Payment of VAT on appeals and the 'financial extremity' test

Out-Law Legal Update | 21 Jun 2019 | 1:32 pm | 7 min. read

The Snow Factor case is the first time the Upper Tribunal (UT) has considered the 'financial extremity' test, which governs whether disputed VAT must be paid before a UT appeal can be entertained in a case where the FTT has ruled in HMRC's favour.

  • Snow Factor case considers payment of VAT before appeal to Upper Tribunal
  • 'Financial extremity' more onerous then 'hardship'
  • Test considers future cashflow and group companies expected to help

The recent case of Snow Factor concerns the 'financial extremity' rule which can mean that disputed VAT does not need to be paid before a taxpayer who has lost in the First-tier Tribunal (FTT) can appeal to the Upper Tribunal (UT). It is believed to be the first case where the provisions have been considered by the UT.

The normal position in relation to a VAT appeal is that the tax in dispute has to be paid before the appeal can be entertained by the FTT. However, the appeal can still go ahead without the VAT having been deposited if HMRC is satisfied (following an application by the taxpayer) that the requirement to pay or deposit the tax would cause the taxpayer to 'suffer hardship'.

The position is different for direct taxes such as income tax, capital gains tax or corporation tax, where the taxpayer can usually apply to HMRC for the payment of the tax to be postponed pending the determination of the appeal. Postponement for these taxes has nothing to do with financial hardship, which is not relevant; it depends upon the taxpayer having grounds for believing that the amount demanded is excessive.

In VAT cases, even if the tax has not been paid because of a successful hardship application, a win in the FTT for HMRC triggers an obligation to pay the tax that the FTT has determined is payable. However, if HMRC is satisfied that 'financial extremity might be reasonably expected to result' if payment is required, HMRC has power to decide how much, if any, of the amount under appeal should be paid; require the provision of adequate security from the taxpayer; and/or stay the requirement to pay.

In direct tax cases, tax which has been postponed is payable if the FTT rules against the taxpayer, and tax is payable in accordance with the decision of the FTT even if a further appeal is made. There is no equivalent of the VAT 'financial extremity' provision.

The Snow Factor case

Snow Factor ran an indoor snowdome and was in dispute with HMRC about whether lift passes were subject to VAT at the reduced rate of 5%. The FTT decided that the supplies were subject to VAT at the standard rate.

Before the FTT hearing, HMRC had accepted an application from Snow Factor that requiring payment of the VAT before the FTT hearing would cause hardship, so Snow Factor had not had to pay any of the disputed VAT. Once the FTT decision went against it, Snow Factor applied to HMRC requesting a stay of the payment of the VAT pending the outcome of an appeal to the UT. HMRC agreed that paying all the outstanding VAT may cause financial extremity, but decided that a lesser amount should be paid in three equal monthly instalments.

Judge Andrew Scott confirmed the UT test (financial extremity might be reasonably expected to result) was more onerous than the FTT test (suffer hardship) but said that was not surprising as the tests arise at different points in the appeal process. The rules relating to the FTT were described in HMRC v Elbrook (Cash & Carry) Ltd  as 'the price for entering the appeal process'. Judge Scott said it was entirely consistent with that objective that the pre-FTT hardship enquiry should not be a lengthy one and should focus on immediately or readily available resources.

The judge confirmed that 'financial extremity' is a more onerous test to satisfy than 'hardship'. 'Extremity is … at the very far end of the spectrum of financial health. Life should not be merely hard. More is required,' he said.

However, he said the test was not whether the taxpayer was insolvent, as there are situations where a company may technically be insolvent because there is a moment when the debts of a company cannot be paid as they fall due, which would not necessarily amount to financial extremity.

Judge Scott said that the financial extremity must 'result' from having to pay the tax so there must be a causative link between the decision to pay some or all of the disputed VAT and the financial extremity. However, he dismissed HMRC's arguments that the result must be both 'direct' and 'immediate'.

He said that there was a timeframe within which the financial extremity must result and this was the period until the further appeal is determined. If the test had to be applied looking only at the immediate circumstances, this would prejudice cyclical businesses, like Snow Factor's, which might be able to pay the amount in one month and then suffer financial extremity the next.

Applying the UT test requires an assessment of what might (rather than would) happen, qualified by reference to reasonable expectations, the judge said. The tribunal had to decide what might reasonably happen if payment were made in accordance with HMRC's decision.

He said the test of reasonableness is an objective one: having regard to the totality of the circumstances, what steps would it be reasonable to expect to be taken to meet the liability? But the test also has subjective elements, as account must be taken of the particular circumstances affecting the taxpayer and the way in which it has chosen to carry on its business, the judge said.

The FTT test involves HMRC being satisfied that the requirement to pay the VAT would cause the appellant to suffer hardship. However s 85B(5)(c) is silent as to the person who must be in financial extremity. Judge Scott said this silence was 'meaningful' and 'contemplates that the impact of the decision might be felt beyond the applicant itself'. He said the test could include the impact on the rest of the group and that it might be reasonable to expect steps to alleviate the cashflow problems to be taken by another member of the group.

Although he decided it was reasonable to expect Snow Factor's sister company to take steps to increase its prices, he did not think it was reasonable to take account of any possible steps the parent company could take, as he said its debt was fixed and it was not trading itself but was funded by distributions from its subsidiaries.

Approach to applying the test

The taxpayer said that although it could have paid the instalments claimed by HMRC, the cyclical nature of its business meant that paying the instalments would cause a deficit a few months later.

The judge stressed that it was not enough for Snow Factor simply to point to a projected cash flow drawn up on the basis that no steps are taken to pay any part of the disputed VAT and leave it at that. In this case, the group had not sought to increase its bank overdraft or considered increasing its income by putting up prices. He said the critical issue was the extent to which (if at all) it was reasonable, before the determination of the substantive appeal, to expect steps to be taken so that Snow Factor was in a position to pay some or all of the VAT without financial extremity resulting.

The judge looked at the period from HMRC's decision to require the payment of instalments to a date some months later by which he said it was likely that the UT decision would have been released. Without having heard arguments from the parties on the measures Snow Factor could be expected to take, and despite admitting he had limited financial information before him and had to make assumptions about future trading operations, he decided in a kind of 'back of the envelope' calculation that it was reasonable to have expected Snow Factor and its sister company to have increased prices by 2%, reduced expenses by 2% and asked for an extension of the bank overdraft.

He then recalculated the cashflow projections on the basis that these steps had been taken from the date of the decision and looked at the impact the payment of the VAT would have. Although the group was projected to have sufficient cash to pay the instalments HMRC demanded, by July the payments would result in the company being over £100,000 in deficit each month to October 2019. The judge said that this amounted to financial extremity. However, this did not mean that Snow Factor did not have to pay anything. He decided that Snow Factor should pay just over half of the VAT, which he considered would not cause financial extremity, if the company increased its prices and overdraft. He cast doubt on whether there was power to require payment in instalments as HMRC had originally done and ordered the payment to be made in a single payment.

The decision is controversial in suggesting that the position of other group companies is relevant and in the way in which the judge came up with the steps he considered it was reasonable for Snow Factor to take to alleviate its cashflow problems. However, it is a useful reminder that the UT test is more onerous and will not be satisfied by all those who have been able to show hardship before the FTT.

Permission to appeal to the Court of Session appears to have been granted, so this decision of the UT may not be the last word on how the financial extremity test should be applied.

This update is based on an article which appeared in Tax Journal on 7 June 2019.