ESC Studios Ltd v The Commissioners for HMRC [2025] UKFTT 747 (TC)

[2025] UKFTT 00747 (TC)Case No TC09554
FIRST-TIER TRIBUNAL
TAX CHAMBER
Hearing Heard on: 30 April 2025Date Judgment date: 16 May 2025
[By remote video hearing]
Appeal reference: TC/2024/05461
Keywords: Late payment of VAT; repayment of VAT awaited from an earlier period; Finance Act 2021, Schedule 26; reasonable excuse; special reduction
Before
TRIBUNAL JUDGE KEITH GORDONMR DEREK ROBERTSON
Between
ESC STUDIOS LTDAppellantTHE COMMISSIONERS FOR HIS MAJESTY’S REVENUE AND CUSTOMSRespondentMs Elizabeth Duncan and Mr Christopher Golding for AppellantMr C Chaudhary, litigator of HM Revenue and Customs’ Solicitor’s Office for RespondentsDECISION

Introduction

[1]The form of the hearing was V (video).[2]The documents to which we were referred are:(1) a 174-page authorities bundle of legislation and case law;(2) a 62-page documents bundle (of which the last 27 pages consisted of two further case reports); and(3) a 15-page submission (statement of reasons) prepared on behalf of HMRC.[3]Prior notice of the hearing had been published on the gov.uk website, with information about how representatives of the media or members of the public could apply to join the hearing remotely in order to observe the proceedings. As such, the hearing was held in public.[4]At the end of the hearing, when we had announced our decision, Mr Chaudhary requested this full decision notice in accordance with rule 35(3)(b).

Overview of the case

[5]The Appellant company appeals against a penalty for £9,025.59 imposed on it in relation to the late payment of VAT relating to the quarter ended 30 June 2024.[6]As announced to the parties at the end of the hearing, we decided to allow the Appellant’s appeal.

The legislative scheme

[7]A VAT-registered entity, such as the Appellant, is required to make periodic returns for VAT purposes and, if it owes VAT in relation to any such period, to make payment to HMRC.[8]The Appellant is required to account for VAT on a quarterly basis, with quarters ending on 31 March, 30 June, 30 September and 31 December. As it pays its quarterly VAT electronically, the due date for payment of any VAT is the seventh calendar day of the second month following the quarter end. (This represents a seven-day extension granted by HMRC under a direction given under the powers of regulation 40(3) and (4) of the Value Added Tax Regulations 1995.) Therefore, for the quarter ended 30 June 2024, the net VAT payable for that quarter was due to be paid to HMRC by 7 August 2024.[9]The net amount of VAT payable is the excess of the taxpayer’s output tax for the period over any input tax which the taxpayer has incurred for the period. In those cases where, for any particular period, the taxpayer’s input tax exceeds the output tax, no VAT is payable by the taxpayer. Instead, HMRC will repay the difference to the taxpayer, once any security checks have been completed.[10]For VAT periods commencing on or after 1 January 2023, penalties for the late payment of VAT by taxpayers are charged under the provisions found in Schedule 26 to the Finance Act 2021. Under that Schedule:(1) No penalty is payable if the tax due is paid in full before the end of the 15 day period (paragraph 4).(2) The 15 day period is defined as the period of 15 days beginning immediately after the date on which the tax was due to be paid (paragraphs 1, 10(2)).(3) If the tax due is not paid in full before the end of the 15 day period, then a penalty is payable. The amount of the penalty depends on whether the tax is then paid in full before the end of the 30 day period (paragraph 5).(4) The 30 day period is defined as the period of 30 days beginning immediately after the date on which the tax was due to be paid (paragraphs 1, 10(3)).(5) The amount of the penalty is equal to the sum of: (a) 2% of the amount of tax unpaid at the end of the 15 day period; and (b) 2% of the amount of tax unpaid at the end of the 30 day period (paragraph 5(2)—(5)).(6) Although the legislation operates by reference to a single penalty being imposed, in effect, a taxpayer is liable to pay a 2% penalty for being more than 15 days late with the payment of tax and a further 2% penalty to the extent that the tax is still unpaid 30 days after it was due.(7) The Schedule contains relaxations to these rules in cases where a taxpayer and HMRC have reached an agreement for the deferral of the payment of some or all of the tax due. The application of those provisions is not relevant to this case and they are not discussed further.(8) Taxpayers are excused liability for a penalty if they have a “reasonable excuse” for paying the tax late (paragraph 12(1)).(9) The statute (paragraph 12(2)) imposes the following restriction on reliance on reasonable excuse. For this purpose— (a) an insufficiency of funds is not a reasonable excuse, unless attributable to events outside the person’s control, (b) where the person relies on any other person to do anything, that is not a reasonable excuse unless the first person took reasonable care to avoid the failure, and (c) where the person had a reasonable excuse for the failure but the excuse has ceased, the person is to be treated as having continued to have the excuse if the failure is remedied without unreasonable delay after the excuse ceased.(10) Furthermore, paragraph 13 provides as follows: 13(1) If HMRC think it right because of special circumstances, they may reduce a penalty under this Schedule. 13(2) In sub-paragraph (1) “special circumstances” does not include– (a) ability to pay, or (b) the fact that a potential loss of revenue from a taxpayer is balanced by a potential over-payment by a taxpayer. 13(3) In sub-paragraph (1) the reference to reducing a penalty includes a reference to– (a) staying a penalty, and (b) agreeing a compromise in relation to proceedings for a penalty.(11) Appeals against penalties are considered at paragraphs 19 to 21 which read as follows: 19(1) A person may appeal against a decision of HMRC that the person is liable to a penalty under this Schedule. 19(2) A person liable to a penalty under this Schedule may appeal against a decision of HMRC as to the amount of the penalty. 20(1) An appeal under paragraph 19 is to be treated in the same way as an appeal against an assessment to the tax concerned (including by the application of any provision about bringing the appeal by notice to HMRC, about HMRCʼs review of the decision or about determination of the appeal by the First-tier Tribunal or Upper Tribunal). 20(2) Sub-paragraph (1) does not apply– (a) so as to require the person to pay a penalty before an appeal against the assessment of the penalty is determined, or (b) in respect of any other matter expressly provided for by this Schedule. 21(1) On an appeal under paragraph 19(1) that is notified to the tribunal, the tribunal may affirm or cancel HMRCʼs decision. 21(2) On an appeal under paragraph 19(2) that is notified to the tribunal, the tribunal may– (a) affirm HMRCʼs decision, or (b) substitute for HMRCʼs decision another decision that HMRC had power to make. 21(3) If the tribunal substitutes its decision for HMRCʼs decision in relation to a penalty under this Schedule, the tribunal may rely on paragraph 13– (a) to the same extent as HMRC (which may mean applying the same percentage reduction as HMRC to a different starting point), or (b) to a different extent, but only if the tribunal thinks that HMRCʼs decision in respect of the application of paragraph 13 was flawed. 21(4) In sub-paragraph (3)(b) “flawed” means flawed when considered in the light of the principles applicable in proceedings for judicial review. 21(5) In this paragraph “tribunal” means the First-tier Tribunal or Upper Tribunal (as appropriate by virtue of paragraph 20(1)).

The case law on reasonable excuse

[11]The Schedule 26 provisions are relatively new. However, paragraphs 12 and 13 are based on, and virtually identical to, provisions found in Schedules 55 and 56 to the Finance Act 2009 which concern penalties for late tax returns and late payments The Schedule 26 provisions are being phased in to replace those in Schedule 56. (respectively). Indeed, the reasonable excuse provision in paragraph 12(2)(a) and (b) is similar to provisions enacted as section 33(2) of the Finance Act 1985 and which were considered by the Court of Appeal in HM Customs & Excise v Steptoe [1992] STC 757, [1992] BVC 142, a case which also concerned a form of penalty for the late payment of VAT.[12]The Court of Appeal put the question before it in the following way (with statutory references updated to reflect the equivalent Schedule 26 provisions):
“The question which has arisen for decision on this appeal can be very shortly stated. It arises in connection with para. (a) of [para. 12](2), but a corresponding point might well arise in connection with para. (b). Does the direction that ‘an insufficiency of funds to pay any tax due is not a reasonable excuse’ prevent the taxpayer from putting forward as a reasonable excuse the reason for the insufficiency of funds? It is obvious that an insufficiency of funds cannot, without more, be a reasonable excuse. But can [HMRC] go behind the insufficiency of funds and, if satisfied that the reason for the insufficiency is a ‘reasonable excuse’ for the default, apply [para. 12(1)]? “This is an issue of statutory construction. If the right answer is that an insufficiency of funds, however caused, can never be a reasonable excuse, it is undeniable that the potential for great hardship to taxpayers is produced. Suppose a trader prudently sets aside in a deposit account in a bank a sum sufficient to meet his expected liability for VAT. And suppose shortly before the due date on which the trader must make a return and pay the tax the bank were to fail, leaving the trader with insufficient funds to pay the tax on the due date. Does [para. 12](2)(a) disqualify the bank failure from constituting a reasonable excuse? If so, the hardship to the trader is apparent. But, of course, the potential for hardship is mitigated by the commissioners’ discretionary power to decline to impose a surcharge.”
[13]The Court was divided on that occasion with Lord Justice Nolan (as he then was) and Lord Donaldson MR dismissing the appeal, whereas Lord Justice Scott (as he then was) would have allowed the appeal. However, all three judges agreed on the question of principle:
“… on its true construction, para. (a) does not prevent the reason for an insufficiency of funds being put forward as a ‘reasonable excuse’ …”
[14]The difference between the judges was as to how that agreed principle should be applied. In the judgment of the Master of the Rolls, the two competing approaches were considered with the learned

judge siding with Lord Justice Nolan:

“Nolan LJ, as I read his judgment explaining and expanding on his judgment in the Salevon case, is saying that, if the exercise of reasonable foresight and of due diligence and a proper regard for the fact that the tax would become due on a particular date would not have avoided the insufficiency of funds which led to the default, then the taxpayer may well have a reasonable excuse for non-payment, but that excuse will be exhausted by the date upon which such foresight, diligence and regard would have overcome the insufficiency of funds. “Scott LJ on the other hand is of the opinion that the underlying cause of the insufficiency of funds must be an ‘unforeseeable or inescapable event’. I have come to the conclusion that this is too narrow in that (a) it gives insufficient weight to the concept of reasonableness and (b) it treats foreseeability as relevant in its own right, whereas I think that ‘foreseeability’ or as I would say ‘reasonable foreseeability’ is only relevant in the context of whether the cash flow problem was ‘inescapable’ or, as I would say, ‘reasonably avoidable’. It is more difficult to escape from the unforeseeable than from the foreseeable. “It follows that if I have correctly interpreted the two judgments, I am in agreement with Nolan LJ rather than Scott LJ On the other hand, if I have incorrectly interpreted either or both, my views are those that I have attributed to Nolan LJ.”
[15]The wording in Schedule 26 differs slightly from that considered in Steptoe because paragraph 12(2)(a) expressly permits an insufficiency of funds to form a reasonable excuse if “attributable to events outside the [taxpayer]ʼs control”. We do not consider that that limits the continuing relevance of the Steptoe judgment – if anything, it slightly extends the scope of what can constitute a reasonable excuse in cases of insufficiency of funds.[16]In Perrin v HMRC [2018] UKUT 156 (TCC), a case where a tax return was submitted late, the Upper Tribunal gave the following guidance in relation to claims for reasonable excuse:
“81. When considering a “reasonable excuse” defence, therefore, in our view the FTT can usefully approach matters in the following way: (1) First, establish what facts the taxpayer asserts give rise to a reasonable excuse (this may include the belief, acts or omissions of the taxpayer or any other person, the taxpayer’s own experience or relevant attributes, the situation of the taxpayer at any relevant time and any other relevant external facts). (2) Second, decide which of those facts are proven. (3) Third, decide whether, viewed objectively, those proven facts do indeed amount to an objectively reasonable excuse for the default and the time when that objectively reasonable excuse ceased. In doing so, it should take into account the experience and other relevant attributes of the taxpayer and the situation in which the taxpayer found himself at the relevant time or times. It might assist the FTT, in this context, to ask itself the question “was what the taxpayer did (or omitted to do or believed) objectively reasonable for this taxpayer in those circumstances?” (4) Fourth, having decided when any reasonable excuse ceased, decide whether the taxpayer remedied the failure without unreasonable delay after that time (unless, exceptionally, the failure was remedied before the reasonable excuse ceased). In doing so, the FTT should again decide the matter objectively, but taking into account the experience and other relevant attributes of the taxpayer and the situation in which the taxpayer found himself at the relevant time or times.” (1) First, establish what facts the taxpayer asserts give rise to a reasonable excuse (this may include the belief, acts or omissions of the taxpayer or any other person, the taxpayer’s own experience or relevant attributes, the situation of the taxpayer at any relevant time and any other relevant external facts). (2) Second, decide which of those facts are proven. (3) Third, decide whether, viewed objectively, those proven facts do indeed amount to an objectively reasonable excuse for the default and the time when that objectively reasonable excuse ceased. In doing so, it should take into account the experience and other relevant attributes of the taxpayer and the situation in which the taxpayer found himself at the relevant time or times. It might assist the FTT, in this context, to ask itself the question “was what the taxpayer did (or omitted to do or believed) objectively reasonable for this taxpayer in those circumstances?” (4) Fourth, having decided when any reasonable excuse ceased, decide whether the taxpayer remedied the failure without unreasonable delay after that time (unless, exceptionally, the failure was remedied before the reasonable excuse ceased). In doing so, the FTT should again decide the matter objectively, but taking into account the experience and other relevant attributes of the taxpayer and the situation in which the taxpayer found himself at the relevant time or times.”
[17]That case built on the decision of the VAT Tribunal in The Clean Car Co Ltd v HMCE [1991] VATTR 234 which posed the following question:
“One must ask oneself: was what the taxpayer did a reasonable thing for a responsible trader conscious of and intending to comply with his obligations regarding tax, but having the experience and other relevant attributes of the taxpayer and placed in the situation that the taxpayer found himself in at the relevant time, a reasonable thing to do?”

The case law on special reduction

[18]The leading case on special reduction is the Upper Tribunal’s decision in Barry Edwards v HMRC [2019] UKUT 137 (TCC). Although that case considers a different penalty regime (the penalties for late Self Assessment tax returns), we consider that the general approach laid down in that case is equally applicable to the penalties under Schedule 26. After considering previous case law in which different approaches had been adopted, the Upper Tribunal warned against giving the phrase, “special circumstances”, a restrictive meaning. In particular, at [73] and [74], the Upper Tribunal agreed with the following proposition from an earlier case:
“Parliament intended to give HMRC and, if HMRC’s decision is flawed, the Tribunal a wide discretion to reduce a penalty where there are circumstances which, in their view, make it right to do so. The only restriction is that the circumstances must be “special”
. Whether this is interpreted as being out of the ordinary, uncommon, exceptional, abnormal, unusual, peculiar or distinctive does not really take the debate any further. What matters is whether HMRC (or, where appropriate, the Tribunal) consider that the circumstances are sufficiently special that it is right to reduce the amount of the penalty.”

Findings of fact

[19]We heard oral evidence from Ms Duncan and Mr Golding. They gave their evidence very credibly and Mr Chaudhary elected not to cross-examine either of them. From the oral evidence and the evidence in our bundle of documents we find the following facts:(1) The Appellant company was incorporated on 11 April 2022 and carries on a trade of the production of films.(2) It has been registered for VAT purposes since 15 July 2022.(3) Its VAT return for the quarter ended 31 March 2024 was due to be filed on 7 May 2024. It was filed on 3 May 2024. It showed a repayment to be payable by HMRC to the Appellant of £478,893.36.(4) The level of input tax that the Appellant sought was higher than usual because the Appellant had three films in production in that period.(5) The Appellant accepts that it is entirely reasonable for HMRC to want to check such repayment claims before paying them and therefore it was not surprised that HMRC chose to check the repayment claim made on the VAT return for the March 2024 quarter. The first questions were asked on 22 May 2024 and a meeting was arranged and the earliest available date for HMRC was 19 June 2024. The Appellant asked HMRC if an earlier meeting might be possible (for example, if another meeting arranged by HMRC was cancelled at short notice) but no such opportunity arose.(6) The Appellant has responded to HMRC’s questions completely and quickly. For example: (a) an HMRC request made on 14 June 2024 was responded to on 17 June 2024; (b) there was a four-hour investigation meeting on 19 June 2024; (c) 21 pieces of documentary information were requested by HMRC at the meeting and supplied by the Appellant on 26 June 2024; (d) further information was requested by HMRC on 3 July 2024 and then provided by the Appellant on 5 July 2024.(7) The Appellant (through its key personnel) feels that HMRC have not reciprocated in dealing with the case as promptly and is concerned that the investigation (and, from the Appellant’s perspective, the Appellant’s expected repayment) has been hampered by a combination of: (a) a lack of resource within HMRC, (b) a lack of understanding within HMRC of the film industry, and (c) HMRC’s concerns about fraud within the film industry (as highlighted by a widely-publicised prosecution known as the Rees case).(8) The Appellant made regular contact with HMRC (on 10 July, 18 July, 24 July and 2 August 2024) to ensure that any further questions that arose could be quickly addressed by the Appellant. On 7 August, the Appellant was told that the investigating officer was going on holiday for two weeks after 13 August but that he was hoping to have his investigation resolved by then. The officer also explained that the delay in the Appellant’s repayment was due to an industry-wide investigation because of a few bad players in the film industry.(9) On 13 August 2024, the Appellant wrote to the investigating officer to ask for an update before his holiday. At 6.10pm on 13 August, however, the officer sent the Appellant a further two queries which appeared to the Appellant to be irrelevant to the investigation being carried out into the Appellant’s repayment claim. Those additional questions were answered in good time but nothing was able to be done by HMRC because the officer was now away.(10) In the meantime, the Appellant’s VAT return for the quarter ended 30 June 2024 showed a net VAT liability of £225,639.93. This was due for payment on 7 August 2024.(11) There was no agreement reached with HMRC for a deferral of the VAT due and (as explained below) no payment was made until more than 30 days after 7 August.(12) Until 7 August, the Appellant had every expectation that the repayment would be made in good time to allow its subsequent VAT bill (which was less than half the amount awaited from HMRC) to be paid. Between 7 August and 13 August, the Appellant had every expectation that the repayment would be agreed before the officer went on holiday.(13) In the course of the Appellant’s written correspondence with HMRC on several occasions, as well as at the 19 June meeting, the Appellant stressed to HMRC the damage to the Appellant’s cashflow and its reputation with its suppliers that the delay in the VAT repayment was causing.(14) On 2 September 2024, the Appellant made a formal complaint about the nature of the investigation. The Appellant did not appreciate at the time that this complaint was not the same thing as a formal request for deferral of the VAT for the June 2024 quarter which had fallen due for payment on 7 August 2024.(15) On 13 September 2024 HMRC sent a query seeking clarification of the language being used in contracts that the Appellant had sent to HMRC on 17 June 2024. Again, the Appellant felt that HMRC’s query was irrelevant to their investigation. At this stage, the Appellant’s request for an interim payment was refused.(16) Eventually, the £478,893.36, first claimed by the Appellant in early May, was repaid by HMRC more than six months later, on 8 November 2024. Some of that repayment was set off against the Appellant’s now outstanding VAT liability for the quarter ended 30 June 2024. The balance was repaid to the company on 20 November 2024.(17) The summer of 2024 was a particularly intense period of time for the company with three different films in production. Mr Golding, who is the Appellant’s accountant, likened it to the January tax return season in an accountancy practice. Mr Golding also noted that, even though HMRC’s checking procedures before making repayments had tightened in recent years, the delays suffered by the company were in his mind of a different scale. The cashflow difficulties being caused by the delayed repayment had an adverse impact on the Appellant’s commercial activities.(18) On 11 September 2024, HMRC issued a penalty assessment of £9,025.59. This is calculated as 4% of £225,639.93, rounded down to the nearest penny. Accompanying paperwork showed the two strands of 2% as £4,512.80 each (i.e. a total of £9,025.60). £4,512.80 is 2% of £225,639.93 (rounded up). The inconsistencies are of course negligible but HMRC might wish to tweak their software to ensure that all reports of the penalties being charged in any particular case are consistent with each other. This was notified to the Appellant which then appealed against the penalty to the Tribunal on 19 September 2024.(19) The VAT was eventually paid in two instalments. The first (£82,331.30) on 4 October 2024 was by set-off of a repayment due to the Appellant in relation to its VAT return for the quarter ended 30 September 2024. The balance (£143,308.63) on 8 November 2024 was by set-off of the repayment due to the Appellant in relation to its VAT return for the quarter ended 31 March 2024.[20]In relation to the Appellant’s beliefs as identified at paragraph ‎19(7), ‎(12) and ‎(15), we make no finding as to whether what was believed to be the case was actually the case as we do not have sufficient evidence to make such findings. However, we find that those beliefs were sincerely held by the Appellant and were not irrationally held.

The Appellant’s complaint to HMRC

[21]The Appellant’s case overlapped considerably with the formal complaint that it had made on 2 September 2024. Indeed, Mr Chaudhary’s first submission to us was that the Appellant’s submissions to us had been addressed by the response from HMRC’s complaints team on 20 November (a copy of which we were not shown).[22]We certainly do not wish to trespass on the complaints process which is separate from this Tribunal. However, we recognise that the background facts underlying the complaint are relevant to the Appellant’s appeal before us.

Penalty for late payment

[23]There was no dispute that the VAT for the 30 June 2024 quarter was paid late. As per the above findings of fact, HMRC properly notified the Appellant of the penalty.[24]The case therefore turns on whether the Appellant can rely on the provisions in either paragraph 12 (reasonable excuse) or 13 (special circumstances) of Schedule 26 to eliminate (or reduce) the penalty. Reasonable excuse HMRC’s arguments

Reasonable excuse

[25]In summary, Mr Chaudhary’s arguments were based on the following propositions:(1) That section 25 of the Value Added Tax Act 1994 requires VAT to be paid on time in accordance with the Value Added Tax Regulations.(2) Checks being undertaken by HMRC in relation to an impending repayment can be time-consuming but an anticipated repayment in relation to another period does not absolve a taxpayer from paying any VAT by the due date.(3) If there are delays in a repayment process, that is the subject matter of a possible complaint and not the basis for not paying any other VAT due in the interim.(4) The penalty in this case was raised in line with the legislation.[26]To support his arguments, Mr Chaudhary referred to the judgment of Lightman J in R (oao UK Tradecorp Ltd) v HM Customs & Excise [2004] EWHC 2515 (Admin) (UK Tradecorp). In that case, the learned judge distinguished between a taxpayer putting in a VAT return which claims a repayment and such a repayment claim being upheld or agreed by what is now HMRC. It is only on the occurrence of the latter that a taxpayer can assert a “right” to the repayment.[27]Mr Chaudhary also referred to the decision of Judge Gammie and Mr Collard in this Tribunal in the case of NSF Utilities Ltd v HMRC [2018] UKFTT 9 (TC) (NSF Utilities). That was a reasonable excuse case with some superficial similarities to the present case in that it concerned the late payment of VAT when a repayment of tax from HMRC was also being claimed. As the Tribunal concluded at [32]:
“… a prudent taxpayer would have sought to take some steps to guard against the possibility that the VAT fell due before the repayment was received (which in fact the Appellant was able to do, albeit late) but we have no evidence that the Appellant did anything. In the circumstances, we conclude that the Appellant had no reasonable excuse for its default. We therefore dismiss its appeal.”
[28]Turning to general propositions concerning reasonable excuse, Mr Chaudhary referred to the case of Rowland v HMRC (2006) SpC 548for the proposition that the phrase reasonable excuse is not statutorily defined and has to be considered in the light of all the circumstances of the particular case and the cases of The Clean Car Co and Perrin (both cited above).[29]Mr Chaudhary accordingly argued that, as the Appellant was not entitled to the repayment of the March 2024 quarter VAT until after HMRC had concluded their investigation (in November 2024), the Appellant could not rely on the lack of that repayment as a reasonable excuse for not paying VAT for the June 2024 quarter which fell due for payment in the meantime.[30]Mr Chaudhary accepted that if, contrary to his position that there was no reasonable excuse in the present case, the Tribunal reached the view that the Appellant did have a reasonable excuse, then that reasonable excuse would have continued until November 2024 when the repayment was finally agreed to by HMRC.

Discussion

[31]We agree with Mr Chaudhary that the Appellant did not have a “right” to the £478,893.36 repayment until November 2024, once HMRC’s investigation into it had come to a conclusion (UK Tradecorp). However, we disagree with him inasmuch as he suggested that that is a full answer to this case. We say so because of the Court of Appeal’s decision in Steptoe.[32]In a part of his judgment in Steptoe,

Lord Justice Nolan (who was in the majority) cited from an earlier judgment of his:

“… the cases in which a trader with insufficient funds to pay the tax can successfully invoke the defence of “reasonable excuse” must be rare. That is because the scheme of collection which I have outlined involves at the outset the trader receiving (or at least being entitled to receive) from his customers the amount of tax which he must subsequently pay over to the commissioners. There is nothing in law to prevent him from mixing this money with the rest of the funds of his business and using it for normal business expenses (including the payment of input tax), and no doubt he has every commercial incentive to do so. The tax which he has collected represents, in substance, an interest-free loan from the commissioners. But by using it in his business he puts it at risk. If by doing so he loses it, and so cannot hand it over to the commissioners when the date of payment arrives, he will normally be hard put to invoke [para. 12(1)]. In other words, he will be hard put to it to persuade the commissioners or the tribunal that he had a reasonable excuse for venturing and thus losing money destined for the exchequer of which he was the temporary custodian.”
[33]The learned judge was therefore recognising that, in general, the net VAT that a trader is required to pay to HMRC in respect of a period will come out of funds that the trader has received from its customers over and above the actual selling price payable for the trader’s goods or services. (The learned judge in the subsequent paragraph then acknowledged that, strictly, VAT does not operate on a cash basis, although cash accounting is an option for many traders.) However, as the Court concluded, that is not to say that a lack of funds can never be the basis of a reasonable excuse defence: as the majority held, it depends on whether the taxpayer has exercised reasonable foresight and due diligence and with a proper regard for the fact that the tax would become due on a particular date.[34]The general position, however, is that a trader’s net VAT liability should come out of funds that should not be carelessly mixed with the trader’s working capital. In the present case, however, the general position described by Lord Justice Nolan can be said to operate in reverse, so far as the March 2024 quarter is concerned. In relation to that quarter, the Appellant has had to find an additional £478,893.36 from its working capital and, in effect, lend it to HMRC until such time as HMRC are able to approve the repayment.[35]It is our finding that £478,893.36 represents a significant sum for the Appellant (we note, for example, that it represents more than twice the net VAT payable by the Appellant in relation to the next VAT quarter) and we do not consider it reasonable for a new and growing company such as the Appellant to be expected to absorb the cash flow costs of this amount, for example by taking a short-term bank loan to assist its working capital until such time as the repayment would eventually be made (the period of which would inevitably be uncertain at the time that any such advance would be made). In particular, whilst the Appellant (reasonably) did not expect the repayment to be made immediately after the March 2024 quarter’s VAT return was submitted, its evidence which we have accepted was that it expected the repayment to be agreed by 7 August 2024 and it took every reasonable step to facilitate that outcome by assisting HMRC in their investigations.[36]Thus, rather than viewing the £225,639.93 (the net VAT payable in relation to the June 2024 quarter) as surplus to the Appellant’s working capital, we view that sum as an amelioration to the £478,893.36 hit to the working capital that was being experienced by the Appellant pending the repayment expected from the March 2024 VAT quarter. The difference which still exceeds £250,000 is not a trivial amount.[37]For these reasons, the facts of this case are very different from those in NSF Utilities. In particular, there is evidence of the Appellant taking active steps to guard against the possibility that the VAT fell due before the repayment was received. In our view, there is nothing more that the Appellant could realistically have done to expedite the repayment from HMRC. The Appellant has been more than prudent. And, for the reasons summarised in paragraph ‎35 above, we do not think it would have been reasonable to expect the Appellant to seek a loan to cover the temporary shortfall (assuming that such would have been available on reasonable terms).[38]We do recognise that the Appellant could have sought a formal deferral of the due date of 7 August 2024 which, if agreed by HMRC, would have then allowed this penalty to be avoided. On future occasions, that might prove to be a sensible precaution for the Appellant to take. However, for the following two reasons, we consider that it was reasonable for the Appellant (having not been in this situation before) not to have taken this formal step:(1) First, as we have found, the Appellant did not initially expect the March 2024 repayment to be delayed beyond 7 August 2024. And when, on that date it enquired of HMRC as to what was happening, it got the impression that the investigation would be concluded by 13 August 2024. Had the repayment been confirmed by that date, no penalty would have arisen as a result of the 15-day grace period conferred by the legislation. Indeed, it was the Appellant’s prompt and unquestioning provision of answers to HMRC’s questions that led it to believe that the investigation would be concluded promptly.(2) Secondly, HMRC had been repeatedly told before 7 August 2024 about the cashflow difficulties that the Appellant was experiencing as a result of HMRC’s own investigation. For a taxpayer in this situation for the first time, we do not consider it unreasonable for the Appellant to have expected HMRC to interpret the Appellant’s clear concerns about cashflow as an implicit application for a deferral of the VAT then becoming payable for the June 2024 quarter (or at least for HMRC to raise with the Appellant the possibility of a formal application being made).[39]Taking a step back, we consider that, overall, the Appellant has acted in a way that one can reasonably expect of a responsible trader conscious of and intending to comply with its obligations regarding tax, given its experience and placed in the situation that it found itself. We say that by applying the approach to reasonable excuse defences as laid down by the Court of Appeal in Steptoe.[40]In any event, and in case we are wrong in that regard, we consider that the conduct of HMRC’s investigation (in circumstances where the Appellant had been so diligent and prompt in responding to HMRC’s questions), which led to the repayment being paid more than six months after the March 2024 VAT return was submitted, meant that the Appellant’s insufficiency of funds was attributable to events outside the Appellant’s control. Even ignoring the Steptoe approach to the reasonable excuse test, we consider that the facts of this case point squarely to the conclusion that the Appellant had an objectively reasonable excuse for not paying the June 2024 VAT by 7 August 2024.[41]As a result, whichever of these two approaches we might take, we find that the Appellant had a reasonable excuse for not paying the VAT due by 7 August 2024. Given the amount of the repayment that the Appellant was expecting (and eventually received), we similarly consider that the Appellant had a reasonable excuse for not making any partial payment of the June 2024 quarter’s VAT. We agree with Mr Chaudhary that any reasonable excuse that the Appellant had continued until the repayment was made in November 2024. As the outstanding payment was deducted from that repayment, it follows that the Appellant’s reasonable excuse subsisted throughout the period of default.

Special reduction

[42]In light of our finding on reasonable excuse, we did not need to consider special reduction. However, we told the parties at the end of the hearing that, had we not accepted the Appellant’s case on the basis of reasonable excuse, we would have concluded that this was a case where we would have reduced the penalty to nil by reason of special reduction. Our reasons are as follows.

HMRC’s arguments

[43]In their statement of reasons, addressing the facts of the case and the thrust of the Appellant’s factual case, HMRC identified the following reasons why the case should not qualify for a special reduction under paragraph 13.(1) Compliance with inspections is not appropriate for special reduction.(2) The Appellant cannot rely on any repayments/repayment claims to pay their future VAT returns.(3) The penalty and interest thereon, has been charged in line with legislation.(4) Any repayment of that interest does not constitute a reasonable excuse for the failure of payment by the due date.[44]Furthermore, HMRC observed that penalties are in place to promote efficient operation of the taxation system and are intended as a measure of fairness, so that taxpayers who pay late do not gain any advantage over those who pay on time. The amount of the penalties charged is set within the legislation.[45]Mr Chaudhary’s oral submissions were consistent with HMRC’s statement of reasons, with Mr Chaudhary adding the following summary of the effect of the Edwards case:
“To be special, the circumstances may or may not be specific to individual but must be relevant to situation under consideration and must be sufficiently special to reduce penalty”
.

The Appellant’s arguments

[46]The Appellant’s case generally relied on the facts of the case speaking for themselves. However, within the Appellant’s letter of complaint to HMRC of 2 September 2024, the Appellant also asked:
“Is it not, therefore in HMRC’s interest to withhold our VAT for as long as possible to increase these penalties? I highlight the fact that there were no specific queries for ESC Studios from July 5th 2024 to August 13th. How is it fair for HMRC to profit from SME’s [a reference to small and medium-sized enterprises] penalties when there is no legitimate reason for withholding VAT repayment?”
[47]The reference to “no legitimate reason” was predicated on the Appellant’s belief that, by then, HMRC were no longer asking reasonable questions

Discussion

[48]We are permitted to intervene with HMRC’s conclusion on special reduction only if we find that HMRC’s decision in that respect was flawed when considered in the light of the principles applicable in proceedings for judicial review (paragraph 21(3)(b), (4)).[49]We do not consider that HMRC took into account any irrelevant consideration. However, we did think that they failed to step back and observe the proverbial elephant in the room being the combination of the following facts:(1) this was a case where HMRC were holding onto nearly half a million pounds that it eventually accepted was owed to the Appellant (over six months later);(2) the Appellant had done all it possibly could do to assist HMRC in their investigation and did so very promptly;(3) the Appellant had repeatedly made HMRC aware of the cash flow difficulties it was experiencing whilst awaiting the VAT repayment;(4) the VAT paid late by the Appellant was less than half of the repayment that the Appellant was waiting for.[50]Although paragraph 13(2) excludes from being a special circumstance for these purposes both a lack of funds and the fact that a late payment by taxpayer is balanced by a potential over-payment that might be repayable to the taxpayer, we consider that those exclusions should be read in a similar way to how the all the judges in the Court of Appeal in Steptoe addressed the question of a lack of funds in the context of a reasonable excuse defence, i.e. the statute “does not prevent the reason for an insufficiency of funds [or the fact that the Appellant is still awaiting a repayment from HMRC in relation to an earlier period] being put forward as a ‘[special circumstance]’” (emphasis added by us). Furthermore, it was quite clear from the Steptoe decision itself that the approach to statutory construction was not limited to the specific issue of lack of funds (as Lord Justice Scott said, “a corresponding point might well arise in connection with para. (b)”). We therefore consider that the facts summarised in the preceding paragraph are not precluded from being considered as a special circumstance, Furthermore, they are highly relevant to the present case and we consider HMRC should have taken them into account.[51]For that reason, we consider that HMRC’s decision on special reduction was flawed, thereby permitting us to substitute our decision for that of HMRC.[52]We recognise that the Appellant could not be said to have the right to repayment for the reasons discussed in UK Tradecorp. We also decline (in the absence of clearer evidence) to accept the thrust of the Appellant’s complaint (as reproduced at paragraph ‎46 above) to the extent that there is any suggestion that HMRC were deliberately withholding the March 2024 repayment so as to trigger a penalty for the Appellant’s late payment of its June 2024 VAT.[53]However, for the same reasons that informed our decision on reasonable excuse, we do not consider that Parliament would have wanted a taxpayer in the circumstances of this case to have to pay penalties (over and above any interest payable for the late payment of VAT). We consider that this is precisely one of those cases where Parliament would consider it inappropriate for any penalty to be payable by the Appellant.[54]Accordingly, if we had not found for the Appellant on paragraph 12, we would have allowed the appeal and reduced the penalty to nil under paragraph 13.

Conclusion

[55]For the above reasons, the appeal is allowed.

Right to apply for permission to appeal

[56]This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application must be received by this Tribunal not later than 56 days after this decision is sent to that party. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice. Release date: 16th MAY 2025

Cited in 1 later judgment