Snow Factor Limited v The Commissioners for HMRC

The provisions of section 85B of VATA 1994 fall to be construed in their context. The context includes the statutory provisions governing the bringing of appeals and the payment of amounts of disputed VAT pending the resolution of a dispute. In my view it is clear that different considerations apply at different points in the course of the appeal process.

In the case of the initial appeal against an assessment to VAT, the general rule is that an appeal is not capable of being heard by the tribunal unless the disputed VAT is paid. That rule is designed to prevent abuse by bringing appeals to delay payment. But the potential harshness of that rule is ameliorated by providing that the VAT need not be paid if to do so would cause hardship to the appellant.

Those rules are designed to set “the price for entering the appeal process” (see [20] of Elbrook). It is entirely consistent with that objective that the hardship enquiry should not be a lengthy one and should focus on immediately or readily available resources.

But once the appeal process has been entered, different considerations come into play. In particular, when the FTT determines a disputed issue in favour of HMRC, the effect of section 85A(3) of VATA 1994 is that the amount of VAT not previously paid to HMRC (because of hardship to the appellant) “shall be paid ... to HMRC”. If the appellant is unsuccessful before the FTT, the VAT must be paid in accordance with the judicial determination, which seems to me to be a wholly unsurprising result.

But section 85A of VATA 1994 has the potential to operate harshly where an appeal is then brought against the decision of the FTT. It is with that case that section 85B of VATA 1994 is concerned. That section begins by making it clear that the simple fact of making a further appeal does not affect the requirement to pay the VAT in accordance with the determination of the tribunal. This general rule is, however, subject to two exceptions: one designed to protect the public revenue (subsection (3)) and the other operating in favour of the taxpayer (subsections (4) to (6)).

Subsection (7) of section 85B of VATA 1994 provides for subsections (3) to (6) to cease to have effect when the further appeal is determined. The operation of the exceptions is, therefore, strictly time-limited. Once the substantive appeal is determined, the position would then be governed by section 85B(2) of VATA 1994 if there is any change in the amount of VAT payable. If the applicant were to succeed on its further appeal on the substantive issue, then any amount required to be paid by this tribunal under section 85B(5) of VATA 1994 would be refunded to the applicant. If the substantive appeal were dismissed, section 85A(3) of VATA 1994 would then be re-engaged and section 85B would be relevant only if there were a further appeal from the Upper Tribunal.

It is with the rule operating in favour of the taxpayer that this application is concerned. The test for relief in this case is whether “financial extremity might be reasonably expected to result” from the payment of the disputed VAT required to be paid by HMRC following its decision on an application to it under section 85B(4) of VATA 1994.

That test differs from the one operating before the taxpayer enters the appeal process (“would cause the appellant to suffer hardship”) and it is no surprise that it does. There is no reason to suppose that a test designed to police the entry of taxpayers into the appeal process ought to be the same as the test operating once an appeal has been judicially determined (albeit that the determination is then subject to further appeal). Indeed, it would be somewhat surprising, in the light of the provision made by sections 85A(3) and 85B(1) of VATA 1994, if the test in section 85B(5) had replicated the section 84(3B) test. It is, of course, possible that the facts will change since the initial decision on hardship (whether made by HMRC or the FTT) so that the appellant would not suffer hardship if required to pay the VAT following the determination of the appeal. But in a great many cases that would not be the case.

Section 85B(5)(c) of VATA 1994 focuses instead on whether “financial extremity might be reasonably expected to result” from HMRC’s decision. Although I consider that this phrase must be construed as a compendious whole in the context of the remainder of section 85B and the other provisions of VATA 1994, it is nonetheless helpful to consider in turn the three different elements of that test:

It was common ground between the parties that “financial extremity” is a more onerous test to satisfy than “hardship”. I agree. It is a matter of law as to what those words mean and, in this context, my judgment is that they must bear their ordinary meaning. The ordinary meaning of that expression takes matters beyond mere hardship. Extremity is just that: it is at the very far end of the spectrum of financial health. Life should not be merely hard. More is required. In addition, it would be inconsistent with the legislative purpose if the test were easier to satisfy than hardship. That is because what needs to be shown is that the result is one which “might be reasonably expected” and not what the result “would” be. If financial extremity were no more than hardship, it would follow that, in many cases, the test in section 85B(5) of VATA 1994 would be easier to meet than the hardship test, which would, in turn, mean that the general rule given by section 85B(1) of VATA 1994 would operate as the exception.

Mr Simpson QC submitted that if the applicant (or, more accurately, the group of companies of which it is a member) were insolvent, that would constitute a state of financial extremity. He also submitted that circumstances falling short of insolvency ought, in principle, to be capable of constituting financial extremity. If Parliament had wanted to confine the test to insolvency, it could quite easily have done so. The fact that it had not showed that the test was a wider one.

In my view, it is not productive to come up with a list of generic cases which might, or might not, be within the meaning of the statutory words when applied to the particular facts of any given case. To do so would carry with it a real risk of supplying a judicial gloss to a simple expression and would, moreover, divert attention from a consideration of the various elements of the test working harmoniously together. Not all insolvencies are created equal: a momentary time at which the debts of a company cannot be paid as they fall due is very different from a case where a company has permanently lost its only sources of income while its (considerable) liabilities remain unaltered. It by no means follows that, having regard to the particular facts of the case (which may include the likelihood of any steps actually being taken by any person to commence insolvency proceedings), the former case will amount to financial extremity in the ordinary meaning of that expression. However, both cases might reasonably be regarded as ones where a company has become insolvent.

The statutory question is more nuanced than what would otherwise be a binary choice of viewing a financial state of affairs (financial extremity or not): the question is whether the circumstances are such that financial extremity “might be reasonably expected” to result from HMRC’s decision. There are two aspects of that qualification that are critical to a proper understanding of the test to be applied under section 85B(5) of VATA 1994. The first is that the test is “might” not “would”. It is a question of possibilities. The second is that not any old possibility will suffice: it must be “reasonable” in the sense explained below.

What might be reasonably expected is something more than a theoretical possibility. There must be some reasonable basis for thinking that the possibility might come to pass. The expectation is a reasonable one, and that is an issue to be decided by reference to what one considers might reasonably happen if payment were made in accordance with HMRC’s decision. I consider that the test of reasonableness here is, in essence, an objective one: having regard to the totality of the circumstances, what steps would it be reasonable to expect to be taken to meet the liability. But the test also has subjective elements: account must be taken of the particular circumstances affecting the taxpayer and the way in which it has chosen to carry on its business.

The final element of the test is that the financial extremity must “result” from HMRC’s decision. There must be a causative link between the decision to pay some or all of the disputed VAT and the financial extremity. But it was also submitted by Mr Thomson QC on behalf of HMRC that this result must be both direct and, more importantly, immediate.

I am unable to accept that submission. There clearly needs to be a causal nexus between the decision and the financial extremity but the directness of the causation is not, in my view, in point. That will be hard (if not impossible) to disentangle from the issue of reasonableness that I have just discussed. There is nothing in the statutory test that leads to an inference that “results” should be impliedly qualified by inserting “directly” before it.

As to the question of immediacy, I consider that there is a timeframe within which the financial extremity must result. That timeframe is indicated by section 85B(7) of VATA 1994, which definitively switches off the effect of subsections (4) and (5) once the further appeal is determined. Section 85B of VATA 1994 is focused on who is entitled to hold the disputed VAT pending the determination of the final appeal.

If Mr Thomson QC were right, it would produce some very odd outcomes, particularly in relation to the far from unusual case of cyclical businesses. There is no warrant, in my view, for taking such a restrictive approach to the meaning of section 85B(5) of VATA 1994. The reference to the result is unqualified. If it had been intended that the result would be “immediate” that qualification could quite easily have been added. A business might be able to pay the amount in one month and then suffer financial extremity the next (well before the appeal is determined). It is hard to see why that is a state of affairs that falls outside the relief provided for by section 85B(4) or (5) of VATA 1994.

In my view section 85B(5) of VATA 1994 has struck a careful balance between, on the one hand, the need to protect the public revenue (and, by extension, the general body of taxpayers) by requiring an amount of VAT judicially determined to be payable to be actually paid to HMRC and, on the other hand, the need to support the rule of law and the integrity of the appellate process by securing that appeals on points of law (for which permission has, by definition, been given) can actually be determined by the higher courts. An element of the test (financial extremity) is harder to satisfy than a section 84(3B) hardship application but that is balanced by the fact that, as the test is looking to the future to some extent (the determination of the final appeal), it requires an assessment of what might (rather than would) happen, itself qualified by reference to reasonable expectations.

Unlike section 84(3B) of VATA 1994, section 85B(5)(c) is silent as to the person who must be in a state of financial extremity. The silence is, in my view, meaningful. It contemplates that the impact of the decision might be felt beyond the applicant itself. That is apt to include the impact on a group of companies of which the applicant is a member (such as this case). Equally, the taking of the steps might, in a group context, be by some person other than the applicant (provided it is reasonable to expect that to happen).

HMRC’s decision letter of 15 November 2018 did not include any reasoning to support its view. It stated the wrong test (“would” cause not “might be reasonably expected to result”). And it purported to require a payment that exceeded the disputed VAT being appealed: see [8] above. None of these observations are, however, relevant to the decision falling to be made in this application: what is required is not a supervisory review of what HMRC has done but a de novo assessment of whether the tests set out in section 85B(5)(a) to (c) of VATA 1994 are met. If they are, then the powers set out in section 85B(6) of VATA 1994 are available for this tribunal to exercise.

How then does section 85B(5)(c) of VATA 1994 apply in relation to HMRC’s decision in this case?

The facts to which the applicant points in support of its application are that, as a result of HMRC’s decision, the immediately available resources available to the group would go into a deficit of £105,230.37 in June 2019 with a deficit continuing until November 2019 of at least £218,773.27: see [48] above.

The appeal on the substantive matter was, at the time of HMRC’s decision, set for a possible hearing at some time between March and June 2019. Allowing a reasonable period for the making of the determination by the Upper Tribunal, it would seem to me that there is a reasonable prospect that the further appeal would not be determined until the autumn of 2019 (September or October).

The critical issue in this application is, in my judgment, the extent to which (if at all) it is reasonable, before the determination of the substantive appeal, to expect steps to be taken so that the applicant is in a position to meet some or all of the liability to pay the disputed VAT without financial extremity resulting. It is not sufficient for the applicant simply to point to the projected cash flow drawn up on the basis that no steps are taken to meet any part of the liability to pay the disputed VAT and leave it at that.

In considering what steps might be reasonable I should have regard to all the circumstances. Those circumstances include the following:

The applicant is entitled to continue to account for VAT on the basis that the FTT’s decision was wrong in law and then be assessed by HMRC accordingly (and presumably appeal the assessments). But, if it takes that approach, it seems to me only reasonable to hold the applicant to the same approach in relation to the payment of the disputed VAT: on its own view, any payment will be recoverable once the appeal is determined in its favour.

What steps would it then be reasonable to expect it to take to meet some or all of the liability for what it considers will be a temporary period?

In determining what those steps might be, it is relevant that the projected cash flow was a reasonable one. It was, as I say above, neither optimistic nor pessimistic. In my view, it is therefore reasonable to have expected the applicant to have taken some steps to trade through any temporary cash flow difficulties. I consider that it is reasonable to expect steps to have been taken to increase prices (or advance receipts) or reduce expenses (or delay payments) to at least some extent. And it is reasonable to expect the bank to have been approached for an extension of the overdraft, assessing its likely reaction by reference to its previous conduct.

Who should have taken the steps?

If it is right to take account of the group position, I also consider that it is relevant to take account of the steps which the applicant’s sister company, Ice Factor Kinlochleven, could reasonably be expected to take. Although no evidence was led on this, it seems evident that the expenses of the applicant’s holding company (Ice Factor International Ltd) will be funded by distributions made to it by its subsidiary companies. It might reasonably be expected that, in addition to action taken by the applicant, Ice Factor Kinlochleven would pick up some of the slack so that Ice Factor International Ltd was in a position to meet its liabilities.

However, different considerations seem to me to be applicable to the action expected to be taken by the holding company itself. Clearly, the applicant is not in a position to control this (the relationship of control is, of course, in the other direction). Furthermore, the majority of the expenses of Ice Factor International Ltd relate to fixed debt in relation to which short-term restructuring is unlikely; and its other expenses are already relatively modest. Accordingly, it seems to me reasonable to take account of possible steps to be taken by Ice Factor Kinlochleven but not by Ice Factor International Ltd.

In my judgment it is also reasonable to anticipate that the cash flow might move against the applicant. That factor is relevant in determining the steps which could be reasonably expected to be taken: to push the expected steps to the maximum might itself be unreasonable. It is reasonable to build in a ‘cushion’ to some degree against the forecast turning out to be worse than expected.

In my view the test that I need to apply involves, adapting the words of Lord Hoffman in Designers Guild v Russell Williams (Textiles) Ltd (trading as Washington DC) [2000] 1 WLR 2416, 2423, the application of a not altogether precise standard to a combination of uncertain features. I consider that, having regard to the matters set out above, the applicant could reasonably be expected to have taken a combination of steps: a temporary but modest increase in prices (or advancement of receipts), a temporary but modest decrease in expenses (or delay in their payment) and a temporary increase in its overdraft to £80,000.

To determine the level of the increase or decrease in receipts or expenses is a difficult task, particularly as I have relatively limited financial information before me and the determination involves the making of assumptions about future trading operations. Recognising the fact that the applicant operates within relative tight margins, it seems to me to be reasonable to assume that both the applicant and Ice Factor Kinlochleven could have increased their receipts by 2% and reduced expenses falling due by 2%. I consider that a reasonable period for which the increases and decreases have effect would be a temporary period of six months.

As I mention above, those steps are premised on the fact that more might be possible; but more would not necessarily be reasonable. In particular, I think that it would not be reasonable to expect a movement in the cash flow of 10% or more. Accordingly, a figure of 2% for both receipts and expenses builds in an element of ‘cushion’ (and, of course, it may be that the easiest course of action would be to make changes to either receipts or expenses (rather than both)). In determining this figure of 2%, I have also had regard to the extent to which the applicant had arranged to pay arrears in respect of its rent and rates totalling £96,000 for the 12 month period. As a percentage increase in the rent and rates otherwise falling due, that is significantly more than 2%; but the assumption that I have made is a universal movement in amounts without exception. Clearly, in reality, the actual changes would be likely to be more varied than this.

I should also make it clear that any one of these things could reasonably be done to a greater or a lesser extent than others: eg, the overdraft could be bigger or an increase in prices could be more significant or receipts could be increased in other ways (eg, by advancing sales). There is, plainly, a very substantial element of judgment in this.

In the course of the hearing, HMRC agreed that, despite the fact that the application was against its decision to require payments in December 2018, January 2019 and February 2019, it would make little sense, if the application were to be dismissed (as they sought), to require payments to be made on dates that had already passed. Instead, they suggested that the payments should be made at the end of February, March and April 2019. In considering the application, however, the statutory question requires the tribunal to consider the effect of the decision that HMRC actually took.

In my view, the correct way to proceed is to recalculate the expected cash flow on the assumption that the payments were made to HMRC in accordance with its decision and on the assumption that the applicant takes the step outlined at [87] and [88] above. For this purpose I would assume that, in relation to the applicant and Ice Factor Kinlochleven, receipts were increased by 2%, and expenses were decreased by the same percentage, throughout the six-month period December 2018 to May 2019 and steps were also taken to increase the overdraft to £80,000 so that, before the determination of the substantive appeal, an increased facility were available (ie, the availability of the overdraft would extend beyond May 2019 until the time at which it might be reasonable to expect the appeal to be determined).

If the forecast is recalculated on the assumptions set out at [92] above, the result is that the immediately available resources to the group for December 2018 to May 2019 would (to the nearest £1,000) respectively become positive figures of £114,000, £239,000, £268,000, £294,000, £218,000 and £147,000. If the consideration stopped there, there would be no question of financial extremity resulting.

However, as I explain above, I do not consider that it would be right to stop there. Consideration also needs to be given to the position in the following months when those months could reasonably be expected to fall before the determination of the appeal (which could be October 2019, although, of course, it could be sooner or later than that).

On the above assumptions, the immediately available resources for June 2019 would (to the nearest £1,000) be a positive figure of £21,000 before becoming a deficit for July 2019 to October 2019 of respectively £104,000, £117,000, £109,000 and £118,000.

The question then is whether this state of affairs is, within the ordinary meaning of that expression, “financial extremity”. I consider that it is. The deficit figures are, in my view, significant: in each case they exceed £100,000. The position lasts for a number of months. The applicant would have to consider taking much more significant action than I have assumed above in order to return the group to a more stable financial footing. Such action would, in my judgment, go beyond what can be reasonably expected.

I should point out that, even if the same 2% change in receipts and expenses were continued beyond the assumed six-month period, the deficit figures would still remain significant (with, approximately, a reduction in the deficit of £10,000 to £12,000 for each subsequent month, so that, for example, the deficit for July 2019 would be around £22,000 lower).

Accordingly, my decision is that, in relation to HMRC’s decision of 15 November 2018, the tests in section 85B(5)(a) to (c) of VATA 1994 are met.

It does not, however, necessarily follow that the application succeeds. If the tests are met, the subsection provides that the tribunal “may” replace, vary or supplement HMRC’s decision by doing one or more of the things listed in subsection (6). That is a power rather than a duty. In relation to the exercise of this power, there is nothing in terms that directs the tribunal to have regard to any particular factor in considering whether, and (if so) how, to exercise it.

In my view, the power available to me should, on first principles, be exercised judicially in the light of the purpose of section 85B of VATA 1994 as I have described it at [72] above. It is clear to me that, in assessing what would be a fair and just disposal of this application, regard must properly be had to the steps that might be reasonably expected to be taken to pay some or all of the disputed VAT.

In my view, it is relevant, therefore, to consider, as at the date of the disposal of this application, what would happen if the applicant and Ice Factor Kinlochleven took the steps described at [87] and [88] above in the six-month period from March to August 2019. I recognise that this takes no account of the fact that the applicant (or Ice Factor Kinlochleven) could reasonably have been expected to take steps sooner than that; but, at least in the case of this application, it seems to me to be fair and reasonable to consider only steps that can be taken once the application is disposed of.

The result would be that, if no payment of the VAT were required and those steps were taken, the immediately available resources to the group for March 2019 to August 2019 would (to the nearest £1,000) respectively become £537,000, £461,000, £390,000, £274,000, £161,000 and £160,000. The resources for September and October 2019 would then become £168,000 and £159,000 respectively.

In those circumstances, it seems to me that, in exercise of the power mentioned in section 85B(6)(a) of VATA 1994, the applicant should pay £155,000 of the disputed VAT to HMRC. Throughout the period beginning with March 2019 and ending with October 2019 the immediately available resources to the group would, if the above steps were taken and if £155,000 were paid to HMRC, be a positive figure. I note that the effect of this decision is that the applicant would be required to pay more than half of the disputed VAT, which, in all the circumstances, seems to me to be a just and reasonable outcome.

What those powers do not seem to contemplate is requiring payment in instalments (which is, of course, what HMRC decided to do in its November 2018 decision). Even if that is a possibility, I can see no reason why payment in instalments would be appropriate in this case, bearing in mind the expected resources available to the group in the next few months. The applicant currently has the resources to pay the sum of £155,000 in a single payment.

The section is also silent as to when the payment should be made. I note, however, that section 85B(2)(b) of VATA 1994 requires payment within 30 days in a case where a determination of the further appeal results in more VAT becoming payable. That would, in my view, be an appropriate period for the payment to be made in this case.

For the above reasons, I decide that the tests in section 85B(5)(a) to (c) of VATA 1994 are met. I exercise the power conferred by that subsection (and subsection (6)(a)) to replace HMRC’s decision by requiring the payment of £155,000 to HMRC. The payment must be made before the end of the period of 30 days beginning with the day on which this decision is released to the parties.