control, and had been caused, for example, through fraud or a sudden credit problem.”
“Businesses that find themselves with insufficient funds to meet their forthcoming tax liabilities need to take swift action and should consider applying to HMRC for a time to pay arrangement under the Business Payments Support Scheme when they first become aware of a potential problem. Where such an arrangement is granted it will effectively delay the critical payment dates.”
“The latest decision regarding the Mutch case potentially provides further support for struggling businesses,” added Mannion.