3KH Ltd & Ors v Revenue and Customs (VAT - CORPORATION TAX - PENALTIES)

3KH referred to the Supreme Court judgment in HMRC v Raymond Tooth [2021] SC 17 at paragraphs 81 and 82 as endorsing that whilst the concept of a discovery is broad such that a failure by one officer to identify or appreciate an insufficiency or under declaration does not preclude a discovery by a second officer that second officer must pick up the file, review the documents and satisfy themselves as to the insufficiency through the "exercise of re-evaluation" of the evidence available.

We were also referred by 3KH to the recent First-tier Tribunal judgment in BJ Shere Khan Star City Limited v HMRC [2024] UJFTT 639 (TC) ( Shere Khan ). That case concerned a restaurant run by members of MJ and MB's wider family. HMRC contended, as here, that sales had been suppressed for both VAT and income tax purposes and that trading from a second restaurant was that of the taxpayer. There were also aspects of the assessments to VAT in respect of over declared zero rated sales and over claimed input tax.

In that appeal, and on the evidence, that Tribunal considered that HMRC's VAT assessments were made to best judgment but on the basis of the evidence considered that there was insufficient evidence of suppression to uphold the assessments in that regard. The zero rating and input tax assessments were however upheld. However, as regards the discovery assessment, and applying the Anderson test, rather than the test for best judgment, there was insufficient evidence on which to form a reasonable belief that there had been suppression of sales and that the second restaurant was not operated by the appealing taxpayer. It accepted that there may have been a suspicion of suppression but no more. Thus the appeal failed on its facts.

Despite making that finding the Tribunal went on to conclude in that case that the officer raising the discovery assessment could not reasonably have formed a subjective belief of an insufficiency because they had formed the view entirely reliant on the findings and analysis of the VAT assessing officer. The Tribunal considered it unreasonable to have acted in this way. This finding is one which does not form part of the reasoning by which the Shere Khan case was decided. As that is the case, we do not consider that we need to apply the principle of comity as recently described by the Upper Tribunal in Suterwalla v HMRC [ 2024] UKUT 188 (TCC) :

In the event we are wrong to have so concluded we respectfully consider the Tribunal in Shere Khan to be wrong in law that an officer cannot be said to have acted reasonably without undertaking their own investigation of primary documents before adopting the analysis and conclusions of another officer as whether there is evidence that takings had been suppressed and/or otherwise under declared. We do not agree that there can be a blanket obligation for there to be a second investigation of the evidence before forming a reasonable belief that there was an insufficiency in assessment for income/corporation tax purposes.

In this context and by reference to paragraphs 81 and 82 in Tooth we consider that it is perfectly permissible for an officer considering an income/corporation tax insufficiency to take as their starting point that VAT assessments have been or are to be issued. In the ordinary course, and unless there is something obviously untoward, the officer is entitled to assume that the VAT assessments have been issued to best judgment in accordance with the principles identified and summarised in Sintra such that there is evidence to support a conclusion that the VAT returns are incorrect.

Plainly the officer considering the income/corporation tax position must then be satisfied that the amount of turnover assessed to VAT has not been declared for income tax purposes by reference to the accounting profit and tax calculations. In that context the officer will also need to consider the net of VAT position and the declared and tax-deductible expenditure. However, provided these additional steps are taken there is nothing to oblige the income tax officer to verify the VAT officer's decision by reference to the underlying primary documents in order to make a discovery,

Findings of fact

We find the following facts from the documentary evidence and the oral testimony of Officer Pinder.

As accepted by Counsel for the 3KH Officer Pinder candidly accepted that she formed her view as to the insufficiency of the 3KH's corporation tax returns based on the detailed investigations undertaken by Officer Beard. She explained that throughout the enquiry she had visibility of his investigation through HMRC's system "caseflow" and that Officer Beard kept her appraised of its progress and explained to her the basis on which he had formed the view that there was suppression of VAT both in connection with cash sales made at TSM and as a consequence of a failure to declare sales made at TSL. He had explained to her the basis of his calculations. On the basis of the analysis in those letters she was satisfied that the turnover which had been assessed to VAT had not been reported for accounting or corporation tax purposes and thus formed the belief that there was an insufficiency of tax that had been assessed by 3KH. She did not consider she needed to interrogate the underlying information as she trusted, from experience having previously worked alongside Officer Beard, that his investigation had been thorough, and his conclusions were rooted in the information provided.

In the letter of 16 May 2018 regarding the VAT Assessments 3KH were notified "due to the cash suppression identified, HMRC will also consider whether the additional net sales will result in Corporation Tax becoming payable. You will be contacted separately regarding this."

That separate contact was made on 23 May 2018 by Officer Pinder who notified 3KH, MJ and MB:

On 23 May 2019 Officer Pinder again wrote to 3KH in the following terms regarding accounting period ended 31 July 2017:

In our view Officer Pinder's conduct was, in all the circumstances, entirely reasonable and proportionate. She relied on the though investigation undertaken by Officer Beard and identified that the sales that he considered had been suppressed for VAT purpose had also not formed part of the tax calculations for corporation tax purposes. She thereby made a discovery. She believed that there was an insufficiency, and that belief was objectively reasonable.

In each of the pre discovery assessment letters Officer Pinder informed 3KH and the directors that without an alternative explanation she was of the view that the suppressed profits had been extracted by the directors; in this regard the letters were in identical form:

No further explanation was provided, and we consider it reasonable for her to have therefore formed the reasonable belief that the under declared profits arising from the suppressed sales had been extracted by MJ and MB as participators. As such there was discovery in this regard.

In so finding we reject the Appellant's contention that Officer Pinder had no more than a suspicion that there was an insufficiency in 3KH's return.

Deliberate issue

Legal test

The legal test on what constitutes deliberate conduct (both for the purposes of the gateway to the issue of a discovery assessment in accordance with paragraph 43 Sch 18 FA98 [8] and Sch 24 FA 2007) has been confirmed in the Tooth Supreme Court judgment at paragraphs 42, 43 and 47 which provide that deliberate conduct requires that a statement is made which, when made, was intentionally misleading.

Parties submissions

3KH contends simply that it, MJ, and MB were unaware of any demonstrated suppression and had no intention to mislead. HMRC submit that MJ and MB were active in the management of the business, would have been at least aware, and more likely directed the means of suppression, the mis recording of takings and expenses and rendering of inaccurate returns.

Findings of fact

We derive the following findings of fact from Officer Beard's witness statement, the documentary evidence and as a consequence of the findings made in respect of the VAT, Further VAT and Discovery Assessment.

In paragraph 25 we refer to the store table information which had been printed on the z readings up to 24 December 2013 but was not recorded thereafter. The information printed on the z readings provided HMRC with demonstrable evidence of significant (£180,342.09 or £3,680.45 on average per day) under declaration for the 01/14 VAT period also demonstrating greater daily average sales when compared to periods following the removal of that data. We consider that the removal of the data from the z reading was likely to be intended to obfuscate the suppression and thereby demonstrates deliberate behaviour by or on behalf of 3KH and the evidential start point for deliberate conduct. We consider that this finding is corroborated by a letter from the till provider which indicated that the system did not reset the store table; i.e. we conclude it was not a system failure of any sort which renders it more likely that someone with authority within 3KH took a deliberate decision to reprogram the z readings thereby removing the data from the daily records retained by the business.

We have found that there is evidence of substantial suppression of cash sales at TSM throughout the period assessed. No realistic or sensible explanation has been provided for the drop in sales between 24 December 2013 and 26 August 2017. What is apparent is consistently z readings have been programmed in a way which sought to hide suppression.

As indicated in paragraphs 28 above MJ and MB gave somewhat inconsistent evidence of their management and the role of the onsite managers. We are more inclined to accept the witness statement evidence that MJ and MB were hands on managers. We also prefer the witness statement evidence regarding the daily operation in the restaurant i.e. we consider it more likely that there was a manager on site at all points of operation with 3 managers there when open and/or busy. We find that cashing up at the end of each day was carried out by someone with the authority of 3KH as the witness statements are clear, and were supported by covert observations, that the till was operated by the cashier or a manager i.e. someone duly authorised by 3KH to perform this task [9] . On the basis that a till does not get accidentally reprogrammed, and a conscious and deliberate act is also required to annotate z readings with figures that differ from the till information we are entirely satisfied that prime documents were deliberately manipulated in order that both VAT and corporation tax returns were completed to mislead HMRC.

Further, it is plain that a fixed and unevidenced proportion of sales were treated as zero-rated without any reference to actual zero-rated sales made and input tax was claimed in circumstances where purchase invoices were not retained. Again this cannot have been accidental and whether it was the directors or the accountant the behaviour is attributed to 3KH, at least for the purposes of identifying deliberate conduct.

As regards TSL we have concluded that 3KH were financially responsible for the operation of TSL and yet failed to declare sales whilst nevertheless claiming input tax. Again this can only have been a conscious decision intended to mislead HMRC.

We have no hesitation in concluding on the facts that 3KH deliberately rendered incorrect VAT returns and submitted corporation tax returns that deliberately declared an insufficiency in 3KH's self-assessment to income tax and that deliberate conduct was demonstrated on behalf of 3KH throughout the period assessed.

Finally, and corroborating such deliberate conduct, in our view, 3KH sought to be as obstructive as possible with the intention of precluding HMRC from quantifying the under declaration. HMRC had to repeatedly visit 3KH and were met with obstruction and both formal and informal requests for information and documentation were ignored or refused. In this regard we note that 3KH does not contest that mitigation for telling (5% of a maximum of 30%) and giving (10% of a maximum of 40%).

Participation Issue

Having concluded that Officer Pinder discovered an insufficiency in 3KH's self-assessment to tax in respect of the section 455 CTA charge in circumstances where deliberate conduct has been established, we have to decide whether the 3KH can satisfy us that the underdeclared profits were not in fact extracted by way of loan or otherwise advanced to them. If they are able to satisfy us, we would use our powers under section 50(6) TMA to reduce the Discovery Assessments and we would set aside the NICs Decisions

Somewhat ironically both parties contend that there is no direct evidence as to what happened to the under declared profits:

In our view the Supreme Court analysis in Armstrad plainly sets the position in civil litigation but not where there is a statutory burden of proof. We read the decision in Thomas as requiring that whilst it was not for HMRC to prove that the taxpayers in that case were settlors, the assessing officer did have to show, by reference to the evidence, that they held an objectively reasonable belief that the taxpayers were settlors. As the reference to R v The Kensington Income Tax Commissioners (ex-party Aramayo) (1931) 6 TC 279 confirms, that belief need not be ascertained by legal evidence. We consider that a prima face case, in that case, that the taxpayers were settlors, could be made out by reference to the circumstances from which an inference might reasonably be drawn. It will then be for the taxpayer to show why the inference is wrong.

In this case HMRC have shown that very substantial sums of cash were not included in the 3KH's declared turnover resulting in an understatement of profits and an insufficiency in the tax returned by 3KH. Officer Pinder did not need to know where the money had gone (and she accepted that she did not know) as in the absence of evidence to indicate that the business retained that cash the logical, or only, inference to draw was that the cash was extracted by or for the benefit of the participators i.e. MJ and MB. We consider that HMRC have established a prima face case of extraction, and it is then for the Appellants to show what did happen to the cash we find to have been suppressed.

The Appellants contend that even were HMRC to have made a prima face case that the profits were extracted as both MJ and MB stated in oral evidence that they had not received a loan from 3KH, and that statement had not been cross examined, it was to be accepted and the inference had been rebutted. In response to the allegation that he had failed to cross examine on this critical issue Mr Simpson argued that HMRC's position on section 455 was clear, the witnesses were not to be believed and there was no other evidence to support their bald statements that they had not received a loan.

In this regard we note that neither of the witness statements asserts that no loan or advance was made to either of MJ or MB. We permitted clarificatory questions to be asked by Mr Blades of the witnesses. We note that Mr Blades did ask MB whether he had received a loan from 3KH. That could not have been a clarificatory question given the absence of any reference to extraction in the witness statement. Further the question was limited to a loan and not to any other form of advance. Having carefully considered our notes it does not appear MJ was asked by Mr Blades whether he received a loan or advance prior to cross examination [he may have asked him in re-examination].

In any event it remains a matter for us, whether we believe the evidence, and we do not believe the witnesses in this regard. They made no attempt to explain what had or could have happened to the cash other than a vague assertion that it may have been stolen by staff contrary to their asserted zero tolerance of cash shortages. Such an assertion is literally incredible and wholly unbelievable in light of our findings as to the extent of the suppression and the hands-on way in which MJ and MB were involved in the business.

We therefore find that the inference that profits were extracted is a very strong one in respect of which there was no contrary evidence we therefore uphold the section 455 CTA charge.

3KH accepts that if, as we have, found that the fund were extracted the NICs Decisions and Penalties were correctly raised.

PLN Issue

Legal test

Pursuant to paragraph 19(1) Sch 24 FA07 where a penalty is payable by a company for a deliberate inaccuracy, which was attributable to an officer of the company, the officer is liable to pay such proportion of the penalty as HMRC specify in a notice.

HMRC must therefore be satisfied that the deliberate conduct was so attributable.

Parties submissions

MJ and MB repeat that any deliberate conduct on the part of 3KH should not be attributed to them. HMRC repeated their submissions on deliberate conduct generally.

Findings of Fact

MJ and MB were both appointed as a director on 14 April 2015.

PLNs were issued to both MJ and MB on in respect of the VAT Assessments and in respect of the Further VAT Assessments attributing the company penalty as to 42.4% [10] to MJ and 50% to MB vis a vis the penalties arising from the VAT and Further VAT Assessments and equally as between them regarding the corporation tax penalties. Initially these were issued for a period longer than the period for which the individuals were directors of the company but were subsequently amended.

For the reasons indicated in paragraph 160 we prefer the evidence provided in MJ and MB's witness statements that they visited TSM frequently and at least daily in the first year after appointment as directors. Between visits they were in contact with the manager by telephone and that they were "hands on" managers actively engaged in the business.

As we have previously indicated we consider that they demonstrated a blatant disregard for the truth when giving evidence to us which we consider corroborates a continued willingness to deliberately make inaccurate statements intended to mislead.

We therefore find that the deliberate conduct was attributed to MJ and MB and the PLNs were correctly issued.

Mitigation Issue

Legal test

When issuing penalties the maximum and minimum rates are determined by reference to the nature of the behaviour giving rise to each individual inaccuracy assessed. In the present case the relevant inaccuracies were: (1) suppression of cash sales for VAT purposes at TSM, (2) failure to declare sales for VAT purposes at TSL, (3) over claimed input tax, and (4) insufficiency in corporation tax self-assessment arising from suppression of sales at TSM/non-declaration of trade at TSL and extraction by the participators. As we have found, each of the inaccuracies was deliberate, HMRC do not contend that the inaccuracies were concealed and the 3KH does not challenge that identification of the errors was prompted. As such and in accordance paragraph 10 Sch 24 FA07, the maximum penalty rate was 70% and the minimum is 35%. When determining where in the range between maximum and minimum penalty rates a particular penalty should be set HMRC take account of the assistance provided by the taxpayer under the headings Telling, Helping and Giving. Reductions to a maximum of 30%, 40% and 40% may be given under each heading.

In the present case, as regards each inaccuracy HMRC allowed 5% in respect of Telling and 10 % in respect of each of Helping and Giving (thereby reducing the penalty charged by 20% of the difference between the maximum and minimum penalties).

Parties submissions

The Appellant does not challenge the reduction given in respect of the penalty associated with the sales from TSL, or the over claim to input tax. Neither do they challenge the reduction permitted for Telling or Giving in relation to the penalties issued in respect of the VAT errors associated with suppression at TSM or the corporation tax inaccuracies. However, they challenge the reduction for Helping contending that it is too low and that the justification for the level of mitigation is factually incorrect.

Findings of fact

The stated reason for permitting 10% reduction in respect of the two relevant inaccuracies is as follows:

By reference to correspondence available to us, HMRC notified the Appellant that it proposed to undertake unannounced visits in the period 19 – 21 July 2017. The visit was made on 20 July 2017 as the restaurant was closing. Officer Beard told us that he was refused entry. His notebook of the visit records that he identified himself to a waiter and asked to speak with the person in charge. It then records that he was approached by someone who Officer Beard described as a manager. Officer Beard explained the purpose of the visit and was told that the manager would need to contact head office. A call was made, and Officer Beard was invited to speak with a Mr Khan on the telephone who said he was company secretary (this was not legally correct). Mr Khan told Officer Beard his was acting outside his authority in attending outside business hours. It was indicated that HMRC could attend unannounced, but it would need to be in business hours and Officer Beard was asked to leave. Officer Beard followed the instruction.

HMRC then sought to make an arranged visit on 21 August 2017. TSM indicated it was inconvenient with MJ emailing HMRC to seek to rearrange because of absence of the bookkeeper and the accountant. Despite this HMRC notified they intended to make an unannounced visit between 22 and 24 August 2017 and visited on 23 August 2017. Officer Beard again informed us, as corroborated by his notebook, that he spoke with Mr Khan on the telephone. He advised that he wished to take data from the till onto a USB stick. Mr Khan understood that a meeting had been arranged for 21 September 2017 and did not therefore understand the purpose of Officer Beard's attendance on 23 August 2017. Officer Beard's notebook shows that he explained that he wanted to uplift till data. In response Mr Khan again alleged that HMRC were acting outside their powers and asked Officer Beard to leave. Officer Beard left without the till data he had attended to acquire.

MJ sought to postpone the meeting which had been arranged for 21 and 22 September 2017 but eventually conceded to the visit taking place indicating that the "paperwork for the last four to five weeks was at the registered office" and the accountant would be available.

Officer Beard explained that a visit took place on 21 and 22 September 2017 however, at the visit 3KH were unable or unwilling to access the till data only providing z-readings. On 3 October 2017 HMRC wrote to 3KH regarding what are described as outstanding matters, in particular a request to review documentation from 2013 to October 2017. The meeting was proposed for 6 November 2017. HMRC also noted that between the unannounced visit on 23 August 2017 and the announced visit on 21 September 2017 the till had been changed. Details of the change and associated documentation were requested.

On 14 November 2017 HMRC were finally provided with access to the till from which they were able to extract data for the period 26 August to 14 November 2017.

Further correspondence ensued and on 16 January 2018 HMRC proposed a visit to TSM (and other restaurants with whom MJ was involved) on 12 February 2018 explicitly to interrogate further data stored on the till with further visits to 3KH's accountants to review documentation on 14 – 16 February 2018. At that visit HMRC attempted to access the programming section of the till but a manager's log in was required but Mr Khan, who managed the visit on behalf of 3KH, did not have the relevant log in. The meeting was aborted.

A further visit took place on 28 February 2018. Although Mr Khan (who again managed the visit for 3KH) had a log in code it would not permit access to the reports section of the till. Default logins were tried but none permitted access. The additional till information was, as we understand it, never obtained.

Discussion

On the basis of our findings it is plain to us that 3KH was obstructive of HMRC's enquiry. 3KH denied lawful access of officers on both 20 July and 23 August 2017 and it took until 14 November 2017 until any till data could be accessed. There were subsequently further difficulties in accessing further till information.

We accept that the brief articulation narrated in the penalty assessment letters could have been more accurate (particularly that for the corporation tax inaccuracy). However, 3KH were well aware of what had happened at each of the visits, they had not helped HMRC, in fact quite to opposite. We were not invited to increase the penalty amount (though we have the jurisdiction to do so under paragraphs 15(2) and 17(2) Sch 24 FA07) and we do not do so, we simply note that a 10% allowance (of a maximum of 40%) appears to us to have been reasonably generous.

We therefore uphold the Penalties in full.

Disposition

For the reasons given we uphold the VAT and Further VAT Assessments, the Discovery Assessments, the NICs Decisions, the Penalties, and the PLNs in the sums in which HMRC invited that they be upheld.

Right to apply for permission to appeal

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.

Bundle 1

48, 55, 57, 61, 83, 101, 125, 127 – 9, 131, 138 – 9, 155, 198, 203 – 4, 221, 227, 247, 248, 314, 317, 360, 386, 454, 463, 557, 565, 615 – 629, 630, 646, 690, 704, 888, 926, 934, 944 – 946, 961, 964 – 990, 997 – 8, 1009 – 1038, 4155, 4484, 4518, 6322, 6387, 6451, 6454

Bundle 2

Bundle 3

5

Supplementary Bundle

3, 5, 11 – 12, 37, 40 – 75,

Note 1 The PLNs were issued to each of MJ and MB on the same dates that each of the Penalties were issued to 3KH [Back]

Note 2 The letter is undated letter but was prepared by on behalf of the 3KH and sent to Mr White in response to Officer Beard’s enquiries concerning 3KH and other companies also operating restaurants. It refers to HMRC’s letter of 23 May 2019. The letter runs to 50 pages, and it was not readily clear how it related to the individual companies referenced only one of which was 3KH. We have limited our consideration of the letter to the parts of it to which our attention was drawn or those which plainly related to 3KH and the Tipu Sultan restaurants. [Back]

Note 3 As per paragraph 23(1) [Back]

Note 4 As per paragraph 23(2) [Back]

Note 5 As per paragraph 23(3) [Back]

Note 6 As per paragraph 23(4) [Back]

Note 7 We note that in the hearing there was disagreement between the parties regarding the circumstances in which the “presumption of continuity” can apply as set out in the case law. In our view the case law entirely supports the approach that both HMRC and we have adopted i.e. to assume that suppression occurred between the points at which it is evidenced to have occurred and until the taxpayer shows that suppression ceased. [Back]

Note 8 Para 42 provides that the power to make a discovery assessment where the taxpayer in question had rendered a corporation tax return is only exercisable in the circumstances specified in paragraphs 43 or 44. Paragraph 43 specifies that discovery assessments can be raised where the insufficiency in the return is brought about carelessly or deliberately by inter alia, the company or a person acting on behalf of the company. [Back]

Note 9 As set out in paragraphs 186 and 187 below when Officer Beard attended on 20 July and 21 August 2017, he was informed there was no manager on site. There was nevertheless someone who cashed up for the night and took the till readings. [Back]

Note 10 We were not told why the penalties were not attributed 50:50. [Back]