The default surcharge system can occasionally produce outcomes that seem incredibly harsh. Neil Warren explains the lessons from a surcharge case which the taxpayer lost.
Imagine you have paid your VAT liabilities on time for the last ten quarters but you slip up in the 11th quarter and make a payment one day late. As result HMRC issues a default surcharge against your business for £297,845. How could this happen?
That is what happened to Global Switch Ltd (TC06252), and there are many lessons to be learned from this highly unusual case.
The key point to be aware of is that a business has two responsibilities as far as the VAT default surcharge regime is concerned:
- Pay the VAT on time: including monthly payments on account for larger companies, which included Global Switch Ltd.
- Submit the VAT returns on time: this was the main problem for Global which led to the big penalty in question.
If you meticulously do these two things on time, the default surcharge regime will be as irrelevant to your business as winning this year’s Premier League football title will be to any team apart from Manchester City.
How did it happen?
The key point to remember about the default surcharge regime is that the level of the penalty rises each time there is a default; from 2%, 5%, 10% and finally to 15%. The business can’t reset the penalty level back to zero unless it has made all VAT returns and all VAT payments on time for a complete 12 month period.
The penalty trap for Global Switch had two triggers:
- The company entered the default surcharge regime in June 2012 due to a late payment. It received a surcharge liability notice for this period. This notice means the business doesn’t get a penalty for the misdemeanour but it will get a penalty if it slips-up again in the following 12 months.
- The company failed to exit the default surcharge regime because it also slipped up in the March 2013, December 2013, September 2014 and September 2015 periods. Therefore, Global Switch was still in the surcharge regime when it made a payment of £2,978,459 one day late for the September 2016 period. By this time the company was subject to a 10% surcharge.
1. A late return counts as a default
The defaults made by Global Switch for the periods September 2014 and September 2015 were because the VAT returns were “filed a few days late”. There was no late paid tax – only late returns. Many advisers incorrectly think that the late return is irrelevant as long as the tax is paid on time.
Having submitted a late VAT return for September 2014, Global had to get everything right up to and including September 2015 periods. It didn’t, and it defaulted with another late return in September 2015.
2. Proportionality argument rarely wins
The taxpayer put forward a valid argument that a £297,000 penalty was very unfair for making a tax payment on 1 November 2016 rather than the due date of 31 October – one day earlier. The tribunal considered binding case law on the issue of proportionality, which concluded that Global’s default was not a “wholly exceptional case” so there was no proportionality issue.
In reality, the chance of winning a proportionality argument is as remote as a three-legged horse winning this year’s Grand National. The main reason is because the surcharge system is based on an escalating level of penalties for each default, so it is hard to argue that the basic principles are flawed.
3. A reasonable excuse needs an exceptional event
The taxpayer’s last throw of the dice was to claim that there was a reasonable excuse for the default in December 2013 period, namely that the underpayment of £1,853 out of a total payment of £2,377,764 was due to an error in the company’s VAT control account.
The tribunal were not sympathetic. It acknowledged that while the error was “genuinely and honestly made”, it was not a reasonable excuse for a default. The lesson here is that a reasonable excuse argument needs to relate to an exceptional event, eg illness, bereavement, computer breakdown etc.
I feel sympathy for the taxpayer in this case, but a strict application of the letter of the law meant there was very little room to appeal the massive penalty the company was charged. The only positive point is that this case should encourage us to redouble our efforts to make sure our clients always give top priority to submitting VAT returns and payments on time. Never under-estimate the shark infested waters of the nation’s favourite tax.
About Neil Warren
Neil Warren is an independent VAT consultant and author who worked for Customs and Excise for 14 years until 1997.