Revenue and Customs v Smith

This is the appeal of the Commissioners for Her Majesty’s Revenue and Customs (“HMRC”) by way of Case Stated against a decision of the General Commissioners for the Division of Beacontree, dated 23 March 2006. The issue on the appeal is whether the General Comissioners were right to allow the appeal of the Respondent, Mr Smith, against HMRC’s refusal to issue him with a Sub-Contractor’s Tax Certificate CIS6.

The background to the legislation which is relevant to this appeal can be found in the judgment of Ferris J in Shaw v Vicky Construction Ltd [2002] EWHC 2659 (Ch), [2002] STC 1544 (“Vicky”) cited for this purpose by Lewison J in Barnes v Hilton Main Construction Ltd [2005] EWHC 1355 (Ch), [2005] STC 1532. This background and the statutory provisions (sections 561 to 565 Income and Corporation Tax Ac 1988 (“ICTA”) and the Income Tax (Sub-Contractors in the Construction Industry) Regulations 1993 SI 1993/743 (“the Regulations”)) are well-known although I need to refer to certain provisions. References to section numbers are to the sections of ICTA and to regulation numbers are to the regulations of the Regulations.

Section 559 applies to payments under certain contracts relating to construction operations where the contract is not a contract of employment and where certain conditions are fulfilled as set out in section 559(1). It lays down the general rule that a contractor who is subject to the section is obliged, when making payment to a subcontractor, to deduct from the sum due a percentage of it (currently 18%) under section 559(4).

Section 559(1) does not apply to a payment where the relevant parties are excepted from the section by virtue of section 561. Under section 561(1), a person is excepted from section 559 if a certificate under the section has been issued to that person and is in force at the time of the payment. Under section 561(2) it is provided that if HMRC are satisfied that an applicant who is an individual satisfies the conditions set out in section 562, they shall issue him a certificate excepting him from section 559.

Under section 562, three tests have to be fulfilled before a subcontractor can obtain a certificate:

Section 562(2A), the turnover test, was introduced by Finance Act 1995. The then Board of the Inland Revenue clearly considered that the business test and the compliance test did not provide adequate protection against the risk of tax loss as a result of irregularities within the construction industry. An applicant must accordingly now satisfy HMRC by such evidence as may be prescribed, that the business

“is likely to involve the receipt, annually in respect of the period to which the certificate would relate, of an aggregate amount by way of relevant payments which is not less that the amount specified in regulations….”

This is a test which appears to look to the future. However, the Regulations make provision for certain evidence of past activity to be sufficient to satisfy the test.

Section 566(2) confers power on HMRC to make regulations in relation to a number of matters including the following:

Regulation 21B (which with Regulations 21C and D was inserted by amendment in 1998) prescribes for the purposes of section 562(2A) “such evidence as complies with either of the six month test or the main three year test” (although this is subject to Regulation 21B(5) which interlinks with Regulation 26 dealing with the period of validity of a certificate but nothing turns for present purposes on those provisions). Accordingly, evidence which satisfies the six month test or the main three year test will be sufficient to satisfy the turnover test.

Regulation 21C sets out the six month test. The evidence complying with that test is evidence of turnover during a period of six consecutive months or any lesser consecutive period falling entirely within the year ending with the date of the application showing turnover in that period to have equalled or exceeded 70% of the threshold.

Regulation 21D sets out the main three year test. The evidence complying with that test is evidence of turnover during a period of three consecutive years falling entirely within the period of four years ending with the date of the application showing that such turnover exceeded the threshold in at least two out of three consecutive years of the four years and that the average turnover for those three years equalled or exceeded 90% of the average of the threshold for those three years.

Regulation 27(1) provides that at any time within a period of six months before the date of expiry of a certificate, the person to whom it was issued may apply for its renewal. In that case, regulation 27(2) provides that the provisions of section 561 are to apply to the application in the same way as they apply to an application for the issue of a certificate.

I should also mention certain provisions of the European Convention on Human Rights (“ECHR”).

Article 8 ECHR is headed “the right to respect for private and family life”. It provides as follows:

“1.

Everyone has the right to respect for his private and family life, his home and his correspondence

2.

There shall be no interference by a public authority with the exercise of this right except such as is in accordance with the law and is necessary in a democratic society in the interests of national security, public safety or the economic well-being of the country, for the prevention of disorder or crime, for the protection of health or morals, or for the protection of the rights and freedoms of others.”

Article 14 is headed “prohibition of discrimination”. It provides as follows:

“The enjoyment of the rights and freedoms set forth in this Convention shall be secured without discrimination on any ground such as sex, race, colour, language, religion, political or other opinion, national or social origin, association with a national minority, property, birth or other status.”

Article 1 of the First Protocol to the ECHR is headed “protection of property”. It provides as follows:

“Every natural or legal person is entitled to the peaceful enjoyment of his possessions. No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and by the general principles of international law.

The preceding provisions shall not, however, in any way impair the right of a State to enforce such laws as it deems necessary to control the use of property in accordance with the general interest or to secure the payment of taxes or other contributions or penalties.”

The ECHR is, of course, incorporated into domestic law by the Human Rights Act 1998. I do not need to set out any of its provisions.

Mr Smith is a self-employed flooring contractor. He has been trading under the name John Smith Floors (London) since 1968 and has been supplying and fitting wooden floors for over 50 years. He has always complied fully with his statutory obligations in relation to taxation and his tax affairs have been fully in order throughout. His clients were, as found by the General Commissioners, principally local authorities and other building contractors.

Mr Smith was issued by HMRC with successive certificates for the periods August 1999 to January 2003 and February 2003 to January 2006. He had satisfied the three statutory tests. He applied in September 2005 for a further certificate from 31 January 2006, the date of expiry of his then subsisting certificate. That application was refused. HMRC’s case was that Mr Smith’s business failed to meet the conditions of both the six month test and the main three year test so that the turnover test was not passed

It was common ground before the General Commissioners that Mr Smith passed the business test and the compliance test but that he failed the turnover test. However, the General Commissioners found that the reason he failed the turnover test was because he worked only part time. He was 68 years old in September 2005 and his business turnover was reduced owing to a period of ill heath during which he had undergone two operations in hospital. They found as a fact as follows:

“The loss of the Sub-Contractor’s Tax Certificate would have a major adverse impact on [Mr Smith’s] business, such that he might well lose his current contracts, given that local authorities and a great number of building contractors were loath to deal with uncertificated contractors. The [General] Commissioners found that the consequential effects (which are the well-known effects in practice of the refusal of an application for a CIS 6 certificate), upon [Mr Smith]’s business would be not in the interests of justice and violated [Mr Smith’s] human rights.”

The General Commissioners accordingly allowed his appeal saying “[we] trust the CIS certificate should be issued to Mr Smith forthwith”.

In explaining why they had reached the conclusion which they did, the General Commissioners said this:

“The [General] Commissioners, taking account of [Mr Smith’s] exemplary tax record, took the view that in this case, unlike Hilton where there was non-compliance, there could be no suggestion of any adverse effect upon the economic well being of the country by us granting [Mr Smith’s] application for a Sub-contractors Tax Certificate CIS6.

……….

The principles outlined in European and UK Law clearly intend to prevent discrimination against those who work on a part time basis and regulations exist which protect part time employees. The [General] Commissioners form the view that discrimination against any worker on the grounds that he or she works part time must be contrary to the principles of and the intention of European and UK law. It is difficult to interpret legislation, particularly the taxation legislation relevant to this case, without taking those principles and the perceived intention of the legislative bodies into consideration.

……..

There is no doubt that [Mr Smith] is a part time worker. To refuse the issue of a CIS 6 certificate on the grounds that he does not satisfy the turnover threshold…, the reason being that he is forced by age and health problems to work part time, must be contrary to the interests of justice, because (1) in comparison with full time workers, the statutory regulations place an extra burden on part time workers, such as [Mr Smith] to satisfy the threshold test and (2) the amount required by these regulations to satisfy the threshold test is not the result of primary legislation, but of subordinate legislation introduced by the Board of HM Revenue and Customs, of which the Appellant is an integral part.”

I will deal first with the issue whether the turnover test is a disproportionate infringement of Mr Smith’s rights which are protected by the ECHR. I do so making the assumption, for the time being, that the turnover test does, indeed, apply in relation to his application for a renewed certificate since, if it does not, it is clear that HMRC would not be entitled to refuse a certificate simply on the basis that the test was not passed, the only ground for refusal so far stated.

Ferris J explained the certification provisions as a remedy for the abuse which he identifies in these words:

“However, it became notorious that many sub-contractors engaged in the construction industry “disappeared” without settling their tax liabilities, with a consequential loss of revenue to the exchequer”.

Earlier legislation had included the business test and the compliance test, but not the turnover test. This came to be seen by the revenue authorities and Parliament as defective. A person might have had no history of non-compliance with tax requirements (or at least no detected non-compliance) and could find the business test reasonably straightforward to pass. Even a dishonest trader might, therefore, before the introduction of the turnover test, have found find it comparatively easy to obtain a certificate.

The turnover test was therefore introduced to prevent a trader in a fairly small way of business from obtaining a certificate. It was apposite to catch, in particular, sole traders providing principally their own labour whose office requirements were small (they might even operate from a room at home), whose stock was negligible and whose tools were easily transportable; in other words, just the sort of person who would find it easy to “disappear”. These would be precisely the type of traders who had few tax compliance obligations, possibly nothing more than an obligation to file an annual tax return and actually to pay any tax and national insurance contributions due. The turnover test, with a threshold, currently £30,000, but not reviewed since 1999, prevents certification of persons who might be perceived as presenting a risk to the treasury through tax evasion. But it allows certificates to be obtained by the more substantial businesses, businesses which would, by their nature, have a more permanent establishment (both in terms of property and staff) and greater compliance obligations thus enabling HMRC to carry out monitoring on a more regular, systematic and effective basis than in relation to a sole trader operating on his or her own.

HMRC consider that the approach which they have adopted is fully compliant with the ECHR and the Human Rights Act 1998. Mr Nawbatt who appears from them finds it very difficult to see how there can be any issue on the application of Article 8. I agree. The right to respect for private and family life is not, so it seems to me, engaged by the certification provisions under consideration.

What might be engaged is the right, under Article 1 of the First Protocol, to protection of property (as the heading puts it) or to peaceful enjoyment of possessions (as the body of the Article puts it). In this context, I do not consider that the certificate, or the right to obtain a certificate, is the relevant property or possession. Rather, the property or possession (if any) is the right of a person in the position of Mr Smith to receive, as a subcontractor, payment in full in respect of contracts which he has made with a contractor: I agree with the analysis of Ferris J in Vicky at paragraphs [43] to [47].

Such a right is, however, subject to the second limb of Article 1, according to which that right does not in any way impair the right of a State, among other matters, to enforce such laws as it deems necessary to secure the payment of taxes. That saving does not give a State an unfettered right to impose taxes or measures to ensure compliance with taxation provisions. As Ferris J puts it in Vicky at paragraph [49]:

“….an interference with property, even for securing the payment of taxes, is justified only if it strikes a proper balance between the demands of the general interest of the community and the requirement of the protection of the individual’s fundamental rights (see National and Provincial Building Society v United Kingdom [1997] STC 1466, 25 EHRR 127; Aston Cantlow and Wilmcote with Billesley Parochial Church Council v Wallbank [2001] EWCA Civ 713 at [44]. [2002] STC 313 at [44], [2002] Ch 51; Lester and Pannick Human Rights Law and Practice (1999) para 4.19.15). It is clear, however, that in a matter of this kind, each state enjoys a wide margin of appreciation. It cannot, in my judgment, be said that the provisions of s 565(3), (4), (8) and (8A) are arbitrary or excessive having regard to the fact that their purpose is, in Mr Cousin’s words “to avoid the notorious practice of sub-contractors being paid gross and then never accounting for their tax liabilities”.”

It is put this way on National and Provincial Building Society itself, at paragraph 80:

“According to the court's well-established case law (see, among many other authorities, Gasus Dosier-und Fördertechnik GmbH (at 435, para 62)), an interference, including one resulting from a measure to secure the payment of taxes, must strike a 'fair balance' between the demands of the general interest of the community and the requirements of the protection of the individual's fundamental rights. The concern to achieve this balance is reflected in the structure of art 1 as a whole, including the second paragraph: there must therefore be a reasonable relationship of proportionality between the means employed and the aims pursued.

Furthermore, in determining whether this requirement has been met, it is recognised that a contracting state, not least when framing and implementing policies in the area of taxation, enjoys a wide margin of appreciation and the court will respect the legislature's assessment in such matters unless it is devoid of reasonable foundation (see Gasus Dosier-und Fördertechnik GmbH (at 434, para 62)).”

Those last words place a very high burden on a person seeking to challenge the measures which a state has deployed to counter tax evasion: not only does the state enjoy a wide margin of appreciation but the ECJ itself (and a fortiori I would say the national court) will respect the legislature’s approach unless devoid of reasonable foundation. As Lewison J put it in Barnes v Hilton Main Construction Ltd [2005] EWHC (Ch) 1355 [2005] STC 1532:

“Under our constitution Parliament is entrusted with the primary role of devising solutions to national economic and social problems. The court’s task is limited to that of review.”

It cannot be said, in my judgment, that a turnover test is, of its very nature, a disproportionate response to the perceived problem of tax evasion in the contruction industry. It is well within the margin of appreciation for Parliament to have adopted, as one of its responses to the abuse of the tax system, a scheme of certification which includes as one of its elements the turnover test. If one ignores, for the moment, special cases of possible discrimination, instances of which have been identified by Mr Blackman (who appears for Mr Smith) – part-timer workers, workers of advanced age, women on maternity leave – a turnover threshold of £30,000 cannot be said to be an unreasonable place at which to draw the line between those eligible and those ineligible for certification. Different minds may take different views on precisely where the line should be drawn, and HMRC itself may consider that the time has come to review the level of the threshold. It is, however, impossible in my judgment to say that the concept of the turnover test is disproportionate and outside the margin of appreciation, let alone that it is devoid of rational foundation. Nor is the actual implementation of such a test with a threshold of £30,000 outside the margin of appreciation or devoid of rational foundation.

There is, in any event, some flexibility in the actual application of the turnover test because of the way that the Regulations make provision for evidence to satisfy the test. The six month test and the main three year test each give some latitude to a strict approach which would require a subcontractor to show that he would reach the threshold turnover in each of the three succeeding years, an evidential burden which might be very hard to fulfil. This structure thus reflects an element of proportionality.

Mr Blackman submits that, even so, the statutory scheme fails to create a fair balance in certain cases – for example those cases mentioned in paragraph 30 above – and is therefore a disproportionate response in those cases to the problem which it addresses. For present purposes it is necessary only to consider the classes of part-time workers and elderly workers such as Mr Smith. Of particular concern, so far as Mr Blackman’s submissions go, are workers who have become part-time workers because of age or ill-health

The reason why it is said that the balance is unfair in these cases is that the scheme is discriminatory against the classes under consideration. It is said that persons in these classes cannot reach, or have more difficulty in reaching, the threshold. They are no more likely, as a class, to abuse the tax collection system than the full-time worker and yet they cannot qualify for the advantage of a certificate. The unfairness can, it is said, be seen by considering the position of Mr Smith himself who passes the business test and the compliance test (the latter with flying colours in the view of the General Commissioners). As applied to him, the turnover test is, it submitted, discriminatory; the reason he is working part-time is because of his age and previous ill-health.

A fair scheme would, it is said, eliminate this discrimination by reducing the threshold in such cases to reflect the part-time nature of the work. Alternatively, where a person is in possession of a certificate but has had to reduce his scale of business so that he can no longer fulfil the turnover test, this should be recognised by a reduction in the threshold for persons previously holding a certificate.

The proportionality of the statutory scheme cannot, however, be judged by the individual case of Mr Smith; it must be recognised that the scheme is applicable across the entire construction industry and the fairness of the balance which has been struck by Parliament must be assessed in the light of that.

I do not consider that the statutory scheme fails to create a fair balance in relation to part-time subcontractors in the construction industry simply by reason of the fact that they are part-time and by reason of that fail to pass the turnover test. There is no reason to think that the risk of tax abuse which it is the purpose of the scheme to eliminate is any less present in persons who choose to work part-time than in full time workers. The statutory scheme is not discriminatory against a person who chooses to work part time any more than it is discriminatory against a worker who, working full time, does not command sufficient pay in the market to reach the threshold.

In any event, a system which adjusted the threshold for part-time workers would be very complex, if not impossible, to operate. It would be necessary to identify what counts as part-time and perhaps divide part-time work into bands eg quarter-time, half-time, three-quarter time workers; it would be necessary to have different thresholds for the different bands; and it would be necessary to introduce systems to monitor the extent of the part-time work Such a system would, itself, present the opportunity for further abuse: a worker could pretend to be part-time and obtain a certificate on the basis of part of his work and a lower threshold but could then work full time, failing to disclose other work and his earnings above the threshold.

The General Commissioners took a different view and said this:

“The principles outlined in European and UK law clearly intend to prevent discrimination against those who work on a part time basis and regulations exist which protect part time employers”.

It is not easy to tell precisely what the General Commissioners had in mind. They put forward a wide proposition for which they cite no authority and which goes beyond what the law provides. Perhaps the General Commissioners had in mind the Part-time Workers (Prevention of Less Favourable Treatment) Regulations 2000 SI 2000/1551; no other provision, at least, has been identified as possibly relevant. But those regulations lay down, broadly speaking, the pro rata principle of equal pay for equal work. They provide for a part-time worker not to be treated less favourably by his employer than a full-time worker. Even if a subcontractor were to be treated as a “worker” within the definition of the regulations and the contractor were to be treated as his employer, the difference in treatment of subcontractors who do and do not have certificates is not a difference in treatment by the contractor as the regulations require. Rather, the difference is a difference in the way that the tax legislation treats the subcontractor, requiring the contractor to make specified deductions for the payments to the employer. I do not find anything in the regulations which renders unfair or disproportionate the application of the turnover test to part-time subcontractors in the same way as it is applied to full-time subcontractors.

Mr Blackman, however, submits that the position is different where the reason that the subcontractor works only part time is because of some objectively identifiable reason preventing full-time work, such as ill-health or old age. He suggests that it is a fact of life of which I should take judicial notice that people in the position of Mr Smith running their own businesses as sole traders will work shorter hours in their old age. On that basis, he submits that the statutory scheme is discriminatory on the grounds of age. In relation to that, I would comment that, if there is any discrimination such as he suggests, it is indirect: it is the result of older subcontractors in the construction industry working part-time only and thus, as a class, being less able to pass the turnover test than younger people carrying on the same type of business.

I am not sure that the premise of this argument (ie older subcontractors generally work only part time) is correct; it is just as likely, I would have thought, that a person would go from full-time work to retirement. I certainly do not consider that it is a matter of notoriety which I should accept without evidence. In that case, it cannot be said that the certification criteria are discriminatory at all. But even if the premise is accepted, so that there is indirect discrimination of the type indicated, it does not follow that the turnover test is thereby rendered unfair or a disproportionate response to the problem of tax avoidance which the statutory scheme addresses. It seems to me that similar complexities and operational difficulties to those which I have identified above in relation to a system for treatment of part-time subcontractors generally would apply to older part-timers. The system would need not only to lay down one or more lower thresholds depending on the age of the subcontractor but it would need also to provide that the lower threshold applied only if the individual concerned in fact worked part time; and different bands might need to apply depending on the extent of the part time working. The dual requirement of age and part-time working would be necessary, otherwise the scheme would be discriminatory against younger workers. To give an example, Mr X falls just below the current threshold and is not entitled to a certificate; he attains an age at which the threshold decreases. He may continue working full-time but his turnover may be above the reduced threshold so that he would become entitled to a certificate. The result would be that a full-time worker could become entitled to a certificate simply by virtue of attaining an older age. However, given that the purpose of the reduction of the threshold is to cater for older people who wish to reduce their working hours, it is clear that the system must, at the same time, introduce a requirement that the older person can take advantage of the new threshold only if he does, in fact, reduce his working hours. But that will produce a system of extreme complexity and one open to abuse in just the same way as described above in relation to the idea that the scheme should provide a lower threshold for all part-time workers regardless of their age.

I do not say that it would be impossible to devise, implement and police a complex scheme of this nature. But what I do say is that it is not necessary to do so in order to provide a balanced and proportionate response to the abuses which the certification scheme is designed to address. In my judgment, the turnover test, as implemented with a single threshold of £30,000, is within the margin of appreciation which is allowed under Article 1 of the First Protocol. Further, it is impossible, I consider, to say that the test as so implemented, is devoid of rational foundation.

It is then suggested as a fall-back position that a fairer balance would be struck if a lower threshold were allowed to an older worker who applies to renew a certificate rather than one who applies for a certificate for the first time. A person who had obtained a certificate, and had thus passed all three tests including the turnover test, could, it is said, be seen to be a person who did not present a risk provided that he continued to fulfil the business test and the compliance test. This approach, in this simple form, is defective since it would in fact introduce a discriminatory element which is not at present there. For instance, consider a trader who has been operating at a turnover of £29,000 for several years and who, being an honest person, has been fully compliant with his obligations under the legislation. It would be unfair if a person who had previously held a certificate were put at an advantage by being allowed a renewal by reference to a lower threshold. Accordingly, it would be necessary to restrict this approach to persons who are old and part-time workers, in which case the complexities and difficulties which I have identified in relation to a reduction in the threshold for older people generally would apply with equal force. In my view, there is no disproportionality in the failure to adopt such a complex solution.

Accordingly, the General Commissioners were wrong, in my judgment, in reaching the conclusion that there was an infringement of Mr Smith’s human rights. I think that this is a matter of law on which I am entitled to overrule the General Commissioners if I consider that they are wrong. However, if and to the extent that the issue is one of fact, I do not consider that any body of General Commissioners properly instructed on the law could have reached the conclusion that the turnover test as implemented in our domestic legislation fell outside the margin of appreciation which the state enjoys in formulating and implementing policy in the field of taxation.

There is, accordingly, no need to “read down” the provision of section 562 or the Regulations in order to ensure protection of human rights as required by the ECHR and the Human Rights Act 1998. I do not, therefore, need address the provisions of section 3 of that Act.

It was common ground, as I have said, before the General Commissioners that the turnover test was not fulfilled by Mr Smith; it was also, I think, common ground that the turnover test did, indeed, have to be fulfilled. Before me, Mr Blackman has raised an argument that the turnover test is not of relevance. He says:

I reject that argument. Paragraphs a. to c. are correct; but the conclusion in paragraph d. does not follow. First, it does not follow as a matter of strict construction of regulation 27. What the regulation says is that section 561 (not section 562) shall apply to an application for renewal. Section 561 has not been amended in any relevant way. What has been amended is section 562, by the introduction of subsection (2A). That automatically results in the turnover test being one of the matters which has to be satisfied under section 561(2)(a) without the need for any amendment to section 561(2) itself. Regulation 27 then continues to apply as it always has done by applying section 561, with the result that the turnover test is automatically incorporated.

Secondly, section 20 Interpretation Act 1978, read with section 23 applying to subordinate legislation, provides that where an Act or subordinate legislation refers to an enactment, the reference, unless the contrary intention appears, is a reference to the enactment as amended. It does not necessarily follow that this rule applies, in all cases, to future amendments ie where an amendment to an enactment takes place after another Act or piece of subordinate legislation which refers to it. The present case is, indeed, an example of that situation: the Regulations refer to ICTA which was itself amended to introduce section 562(2A) after the introduction of the Regulations. The correct answer can be reached only by an examination of all the circumstances, including the nature of the amendment and the nature of the reference made to the Act which is amended. In the present case, it is clear, in my judgment, that Parliament, in introducing section 562(2A), intended the turnover test to apply to all applications for a certificate and did not seek to draw a distinction between first applications and renewals.

I accept the submissions made on behalf of HMRC that the General Commissioners were in error in the conclusion which they reached. In particular, they erroneously concluded that the statutory test constituted a disproportionate infringement of Mr Smith’s rights under Article 8 ECHR to respect for privacy and family life. They did not address the right to enjoyment of possessions but had they done so they could not properly have concluded that there was an infringement of that right. Mr Smith did not, in fact, pass the turnover test. Once it is accepted that the turnover test does not result in a disproportionate infringement of Mr Smith’s rights under the ECHR, it follows that HMRC were correct in refusing a certificate since there is no sustainable argument that section 562(2A) does not apply when Regulation 27 comes to be applied.

Accordingly, HMRC’s appeal is allowed.