In Design Rationale Ltd v HMRC [2017] UKFTT 878 (TC), the First-tier Tribunal (FTT) has held that a lack of funds caused by HMRC owing significant amounts to the taxpayer was a reasonable excuse for the taxpayer failing to account for VAT on time.


The taxpayer designs and manufacturers interior fittings. It is also a sub-contractor and falls within the Construction Industry Scheme (CIS). During the tax year 2016/17 it did not have “gross payment” status, and so payments to it for labour were made by main contractors who deducted amounts from the payments in accordance with the rules of the CIS.

The taxpayer entered the default surcharge regime for its 11/16 period. It was informed that no liability to a surcharge had been incurred but was warned that a further default within 12 months may lead to a surcharge liability.

Due to overpaying tax through the CIS for 2016/17, which could not be repaid until the end of the year, the taxpayer had insufficient funds to account for VAT from 11/16 onwards. It subsequently defaulted in the 02/17 period. HMRC issued a Notice of Assessment in respect of this default imposing a surcharge of 2% of the VAT paid late.

The taxpayer requested that HMRC review its decision. The conclusion of HMRC’s review was to uphold the default surcharge despite knowing that the VAT debt had not been paid as the taxpayer was awaiting a refund under the CIS. In HMRC’s view, this did not amount to a reasonable excuse for non-payment of VAT by the due date. The taxpayer appealed to the FTT.

FTT decision

The appeal was allowed and the assessment was reduced to nil.

In reaching its conclusion, the FTT noted that in HMRC’s conclusion letter, the officer did not say why the taxpayer did not have a reasonable excuse, but instead informed it what, in her view, a reasonable excuse was, namely, something that prevented the taxpayer from meeting a tax obligation on time that it had taken reasonable care to meet. HMRC did not address the taxpayer’s repeated statements that it could not pay the VAT and the reason why.

The FTT followed Commissioners of Customs and Excise v Salevon Ltd [1989] STC 907 and Commissioners of Customs and Excise v Steptoe [1992] STC 757, which rejected the notion that the cause of an inability to pay was irrelevant.

In the circumstances, the FTT considered the taxpayer had taken reasonable care to meet its obligations (including utilising overdraft facilities) and its inability to pay was clearly due to the fact that HMRC was in possession of an amount well in excess of any possible estimate of the taxpayer’s relevant liabilities which it could not offset against the VAT liability. In the view of the FTT, this was a reasonable excuse for the purposes of section 59(7), VATA 1994.


Whilst penalty cases tend to be fact specific, this decision serves as a useful reminder that HMRC should not automatically reject lack of funds as a reasonable excuse for the purposes of section 59(7) VATA 1994. The broader circumstances surrounding a taxpayer’s default must be taken into consideration.

A copy of the decision is available to view here.