In a recent case, the First Tier Tribunal (the FTT) was asked to consider whether a charitable independent school had a reasonable excuse for late payment of monthly PAYE and NICs.
The school, Fernhill Primary School Limited (Fernhill) had 175 pupils at the time it launched the appeal; previously it had just over 200.
The statutory date for PAYE payment is 14 days after the end of the tax period on the 5th of each month. However, HMRC allows three extra days for electronic payments, meaning that payments are deemed to be late if they are made after the 22nd day of the month. Fernhill made electronic payments between June 2012 and March 2013, but ten were late. HMRC charged Fernhill a penalty for the late payments. Fernhill asked the FTT to set aside HMRC's penalty, on the grounds that it had a reasonable excuse for its failure to pay on time.
At the FTT, Fernhill offered various explanations as to why it had found it difficult to make the payments on time. The school had ongoing cash flow problems even before it began defaulting on its monthly payments. This was attributed in part to bad debts: parents who had fallen into financial difficulties as a result of the economic downturn were unable to pay the school's fees and, in some instances, had faced bankruptcy.
Fernhill collected fees at the beginning of the month, meaning that by the time its PAYE and NICs payments were due, it was running short of liquid assets and generally had to wait until after it had collected the following month's fees before being able to settle its PAYE and NICs liability. Fernhill had found it impossible to obtain short-term bank finance to smooth its cash-flow, and although a benefactor had offered to lend money to the school, this offer was contingent on the benefactor's business having enough of a surplus to make the loan.
The law provides that where an employer has a reasonable excuse for failing to make PAYE and NICs payments by the due date, that failure will not count as a default. It goes on to clarify that certain matters will not constitute a reasonable excuse. An insufficiency of funds will not qualify, unless attributable to events outside the employer's control.
Although the term "reasonable excuse" is not define in legislation, it has been considered in various cases, including in the context of determining whether or not the excuse offered falls within the excluded categories. The FTT analysed these cases and found that, broadly speaking, an employer's behaviour will be central in deciding whether or not it had a reasonable excuse.
Insufficiency of funds
The case law showed that "the appropriate test concerning whether an insufficiency of funds amounts to a reasonable excuse is to examine if the underlying cause of the insufficiency is 'reasonably foreseeable' or 'reasonably avoidable'". If it was reasonably foreseeable or avoidable, it will not amount to a reasonable excuse.
As a general rule, bad debts will not amount to a reasonable excuse, since they are an inherent risk for most types of business.
In cases on whether the economic downturn might form the basis of a reasonable excuse, case law established that the question is "whether, given the exercise of reasonable foresight, due diligence and a proper regard for the fact that tax is due, the lack of funds is reasonably avoidable".
The FTT's decision - did Fernhill have a reasonable excuse?
Having reviewed the relevant cases, the FTT held that whether Fernhill's insufficiency of funds could amount to a reasonable excuse depended on the answer to two questions:
- whether there was an underlying cause of Fernhill's lack of funds in 2012-13; and
- whether the lack of funds was reasonably avoidable, given the exercise of reasonable foresight, due diligence and a proper regard for the fact that tax was due on a particular date.
The FTT first considered whether the school's bad debts constituted a reasonable excuse. The case law showed that, to allow bad debts as a reasonable excuse, the FTT had to be satisfied that there was something particular about Fernhill's business that rendered the risk of bad debts out of the ordinary. In its view, the risk of bad debts is a normal hazard of independent schools that is all the greater in an economic downturn. Fernhill's bad debts were reasonably foreseeable and most of the debts referred to in Fernhill's evidence arose before 2012-13. As such, they could not amount to a reasonable excuse.
However, the FTT went on to find that Fernhill's lack of funds in 2012-13 had two specific causes. First, the loss of 15 pupils – at three times the expected attrition rate – severely affected the school's finances, which were already weakened by cumulative deficits from previous years. This was aggravated by increased costs that arose because of the prolonged sick leave of three members of staff. Secondly, the school had no capacity to raise short-term finance to ease its cash-flow difficulties, and the pledge from the benefactor was contingent upon her own business having enough surplus to lend the required working capital to Fernhill.
The FTT stated that the loss of 15 pupils and the school's inability to raise short-term finance were underlying causes of its lack of funds that were not reasonably avoidable and, as such, amounted to a reasonable excuse for its late payments from August 2012 onwards. Noting that Fernhill had paid the amounts due between six and 23 days late, the FTT found that the school had a proper regard for the fact that tax was due and had remedied each failure without unreasonable delay. Since June 2014, it had made all its monthly payments on time.
In its evidence, HMRC mentioned that Fernhill had not returned any of its calls, citing this as an indication of unreasonableness. The FTT took the view that, given the contents of the messages HMRC had left, it was not unreasonable for Fernhill to see them as 'chaser' calls that did not require a reply (other than in the form of payment). At the time, the in-month PAYE penalty regime was only in its third year and it was probably not widely known by employers that there was scope for negotiating a 'time to pay' agreement. In light of these points, it did not consider Fernhill's failure to return HMRC's calls unreasonable.
For these reasons, the FTT discharged the penalties from August 2012 onwards, but upheld the earlier penalties.
This case offers scant comfort to schools that are struggling to pay HMRC because they have suffered from the economic downturn or because their schedule for fee payments results in regular and predictable cash-flow problems. However, it does provide a glimmer of hope to those whose difficulties are due to unexpected or unavoidable occurrences. It also serves as a reminder to schools that it is possible to negotiate with HMRC if circumstances make it hard for them to make PAYE and NICs payments on time.