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No VAT due on dishonest employee’s private bank account payments

5th Jul 2019
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Neil Warren investigates the curious case of Total Catering Equipment, where the company claimed bad debt relief on payments made to a fraudulent employee’s personal bank account.

The cashless society is becoming more prominent by the day, with more debit card transactions and fewer cash payments taking place. The implications of this trend are enormous but I never thought that VAT could be affected until I read the startling case of Total Catering Equipment Ltd (TC7184).

Case facts

The case concerned bad debt relief on goods for which the company never received payment because a dishonest employee gave customers his personal bank account details rather than those of his employer.

The dishonest employee took orders for goods over the telephone from customers but arranged for debit card payments to be paid into his personal bank account, rather than the business account.

The company originally accounted for output tax because sales had been made, but when the directors learned of the employee’s dishonesty they claimed bad debt relief on a subsequent VAT return. It seems that the employee never repaid the money and although there was police involvement, no prosecution was made.

HMRC approach

HMRC’s view was that the dishonesty was the same as if the employee had stolen cash from the till – that is, output tax was still due because a supply had taken place (as per HMRC Notice 727/3, para 5.2).

However, the judge said this was a different situation because the cash scenario meant the company was a “victim of theft by one of its employees.”

Instead, the employee had made a “dishonest frolic on his own” (an old legal expression that you might want to Google for interest) and had not acted “within the scope of his employment”. The company was entitled to claim bad debt relief and the appeal was allowed.

Bad debt relief claim

My personal view is that because customers have made payment for the goods in question and have been charged VAT on the sales by a VAT-registered business, then output tax must be declared by the seller. End of story.

The taxpayer claimed bad debt relief on the basis that the company had never received payment and the tribunal agreed. But how can you have a bad debt when the customer has fully paid his dues?

Daily gross takings

I discussed this case over a number of emails with a VAT friend and he felt there might be an argument within EU law for the output tax to be reduced as an adjustment to daily gross takings, rather than a claim for bad debt relief.

This seems reasonable because Art 90 of the VAT Directive 2006/112/EC says: “where the price is reduced after the supply takes place, the taxable amount shall be reduced accordingly under conditions which shall be determined by the Member State.”

A bizarre argument put forward by HMRC and also rejected by the court was that the employee had acted as an agent when he banked the money into his own account. However, this approach is flawed if the employee had no intention of parting with the cash.

Learning points

As well as winning the award for most surprising VAT tribunal decision of 2019 so far, the case also wins a prize for producing the shortest report I have read – just four pages!

Hopefully, instances of dishonest employees pinching money from their employers are few and far between. It will be interesting to see if HMRC appeals the decision.

The case is a good reminder that a business can legitimately reduce its daily gross takings figure for output tax purposes in many situations: for example, if refunds are given to customers or voluntary tips are received.

Tips are outside the scope of VAT as long as the customer is not obliged to make the payment.

Replies (19)

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By SteLacca
07th Jul 2019 09:32

It's nice that the so called simple tax is so simple.

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By Duggimon
08th Jul 2019 10:41

This seems a ridiculous ruling. We've got the outcome where the customer has paid and so reclaimed input VAT, but the VAT is never paid over to HMRC because the supplier gets the bad debt relief.

Presumably the missing part of the outcome is where, in addition to the criminal proceedings against the fraudster, HMRC also compel them to register for VAT and hand over 1/6 of their ill gotten gains.

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Replying to Duggimon:
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By Rgab1947
08th Jul 2019 14:51

HMRC should prosecute the employee as the employee has in effect stolen the VAT due from HMRC.

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By Mikesch
08th Jul 2019 11:19

Looks to me the employee stole from the company. Output VAT should be paid.
Otherwise any retailer who can prove that their employees had a hand in the till could reclaim the VAT on the stolen money too, right?

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Replying to Mikesch:
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By NH
08th Jul 2019 12:51

A distinction was made between the diversion of monies in this case (where the supplier was deemed to never had received the money) and a theft by an employee from, eg; a till or subsequent withdrawals from the business’ bank account (where a business would have received payment before the money was stolen).

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Replying to NH:
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By Roland195
08th Jul 2019 14:04

So the same could apply to the employee of an ice cream van by diverting the cash to his own pocket?

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By NH
08th Jul 2019 14:19

Not really, the ice cream employee would be highly unlikely to record the sale in the first place

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Replying to NH:
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By Mikesch
08th Jul 2019 22:06

Hm, it’s ambiguous though isn’t it. One of my clients is a pub owner. He had to let go one of the bartenders as he frequently rung up cash sales on the till but put the money in his pocket. Same difference imo.

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By richards1
08th Jul 2019 11:42

Seems to me that the dishonest employee has the VAT so HMRC should pursue him/her for payment

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David Winch
By David Winch
08th Jul 2019 12:01

The author may know more than we do when he notes, "It seems that the employee never repaid the money and although there was police involvement, no prosecution was made".
I would not be surprised if that were the case and, if so, it could have something to do with limited police resources.
David

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By NH
08th Jul 2019 12:50

Now that the ruling has been handed down, how hard would it be for HMRC to get the VAT back from the employee, doesn't take much resource to send a nasty letter followed by a visit from the boys, that would seem like the most obvious course of action

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By Dandan
08th Jul 2019 13:47

I do not understand why it seems to bother so many people that HMRC did not win that one.

Surely, the trader did not receive a penny and it is fair that they get bad debt relief. For once practicality prevails but some people are not happy about it.

Let's not forget how unfair VAT is ; especially for the final end user . After you have paid all you taxes and are left with your "disposable income", you then get cloberred as soon as you spend it. It is the most evil form of tax aimed at the individual.

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By whopkinscom
08th Jul 2019 13:52

The way I read it is that the customer was "de-frauded", i.e. they didn't pay the supplier and were tricked into paying the money into a different account. Therefore surely the customer still owes the debt and in the circumstances, the supplier is treating it as a bad debt.

Presumably the supplier could still pursue the customer for payment - though this would obviously not be a sensible business decision?

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By carol1971
08th Jul 2019 14:32

I was initially surprised by the ruling until I read W Hopkinsom comment.
It appears to me that in this case, the customer is the one defrauded and not the employer....so the customer still owes the money and so presumably should repay vat ?
I wonder about their legal position/ defence as the customer was dealing with a representative who was acting on behalf of their employer. After all I assume the customer received the goods.

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Replying to carol1971:
David Winch
By David Winch
08th Jul 2019 14:46

I think the Tribunal concluded that the customer was NOT dealing with a representative who was acting on behalf of their employer. The person they were dealing with was off on a dishonest frolic of his own. The customer was deceived regarding the position.
David

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By geoffmw1
08th Jul 2019 17:14

This looks like a case of poor controls. Over what period of time did the fraud take place?

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By geoffmw1
08th Jul 2019 17:16

Over what period of time did this fraud take place? It looks as though the controls were lacking.

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By C.Y.Nical
08th Jul 2019 21:18

"Hopefully, instances of dishonest employees pinching money from their employers are few and far between."
Oh my word. Oh dear, oh dear.
I worked for the country's biggest chain of off-licences, and the biggest chain of CTNs. Huge turnover businesses, both of them. "Shrinkage" by way of shoplifting was negligible. Hardly worth bothering about. But theft by staff was a huge problem that required dedicated teams of internal auditors, stock-takers, and mystery shoppers. There were systems that alerted management quickly when a particular branch had the disease and thousands of pounds worth of resources would be thrown at the target ASAP and would continue to be thrown until a camera or a marked fiver or some other device caught the thief. This was a routine occurrence.
I remember being told by a business transfer agent from whom we used to buy sole-trader businesses that when the figures for a prospective sale didn't stack up he would ask the seller about his staff. At the end of the list would be Jenny or Dave, 'longest serving employee, family friend, would trust them with my life'. "That's always the one", said the business transfer agent.
Most people are honest. But temptation is a sin we are all susceptible to and every business should have systems in place that prevent staff from stealing, so the staff don't have to fight temptation.

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By mickeyparish
19th Aug 2019 17:02

Seems to me that this is akin to well documented fraud cases where fraudsters contact a company pretending to be a supplier and ask for bank details to be changed. Money for genuine bills is then siphoned off to the fraudster. Legally the purchaser is still liable to pay the supplier, but if they refuse and the supplier cannot get redress, it is a bad debt.

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