The case of 50 Five (UK) Limited serves as an example of why due diligence is an essential component when acquiring an existing business. The consequences of not understanding the accounting position of the target business can have an impact on the acquired business and the shareholders.
Ms Parkin and Mr Klumpenaar acquired an existing business whose trade was fitting and installation of heating and water systems. They sought to challenge VAT assessments raised by HMRC against the business they had purchased, but the case was struck out by the tribunal as there was no reasonable prospect of the appeal succeeding.
The tribunal noted that: “It is bound by the judgment of the upper tribunal in AN Checker Heating and Service Engineers [2018]. In that case, it was determined that the legislative provisions which permit the sale of energy-saving materials at the reduced rate of VAT apply only where the supply of those materials is independent of an installation service. As such the installer will be charged the reduced rate but when making a supply on to the customer the full standard rate of VAT must be charged. Given that VAT is a consumption tax and the reduced rate is presumably intended to benefit the consumer, that judgment is counter intuitive.”
It is therefore inferred from this that the historical assessments issued by HMRC were in relation to charging a reduced rate on supplies instead of the standard rate. The transcript does not mention what the value of the assessment is or what periods it covered.
The case transcript does not explain how the business was acquired but presumably they either bought the shares of the existing company (unknowingly taking on its historical liabilities) or they transferred the business as a going concern to their own company but retained the VAT number of the seller. Either way, the new owners were liable for the historical VAT assessments, which they knew nothing about.
Historical errors
Acquiring a business without knowing much about it is a significant business risk. From a VAT perspective, historical errors can arise. Often even the seller isn’t aware they’ve made an error, whether it is an option to tax not being notified, cross charges between connected companies or zero-rating exports without holding proof of export.
The list of potential issues is long and away from VAT and into other taxes, other risks such as payroll/NI errors, employment law (minimum wage), SEISS grants and Bounce Back Loans are all possible tripwires for an unsuspecting buyer.
Due diligence doesn’t remove the historical liabilities, but it informs the buyer and this may lead to a reduced selling price or corrective action being taken before the purchase takes place. If the issues are significant then the sale may not go ahead.
A buyer may just want to get on and buy, thinking they don’t have time to grind through a due diligence process. Plus, of course, there are the additional fees from the accountants. However, as this case clearly demonstrates, a little patience and outlay would likely have paid for itself in terms of cash, and in avoiding having to deal with HRMC and going to tribunal. All that time expended post acquisition could have been spent focusing on growing the business.
Transfer of a going concern
The buyers in this case could have chosen to buy the business as a transfer of a going concern and obtained a new VAT registration for the new business. This would contain the VAT error to the old VAT number of the seller.
Whether a sole trader incorporating or acquiring a target business, it makes sense to obtain a new VAT number to reduce exposure to historical risks. Acquiring shares in an existing business comes with the risk of historical errors, so if buying shares it makes sense to perform some sort of due diligence. If nothing else it then acts as a formal document that can form part of the purchase agreement.
In the case of 50 Five (UK) Ltd, their only recourse is to sue the previous owners. How successful that will be is uncertain – the sellers may have closed up shop and retired – but ultimately, the liability belongs with the company and to sue individual shareholders is not without difficulty. Proving the sellers knowingly sold with a VAT liability would be easier if a basic due diligence had asked some basic questions.
Sympathy for the taxpayer
The tribunal had sympathy but ultimately had no room to manoeuvre. The tribunal did suggest to HMRC that it may want to take a lenient position in terms of application of penalties, but the penalty regime is based on assisting and disclosing – there isn’t a rule for “feeling sorry for the taxpayer”. Perhaps a penalty suspended would be the fairest solution but there is no getting around the VAT liability owed to HMRC – a very expensive business purchase indeed.