Two recent Upper Tribunals decisions have considered the proportionality of VAT default surcharges in the light of European law. In each case, the taxpayer was unsuccessful, although the relevant tribunal made it clear that, in an exceptional case, a default surcharge could be struck out on these grounds. However, the reasoning adopted by the tribunals suggests that it may be difficult to find a case of this nature. In particular, it appears that neither the extent of the delay in payment, nor the existence of a spike in profits in the default period, is a relevant factor in this context.
Tony Beare (Slaughter and May) describes the potential impact of two Upper Tribunal decisions in relation to the proportionality of VAT default surcharges.
In recent years, the tribunals have seen a number of appeals against VAT default surcharges on the basis of disproportionality. In the two leading Upper Tribunal decisions in this area, the taxpayer was unsuccessful, but neither tribunal ruled out the possibility of a successful appeal on this basis on other facts. This is not surprising, given the mechanical way in which the default surcharge regime operates.
The requirement that a VAT default surcharge should be proportionate stems from two distinct lines of European jurisprudence: the application of the relevant EU directives; and human rights law. There are no material differences between the two strands as to which test should be applied in this context. The relevant EU directives contain no harmonisation of enforcement provisions. Member states have the power to choose the penalties which seem appropriate to them, but that power must be exercised proportionately.
This means that penalties must not go beyond what is strictly necessary for the objectives pursued; and that a penalty must not be so disproportionate to the gravity of the infringement that it becomes an obstacle to the underlying aims of the relevant directives.
In similar vein, the taxpayer’s rights under the European Convention on Human Rights require that there be a reasonable relationship of proportionality between the means employed and the aim pursued.
The default surcharge regime (under VATA 1994 s 59A)) operates in a straightforward manner.
A first default does not give rise to a surcharge, but triggers the issue of a surcharge liability notice, which creates a ‘surcharge period’ of a year.
A second default in the course of that surcharge period gives rise to a surcharge calculated at 2% of the VAT in respect of which the default is made, and an extension of the surcharge period.
Subsequent defaults within the extended surcharge period (as further extended by any such subsequent defaults) give rise to further surcharges which are calculated by applying an increasing percentage (5%, then 10% and then 15%) to the relevant amount in respect of which the default is made.
Five features of the regime are noteworthy:
Each of these features has been the subject of comment in the course of the decisions mentioned above.
The two leading cases in this area are the Upper Tribunal decisions in HMRC v Total Technology (Engineering) Ltd [2012] UKUT 418 (TCC), [2013] STC 681 (Total Technology); and HMRC v Trinity Mirror plc [2015] UKUT 0421 (TCC) (Trinity Mirror).
The tribunals in both cases approached the question on the basis that the regime could be disproportionate either if the regime as a whole was disproportionate, or if the way in which the regime applied to an individual taxpayer operated in a disproportionate manner.
Both tribunals concluded that there was nothing in the regime as a whole which leads to the conclusion that its architecture is fatally flawed, but that the regime could operate in a disproportionate manner in an individual case. In particular, the tribunals observed that the absence of a maximum penalty is a flaw in the regime.
The key points arising from the two decisions may be summarised as follows.
The first is that the proportionality (or otherwise) of a particular surcharge needs to be considered in the context of the underlying aims of the relevant directives. The tribunal in Trinity Mirror observed that for a penalty to be struck down as disproportionate, it was not enough for the penalty simply to be found to be disproportionate to the gravity of the default. Instead, it said, quoting an earlier case, that the surcharge must be ‘so disproportionate to the gravity of the infringement that it becomes an obstacle to [the underlying aims of the directives]’.
It noted that the underlying aim of the relevant directives in this case is the principle of fiscal neutrality (as the VAT regime is intended to tax only the final consumer); and that it is a necessary concomitant of a system that provides for the deduction and collection of tax at each stage in the process that tax should be accounted for and paid on a timely basis. It followed from this that the use of the amount unpaid as the objective factor by which the amount of the surcharge varies is not a flaw in the system. On the contrary, as the achievement of the aim of fiscal neutrality depends on timely payment, that criterion is an appropriate, if not the most appropriate, factor.
Secondly, the question of whether the taxpayer had a reasonable excuse for its default is not a relevant factor in considering the proportionality of a penalty, because it is axiomatic that, in any case where the surcharge has arisen, the taxpayer will not have a reasonable excuse for its default. A similar approach was adopted in relation to the general compliance record of the taxpayer. The tribunal in Total Technology noted that the fact that, in determining whether or not a surcharge arises, the regime does not take into account the general compliance record of the taxpayer does not give rise to ‘any unfairness, let alone anything approaching a lack of proportionality’.
Thirdly, both tribunals considered that, as the objective of the regime was to penalise a failure to pay VAT on time (and not to penalise for a further delay in payment), the fact that a late payment was made only one day after its due date was not sufficient to render an otherwise proportionate penalty disproportionate. In similar vein, the tribunal in Total Technology noted that the absence of any link between that the amount of the penalty and the taxpayer’s profitability is irrelevant, both in considering the proportionality of the regime as a whole and in considering the position of an individual taxpayer.
The result of all this was the conclusion drawn by the tribunal in Trinity Mirror, which conceded that the absence of a financial limit on the level of the surcharge might result, in an individual case, in a penalty that might be considered disproportionate, but that this was likely to occur only in a ‘wholly exceptional case’ and be dependent upon its own particular circumstances.
The tribunal declined to identify common characteristics of a case where such a challenge to the surcharge would be likely to succeed. In particular, the tribunal noted that it was not appropriate for a court or tribunal to set any maximum penalty or range of maximum penalties, because that would in effect be to legislate.
It was noted that the relevant directive in this case conferred on Parliament a wide discretion in devising a suitable scheme for penalising late payment; and therefore a court or tribunal should not be quick to substitute its own view of what is fair for the penalty which Parliament has imposed.
The tribunal went on to say that, in particular, it should not be taken to have endorsed the suggestion that the exceptional circumstances referred to would include cases where there has been a ‘spike’ in profits in the period of default.
Although understandable, it is a pity that, having held that there could, in principle, be a ‘wholly exceptional case’ in which the surcharge imposed on a particular taxpayer may be struck down on the basis that it is excessive, no guidance has been given as to what those circumstances might be. Between them, the tribunals have already discounted, as a basis for striking down a surcharge:
In Trinity Mirror, the VAT payment of £3,545,324 was just one day late and the amount of the surcharge was £70,906.44 which, expressed as an annual percentage, is almost 730%. If that is not disproportionate, it is hard to see what facts could arise in the future that would give rise to the ‘wholly exceptional case’ to which the tribunal in Trinity Mirror referred.
Once the reasoning set out in the two cases is adopted, most, if not all, circumstances would seem to be precluded. In particular, logic suggests that the quantum of a surcharge alone can never be the determining factor, because that will always be the specified percentage of the amount in default.
Two recent Upper Tribunals decisions have considered the proportionality of VAT default surcharges in the light of European law. In each case, the taxpayer was unsuccessful, although the relevant tribunal made it clear that, in an exceptional case, a default surcharge could be struck out on these grounds. However, the reasoning adopted by the tribunals suggests that it may be difficult to find a case of this nature. In particular, it appears that neither the extent of the delay in payment, nor the existence of a spike in profits in the default period, is a relevant factor in this context.
Tony Beare (Slaughter and May) describes the potential impact of two Upper Tribunal decisions in relation to the proportionality of VAT default surcharges.
In recent years, the tribunals have seen a number of appeals against VAT default surcharges on the basis of disproportionality. In the two leading Upper Tribunal decisions in this area, the taxpayer was unsuccessful, but neither tribunal ruled out the possibility of a successful appeal on this basis on other facts. This is not surprising, given the mechanical way in which the default surcharge regime operates.
The requirement that a VAT default surcharge should be proportionate stems from two distinct lines of European jurisprudence: the application of the relevant EU directives; and human rights law. There are no material differences between the two strands as to which test should be applied in this context. The relevant EU directives contain no harmonisation of enforcement provisions. Member states have the power to choose the penalties which seem appropriate to them, but that power must be exercised proportionately.
This means that penalties must not go beyond what is strictly necessary for the objectives pursued; and that a penalty must not be so disproportionate to the gravity of the infringement that it becomes an obstacle to the underlying aims of the relevant directives.
In similar vein, the taxpayer’s rights under the European Convention on Human Rights require that there be a reasonable relationship of proportionality between the means employed and the aim pursued.
The default surcharge regime (under VATA 1994 s 59A)) operates in a straightforward manner.
A first default does not give rise to a surcharge, but triggers the issue of a surcharge liability notice, which creates a ‘surcharge period’ of a year.
A second default in the course of that surcharge period gives rise to a surcharge calculated at 2% of the VAT in respect of which the default is made, and an extension of the surcharge period.
Subsequent defaults within the extended surcharge period (as further extended by any such subsequent defaults) give rise to further surcharges which are calculated by applying an increasing percentage (5%, then 10% and then 15%) to the relevant amount in respect of which the default is made.
Five features of the regime are noteworthy:
Each of these features has been the subject of comment in the course of the decisions mentioned above.
The two leading cases in this area are the Upper Tribunal decisions in HMRC v Total Technology (Engineering) Ltd [2012] UKUT 418 (TCC), [2013] STC 681 (Total Technology); and HMRC v Trinity Mirror plc [2015] UKUT 0421 (TCC) (Trinity Mirror).
The tribunals in both cases approached the question on the basis that the regime could be disproportionate either if the regime as a whole was disproportionate, or if the way in which the regime applied to an individual taxpayer operated in a disproportionate manner.
Both tribunals concluded that there was nothing in the regime as a whole which leads to the conclusion that its architecture is fatally flawed, but that the regime could operate in a disproportionate manner in an individual case. In particular, the tribunals observed that the absence of a maximum penalty is a flaw in the regime.
The key points arising from the two decisions may be summarised as follows.
The first is that the proportionality (or otherwise) of a particular surcharge needs to be considered in the context of the underlying aims of the relevant directives. The tribunal in Trinity Mirror observed that for a penalty to be struck down as disproportionate, it was not enough for the penalty simply to be found to be disproportionate to the gravity of the default. Instead, it said, quoting an earlier case, that the surcharge must be ‘so disproportionate to the gravity of the infringement that it becomes an obstacle to [the underlying aims of the directives]’.
It noted that the underlying aim of the relevant directives in this case is the principle of fiscal neutrality (as the VAT regime is intended to tax only the final consumer); and that it is a necessary concomitant of a system that provides for the deduction and collection of tax at each stage in the process that tax should be accounted for and paid on a timely basis. It followed from this that the use of the amount unpaid as the objective factor by which the amount of the surcharge varies is not a flaw in the system. On the contrary, as the achievement of the aim of fiscal neutrality depends on timely payment, that criterion is an appropriate, if not the most appropriate, factor.
Secondly, the question of whether the taxpayer had a reasonable excuse for its default is not a relevant factor in considering the proportionality of a penalty, because it is axiomatic that, in any case where the surcharge has arisen, the taxpayer will not have a reasonable excuse for its default. A similar approach was adopted in relation to the general compliance record of the taxpayer. The tribunal in Total Technology noted that the fact that, in determining whether or not a surcharge arises, the regime does not take into account the general compliance record of the taxpayer does not give rise to ‘any unfairness, let alone anything approaching a lack of proportionality’.
Thirdly, both tribunals considered that, as the objective of the regime was to penalise a failure to pay VAT on time (and not to penalise for a further delay in payment), the fact that a late payment was made only one day after its due date was not sufficient to render an otherwise proportionate penalty disproportionate. In similar vein, the tribunal in Total Technology noted that the absence of any link between that the amount of the penalty and the taxpayer’s profitability is irrelevant, both in considering the proportionality of the regime as a whole and in considering the position of an individual taxpayer.
The result of all this was the conclusion drawn by the tribunal in Trinity Mirror, which conceded that the absence of a financial limit on the level of the surcharge might result, in an individual case, in a penalty that might be considered disproportionate, but that this was likely to occur only in a ‘wholly exceptional case’ and be dependent upon its own particular circumstances.
The tribunal declined to identify common characteristics of a case where such a challenge to the surcharge would be likely to succeed. In particular, the tribunal noted that it was not appropriate for a court or tribunal to set any maximum penalty or range of maximum penalties, because that would in effect be to legislate.
It was noted that the relevant directive in this case conferred on Parliament a wide discretion in devising a suitable scheme for penalising late payment; and therefore a court or tribunal should not be quick to substitute its own view of what is fair for the penalty which Parliament has imposed.
The tribunal went on to say that, in particular, it should not be taken to have endorsed the suggestion that the exceptional circumstances referred to would include cases where there has been a ‘spike’ in profits in the period of default.
Although understandable, it is a pity that, having held that there could, in principle, be a ‘wholly exceptional case’ in which the surcharge imposed on a particular taxpayer may be struck down on the basis that it is excessive, no guidance has been given as to what those circumstances might be. Between them, the tribunals have already discounted, as a basis for striking down a surcharge:
In Trinity Mirror, the VAT payment of £3,545,324 was just one day late and the amount of the surcharge was £70,906.44 which, expressed as an annual percentage, is almost 730%. If that is not disproportionate, it is hard to see what facts could arise in the future that would give rise to the ‘wholly exceptional case’ to which the tribunal in Trinity Mirror referred.
Once the reasoning set out in the two cases is adopted, most, if not all, circumstances would seem to be precluded. In particular, logic suggests that the quantum of a surcharge alone can never be the determining factor, because that will always be the specified percentage of the amount in default.
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