HMRC must reform default surcharge regime
Following the onset of the recession, the Chancellor gave an undertaking that HM Revenue & Customs would take a more accommodating approach to businesses that genuinely had difficulty in making their tax payments on time. As the recession has progressed and tax revenues have plummeted, this undertaking has often been less apparent in practice.
With immaculate bad timing, in the midst of business failures and cash flow crises, from 1 May 2010 HMRC is introducing new penalties in relation to late returns and payment of several taxes including PAYE tax, NIC and construction industry scheme deductions. But these new penalties do have some features to recommend them when set against that nasty hangover from the 1980s, the VAT default surcharge regime for the rate of most of these new penalties will be affected by how late the return or payment is made. HMRC will also have power to mitigate the penalties. These features are absent from the VAT default surcharge regime.
The default surcharge imposes a penalty of from 2 to 15% depending upon the number of times a business has made a late return or payment within a given period. A clean record for 12 months gives a trader a fresh start at the bottom of the surcharge scale. However, the level of surcharge is unaffected by the length of delay in paying the VAT due. The surcharge is the same whether the VAT is paid a day or two months late. Nor is there any fixed maximum penalty and no distinction is made between, at one extreme, a trivial slip or deliberate lateness at the other. There is no scope for mitigation and only very limited scope for pleading a reasonable excuse.
A recent default surcharge appeal vividly illustrates the distorted results that can flow from this system. Enersys Holdings UK Limited made its VAT payment a day late and suffered a 5% surcharge amounting to £131,881. This amounted to 16% of the company’s profits and 44% of its corporation tax liability for an entire year. The company appealed to the First-tier Tax Tribunal. “Reasonable excuse” was one of the grounds for this appeal, which the Tribunal had to reject. Both the relevant legislation and case law provide only very limited scope for arguing reasonable excuse and the human error leading to the company’s delay did not pass muster. In the absence of any power to mitigate the surcharge, the Tribunal struck it down in its entirety.
The grounds for this unusual decision were derived from EU law; VAT is a European tax and its application and administration must be consonant with European law. The European Court has found that tax penalties must be proportionate to the mischief they are designed to combat; there must be a balance between punishment and deterrence on the one hand and reasonableness on the other.
Some of the contrasts between the surcharge and some of the new penalties helped persuade the Tribunal that this particular default surcharge failed to strike that balance; it was “not merely harsh but plainly unfair”.
The default surcharge system does have the benefits of certainty and ease of administration; yet penalties like those levied against Enersys cannot be defended. The time is overdue for the default surcharge system to be reformed so that the penalties imposed reflect the length of delay and provide for an upper limit and scope for mitigation.
Terry Dockley, VAT Director, James Cowper LLP,01635 35255 or email: tdockley@jamescowper.co.uk