A limited company just got one over HMRC on VAT; here’s how

About the only thing that isn't flagged to change after tomorrow’s Autumn Budget is HMRC penalties for late VAT returns and payments.

And in MPMH Construction Ltd v HMRC, the First-Tier Tribunal recently allowed an appeal against default surcharges of almost £250,000, having determined that by virtue of the “unique and particular” effect of the Covid-19 pandemic, the taxpayer had an “objectively reasonable excuse” for the late payment of VAT.

In considering the decision, exclusively for ContractorUK, I want to look at its focus on ‘reasonableness’ and also what VAT-registered contractors can learn from it, writes Suraj Chauhan, consultant at law firm Chartergates.

MPMH vs HMRC: background to the FTT case

The appeal concerned default surcharges for VAT periods 02/21, 05/21, 08/21, 11/21 and 02/22 totalling £247,151.18 calculated at 15% for late payment of VAT.

Undertaking highly specialised healthcare construction projects, during the pandemic, MPMH worked exclusively on NHS projects.

Although it ordinarily worked according to “framework agreements” (involving the monthly submission of work-in-progress valuations, which were invoiced and paid within 21 days), this changed during the pandemic.

NHS Boards went on the turn due to covid

The NHS Boards, for whom MPMH undertook work “ceased to comply with the framework agreements regarding payment terms” and their finance departments became uncontactable, as staff were shielding and/or working from home.

Nevertheless, MPMH was expected to fulfil its contractual obligations (including issuing timely VAT invoices). However, this caused “huge cash-flow difficulties” and was compounded by staff output, productivity and rising material costs/shortages.

When a 32-week project becomes a 110-week project…

It also meant that work priced pre-pandemic was costing MPMH more to complete (for example, a project priced to take 32 weeks actually took 110 weeks to complete).

Despite such “enormous financial burdens and constraints”, to continue trading, MPMH had to pay staff and suppliers.

In evidence, MPMH’s “honest and truthful” director expressed that it was “let down seriously by the NHS”, stating that it was “unreasonable and entirely unforeseeable” for one government department to levy a 15% surcharge on the late payment of VAT to it, resulting from unpaid contractual obligations by another government department.

MPMH Ltd versus HMRC: grounds of appeal

As well as conveying its commitment to complying with the VAT rules, MPMH’s appeal grounds focussed on the impact of the pandemic as explaining the late VAT payments.

The weekly changing government guidance was cited as disrupting staffing/scheduling causing significant operational challenges, while project delays, delayed payments and unpaid invoices had a substantial “cumulative impact on the cash position”.

With £500,000 outstanding from NHS contracts, there were “severe cash flow problems”, and full payment of the VAT liabilities would have left MPMH unable to meet its other liabilities.

Late by just a few days, but the taxman doesn’t tolerate tardiness

Evidence of MPMH’s payments to HMRC demonstrated that the VAT payments for the 02/21, 11/21 and 02/22 returns were only two, five and four days late.

MPMH also highlighted its regular payments to HMRC for the VAT liability arising from the 05/21 and 08/21 returns (almost £500,000), and attention was drawn to its efforts in negotiating a Time To Pay arrangement with HMRC, which despite acknowledgement by the tribunal as falling on “deaf ears”, MPMH continued to pay towards.

The Reasonableness Test

The tribunal stated that the key question within the “objective” test is:

 “was what the taxpayer did a reasonable thing for a responsible taxpayer 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 at the relevant time, a reasonable thing to do?”

While MPMH acted “reasonably”, the tribunal expressed that to be reasonable, the excuse must be “genuine” and “objectively reasonable”.

The tribunal found “it difficult to imagine how any reasonable trader…would have behaved differently”, stating that “neither the appellant…nor objectively any other reasonable taxpayer imbibed with the appellant company’s attributes, could have predicted, foreseen, or for that matter avoided the factors” which resulted in the default.

What the taxman tried to argue to get his £240k penalty approved

HMRC argued that the legislation excluded the “insufficiency of funds” as a reasonable excuse for late payment of VAT.

However, the tribunal held that this failed to “acknowledge the underlying reasons” for MPMH’s shortage of funds.

HMRC emphasised MPMH’s “historically poor compliance record”.

However, the tribunal reasoned that not appealing earlier the defaults only added “greater weight to the validity of the reasons” supporting the appeal.

Would your company qualify as a not a general run-of-the-mill biz?

Ultimately, in allowing the appeal, the tribunal found that MPMH had an objectively reasonable excuse, explaining that it was not a “general ‘run of the mill’ business” suffering from “general unspecified cash flow problems”.

The effect of the pandemic on it was “unique and particular” and MPMH’s reliance on NHS contracts had affected it “exceptionally and specifically”.

MPMH’s VAT victory over HMRC: implications for contractors

Although fact-sensitive, the decision critically reinforces the high standard to which taxpayers are required to prove the existence of a reasonable excuse, emphasising that any old excuse will not suffice.

Furthermore, despite the obviously exceptional circumstances, the decision again underlines HMRC’s rigid, unsympathetic and narrow approach to VAT non-compliance.

Since January 2023, the default surcharge regime has effectively been replaced by new regimes governing the late submission of VAT returns and payment of VAT.

Six steps to avoiding paying VAT penalties by HMRC

Yet reasonable excuses remain ever relevant. As such, VAT-registered limited company contractors would be well advised to:

• Ensure that VAT returns are submitted on time;
• Ensure that funds are available to pay VAT liabilities in a timely manner;
• Be mindful of the VAT liabilities arising from issuing VAT invoices;
• Take reasonable steps to address difficulties and/or circumstances affecting the timely submission of VAT returns and payment of VAT;
• When difficulties and/or circumstances arise affecting the timely submission of VAT returns and payment of VAT, maintain and retain detailed evidence;
• If there is contact with HMRC concerning the submission of VAT returns and/or payment of VAT, maintain and retain adequate records and evidence (including notes of telephone calls).

Lastly, don’t go it alone…

Finally, if penalised for such VAT non-compliance (as MPMH was), contractor limited companies should stand back and review the decision -- with professional input as appropriate -- before determining whether to challenge or appeal, even in the likely event that the HMRC penalty is less than the swingeing £247,000 that MPMH faced but which has now been thrown out.