19121
Assessment – Quantum – Appellant's records defective – Assessments based on turnover in accounts – Evidence by auditor that turnover overstated – Material insufficient to satisfy burden of proof – Appeal dismissed
LONDON TRIBUNAL CENTRE
CHECKPOINT SYSTEMS (UK) LTD Appellant
HER MAJESTY'S REVENUE & CUSTOMS Respondents
Tribunal: THEODORE WALLACE (Chairman)
M M HOSSAIN FCA, FCIB
Sitting in public in London on 12-14 April 2005
David Scorey, counsel, instructed by Pricewaterhouse Coopers, chartered accountants, for the Appellant
Jeremy Hyam, instructed by the Solicitor for the Customs and Excise, for the Respondents
© CROWN COPYRIGHT 2005
DECISION
- This is an appeal against assessments totalling £274,959 for the four periods 03/98, 06/98, 09/98 and 12/98. It is common ground that the Appellant's records were seriously defective and that the assessments were raised to best judgment. The appeal is against the amount of the assessments. Following an amendment to that for 03/98 they are solely based on output tax.
- The assessments are calculated by reference to the excess of the turnover shown in the audited accounts for the year ended 31 December 1998 over the outputs declared on the VAT returns.
- The Appellant contends that the turnover in the 1998 accounts was later found to be incorrect by the auditor, Keith Anderson, who made adjustments to the turnover in the 1999 accounts to reflect the errors, which adjustments included a debit of £1,567,942 from turnover attributable to turnover for 1998 being overstated. Mr Scorey submits that £274,390 being VAT on this amount should be deducted from the assessments, leaving only £569.
- Three witnesses gave evidence confirming witness statements and were cross-examined: Keith Anderson FCA, the partner of Pricewaterhouse Coopers ("PWC"), who was responsible for the statutory audit of the Appellant company since 1993; David Francis Pearson FCA, a specialist accountant with Customs since 1994 who had previously been in the private sector; and Robert Hanley, a senior auditor with Customs at the Harlow VAT office. A statement by Mrs Patricia Ford, of Customs' Large Business Team, was agreed.
- The documentary evidence included the following: the Appellant's statutory accounts for the four years 1996 to 1999; various invoices or proforma invoices; a brief undated report by Peter Bracken of Customs (since retired) on five visits in 1998; a report by Mr Hanley which was undated covering the 1998 visits and later material, being amended on computer at various times up to March 2000; a Report by PWC in June 2000; a note by Mr Hanley of a meeting on 12 June 2000 attended by a director of Meto Ltd, an associated company of the Appellant, by four representatives of PWC and by Mr Pearson, Mr Bracken and Mr Hanley; a journal extract by PWC dated 9 August 2000; a printout of invoices from the Appellant to B&Q from January 1997 onwards provided by B&Q to Customs; a list of nineteen proforma invoices which were received, claimed or paid by customers; correspondence; and trial balances for 1997, 1998 and 1999 produced by the Appellant a week before the hearing.
- We deal first with the underlying facts which were not in dispute.
- The Appellant was a subsidiary of Checkpoint Systems Inc., a US company. Its business consisted of the installation, sale and rental of electronic security equipment for retailers. The Appellant provided plastic tags and labels with barcodes which were attached to goods to activate ancillary equipment which detected goods leaving the stores without being scanned. It also provided closed circuit television but did not provide the scanning equipment with the tills. The equipment was manufactured in Puerto Rica and delivered by an associated company in Belgium to the UK. Where contracts involved installation, as with B&Q, equipment was moved to the customer's premises and held on consignment before installation. The Appellant had a relatively small warehouse.
- The 1998 accounts recorded 91 employees of whom 80 were engaged in selling and distribution. The accounts for the three years 1997 to 1999 showed average turnover of £15 million and a loss over the three years of £16 million. Some £½ million a year of turnover was from rentals on operating leases. The 1998 accounts show additions to assets leased out by the Appellant on operating leases of £1.2 million before depreciation; the 1999 accounts showed disposals of £2.1 million. Trade debtors shown were £7,439,795 at 31 December 1998 and £4,008,863 at 31 December 1999.
- The Appellant used a specially designed accounting system developed in USA called Exchequer, running on a network server in Belgium which also served the corporate group in Europe and USA. The system was designed to be compatible with the parent company and accounts were drawn up using US Generally Accepted Accounting Principles ("GAAP"). Prior to a change in US GAAP revenue recognition policies in 1999, sales were recognised when the product left the Appellant's premises, with proforma invoices being created. In order to adjust for UK GAAP which recognises the sales when the product is installed, dummy credit notes were raised to cancel the proforma invoices with full invoices being issued to customers on installation.
- In addition, under US GAAP, all sales under financing arrangements were considered to be finance leases with the full value of the leased asset being recognised as a sale at the outset. Under UK GAAP the revenue on operating leases can only be recognised as the rentals accrue. This difference in accounting treatment required adjustments to the turnover figures produced on the Exchequer system.
- At the time of the visits by Mr Bracken and Mr Hanley in 1998 the Appellant occupied offices and a warehouse at Harlow. The warehouse was not large. In September 1999 the Appellant moved to High Wycombe. In December 1999 the Appellant's parent company acquired a German Company, Meto AG, which had a UK subsidiary, Meto UK Ltd, based at Bracknell. The Appellant relocated to Bracknell in April 2000 and became part of the Meto UK VAT group. Records were lost during the relocations from Harlow to High Wycombe and thence to Bracknell. Ray Adams the employee of the Appellant seen at the visits in 1998 had left the Appellant at the time of PWC's report in June 2000 together with the rest of the accounts department.
- Two of the three directors at the start of 1998 resigned during the year. Mr Lesse who was a director throughout 1998 resigned in June 2000. Mr Austin who was appointed on 10 September 1998 was still a director in 2002. Mr Midani who was appointed on 1 November 1998 resigned on 5 July 2000.
- Mr Bracken's first visit was on 19 May 1998. He made four more visits in 1998, three with Mr Hanley. His report of one page stated that all records were maintained at Harlow. He was unable to reconcile declared outputs against the VAT account. He noted that large quantities of goods were imported from associated companies. Discrepancies were identified between Box 1 (output tax) and Box 6 (sales). His report stated that "one (probable) reason for the discrepancies relates to warehouse transfers where dummy invoices are raised, balanced by credit notes and replaced by actual invoices." He retired during 2004 and his notes of the visits which totalled over 16 hours are no longer available.
- Mr Hanley did not keep any notes of his visits. He initially made trigger notes but did not keep them. He compiled a report on computer from the trigger notes after
each visit and updated it subsequently. The last amendment was in March 2000. The report was not dated and it was not possible to tell what was entered or amended at what dates. The report took up seven pages in the bundle. Much of it was directed to matters not material to this appeal.
- At the visit on 6 August 1998 Mr Van Den Bogert, of MIS Network Support, Belgium, was present. Mr Hanley's report stated that the network server was located in Belgium and was supported on line from Belgium. The Appellant was one of a number of satellite users. The disk drives were located in Belgium. Programs were shared, but data was up and downloaded between the user and central support services.
- The report stated that an order was raised for all sales, an order number being generated. Separate sales invoice numbers were generated.
- A section of the report covered roll out deliveries, which were a contracted series of installations over a period of time for a customer at separate addresses, being composite supplies of goods and services. Before January 1998 "dummy" invoices without VAT had been raised when the goods were moved from warehouse stock. As and when installation schedules were received from the engineers, another order was raised, a tax invoice was produced and a credit note was used to cancel the completed part of the dummy invoice. The top copy of the dummy invoice although not meant to be sent to the customer was not retained. After 1 January 1998 no dummy invoices or credit notes were raised.
- The report stated that the difference in accounting practice for lease income between USA and UK involved the issue of proforma invoices to the US parent company.
- The Appellant provided files on disk on which Mr Hanley carried out tests. He found that some invoices said to be internal, dummy or proforma, carried VAT and were found in the records of customers.
- In March and June 2001 having concluded that there was no other satisfactory method of ascertaining the Appellant's correct VAT liability, Mr Bracken raised assessments for periods 03/98 to 12/98 calculating the underdeclared output tax on the difference between the turnover stated in the audited accounts and the outputs declared on the returns. The 03/98 return also included a substantial amount of input tax, however that was abandoned in an amendment in 2002.
- Assessments raised for earlier periods were the subject of separate appeals which have been settled by agreements under section 85.
- The statutory accounts for 1996 were signed on 16 March 1999; those for 1997 and 1998 were signed on 2 May 2000 and 6 June 2000 respectively and that for 1999 was signed on 7 February 2002, after the appeals had been lodged.
- The accounts for 1997, 1998 and 1999 included the following figures:
1997 1998 1999
Turnover £16.045m £17.945m £10.765m
Cost of Sales 7.964m 10.353m 9.962m
Stock and Work in progress 5.952m 2.261m 1.227m
Trade debtors 5.945m 7.440m 4.009m
The trial balance adjustments for the three years were as follows:
Turnover per ledger 19.151m 16.009m 15.287m
Excess debtors - - -1.568m
Other adjustments 1999 - - -3.097m
Adjustment 1997 to 1998 -3.639m +3.639m -
UK GAAP -1.345m -2.249m -0.332m
Lease rentals +0.538m +0.545m +0.475m
Reversal from 1996 +1.340m - -
Turnover for A/Cs 16.045m 17.945m 10.765m
The descriptions of these adjustments are our descriptions based on the evidence given.
- The crucial figure for this appeal is the deduction in 1999 of £1,567,942, rounded in the table to £1.568 million, for excess debtors. On the basis of the evidence of Mr Anderson, the auditor, the Appellant contends that this should be deducted from the turnover for 1998 which was used as the basis for the assessments. VAT at 17.5 per cent on this figure is £274,390. If this is deducted the assessments are reduced to £569.
- In March 2002 Customs obtained spreadsheets from B&Q showing invoices from the Appellant totalling £3,080 for 1996, £87,363.50 for 1997 and £3,060,531.60 plus VAT for 1998. This was in response to a request for a full account listing from 1 January 1997 of invoices received from the Appellant. All were recorded as paid, the 1996 invoice being paid on 24 January 1997. £52,356 1997 invoices were paid on 30 January 1998.
- Mr Anderson confirmed statements dated 8 July 2003 and 24 February 2005 and introduced the trial balance sheets. He was cross-examined for about four hours.
- He said that he had audited the Appellant's accounts since 1993. He was always aware of two significant audit risks. The first was that being a sales based company there was a risk of sales being booked too early. The second was the US GAAP practice of recognising sales on operating leases at the outset of a contract. His team would do some work before the year end and then six or seven man days in January. A report would be prepared raising any necessary queries. The audit would be completed when those were answered.
- Mr Anderson said that the trial balances had been created by David Hills, his audit manager.
- In 1997 £3,639,109 had been excluded from the initial turnover because a contract with B&Q to fit out 290 stores had been booked although only 30 had been completed by 12 December 1997, the balance of the stock being held by B&Q on a "reserved basis" while being upgraded prior to installation; the £3,639,109 was not legally due at 31 December 1997 and could not be recognised as income under UK accounting standards.
- Internal proforma invoices for £1,678,560 plus VAT (26 September 1997), £225,280 without VAT (20 October 1997) and £4,059,366 without VAT (24 December 1997) were raised in respect of the B&Q contract. The first gave details of
additional charges for six categories of items (for example £544,000 for "C/P VI deactivators x 1280"); the second was an additional charge for "EAS equipment", the third was six additional charges for "various installation equipment". Spreadsheets provided by PWC to Customs showed credit notes with corresponding numbers for £1,877,986 on 24 December 1997, £1,724,611 plus VAT on 20 October 1997 and £150,138 on 6 February 1998. The net effect of the above was internally invoiced sums of £2,210,471 and negative VAT of £8,059. None of those invoices was found in B&Q's records.
- It appears from a journal extract dated 9 August 2000 shows that the figure of £3,639,109 was the balance remaining from B&Q sales amount of £4,122,441, originally recognised for the sales, over the £483,332 allowed for UK accounting purposes. Referring to £483,332 trade debtors and turnover, the journal read,
" Being the recognition of sales to B&Q at 30 of the 290 stores where stock had been delivered and held on a reserved basis The full sales amount of £4,122,441 was recognised for US reporting purposes but as the equipment was not installed as required by the contract only a proportion of the turnover was allowed for UK reporting purposes."
- Mr Anderson did not explain the relationship between the £4,122,441 in the journal extract and the proforma invoices and credit notes.
- In his first statement Mr Anderson said that in 1998 the Appellant advised PWC that the roll out to all 290 B&Q stores was complete, that B&Q was withholding £1.8 million pending resolution of some technical issues but that those issues had been resolved subject to Checkpoint Inc. accepting responsibility for the technical modifications. Mr Anderson told us that the managing director, Mr Midani, was adamant that the B&Q debts were valid. Mr Anderson stated that when the 1998 Accounts were signed in May 2000 initial work for the 1999 Accounts had been completed but the books had not been fully written up; PWC had noted that the B&Q debtors figure had reduced to £292,000. PWC concluded that the B&Q debt had been largely paid and recognised the £3,639,109 deferred from 1997 as revenue in the 1998 accounts.
- When clearing the 1999 accounts, PWC were told that £2.5 million transferred during the year from debtors to finance lease assets were long term debtors with incomplete evidence to confirm the balances. PWC noted that cash collection had been poor since the move to High Wycombe in September 1999. Mr Anderson said that when he was investigating the figures for the 1999 accounts the company had relocated again, senior management had changed and the company had been reorganised. There was no one with any detailed knowledge of prior transactions. The new management agreed to investigate all 1998 debtor balances and to establish the position with each customer. He said that the new managing director went back to B&Q twice. He got some more money but was not able to contest the balance. B&Q stated that they had paid up to date.
- Mr Anderson said that towards the end of 2000 it transpired that included within the £2.5 million transfer in the previous year to finance lease assets was £1,252,172 relating to B&Q debtors. Mr Anderson said that the contracts made by the Appellant normally consisted of exchanges of correspondence varied for each location; there were no formal contracts. We note however that PWC's report of June 2000 referred at paragraph 3.3 to examining a copy of the contract with B&Q. Mr Anderson said that common practice to make a transfer in the ledger if the basis of settlement changed from sale to leasing. Credit was initially taken as if a sale, this being the US accounting treatment. If a finance company leased to the customer there
would be a sale to the finance company. However if the customer leased directly on an operating lease it was not a sale. The reclassification of £2.5 million would have been correct if a finance company undertook the liability : however there was no evidence to support the transfer of the B&Q debt to someone else. Mr Anderson said that he suspected that problem debtors were taken out of ordinary debtors in the ledger and transferred to finance leases. In the past every previous classification of this type had been supported by documents.
- Mr Anderson said that four other adjustments on the trial balances for 1999 related to specific invoices raised in error because goods were not delivered or the invoices were duplicated and in respect of those there was no evidence to allocate them between 1998 and 1999. The figure of £1,252,172 and the balance of £315,770 however related to debtors which were not validated but which had been attributed to turnover included in the 1998 statutory accounts. The £315,770 was to one customer.
- The US management did not want adjustments. The group finance director came from the USA to find why they were necessary and had to agree reluctantly to adjustments to reverse trade debtors. The figure of £1,567,942 was the balance of some £10 million of transactions mainly with B&Q which was not settled. Some £4.5 million in all was deducted from trade debtors in the balance sheet and from turnover in the 1999 accounts. He said that in all ten adjustments were made to 1999 turnover; three were volunteered by the client, the rest were occasioned by PWC enquiries.
- Mr Anderson said that PWC debated whether to make a reference to the turnover adjustment in the accounts and decided to say nothing but to make a disclaimer as to whether the profit and loss account gave a true and fair view of the loss for 1999. It was not possible to establish a reliable figure for a prior year adjustment. The decision was made after discussion with a consultant partner.
- Asked by Mr Hyam whether the £1,252,172 originally recorded as a debt from B&Q was in reality a bad debt, he said that it was not. He said that the Appellant had never had any significant bad debts. Apart from the fact that dummy invoices had been raised there was no evidence that the £1,252,172 or the other £315,770 represented sales that had been made or why they had not been collected. He said that there were no bad debts with customers like B&Q and other large retailers.
- Mr Anderson denied the suggestion that the reduction in turnover was due to the absence of evidence. He said that the Appellant had quantified the external invoices to B&Q and £1,252,172 represented the excess which had been taken as income.
- When Mr Hyam asked him why the Tribunal should ignore what PWC had been told for the 1998 Accounts, Mr Anderson said that he had a lower opinion of the managing director in 1998 than of the subsequent directors.
- Mr Anderson said that a complex system such as that operated by the Appellant had to be supervised by someone who understood it. He was not aware of anyone with proper financial control.
- He told the Tribunal that he first had concerns about the accounting system in December 1999 when PWC formed a preliminary view that there was an unsubstantiated balance. PWC had not circularised debtors; experience had shown that retailers with a number of branches did not reply. Instead PWC examined what payments were received later or looked for proof of delivery or installation. He said that none of the PWC audit team were involved in the VAT returns.
- He said that the Appellant never made a trading profit until the merger in 2000. He believed the group was making a high margin on manufacturing the goods.
- Mr Hanley said that spreadsheets listing output tax on internal invoices and credit notes provided by PWC in 2000, which PWC considered had been erroneously included in the returns for periods 12/96 to 03/98, had been analysed and 14 invoices had been identified as received, claimed or paid by the customer. One invoice for B&Q and one for Great Miles were in period 03/98.
- Mr Pearson stated that Customs had repeatedly asked for examples of journal entries for US GAAP together with the evidence of the VAT accrued on them, but that these had never been produced. Customs had asked for the detailed VAT control accounts with no response.
- He stated that it was unreasonable for the Appellant to isolate the B&Q adjustment and argue that the assessments should be reduced without producing all the records.
- He said that he had not been involved in the amount of the assessments, however he knew that with the lack of evidence elsewhere the turnover shown in the accounts was the only possible basis. He found difficulty in accepting Mr Anderson's evidence that the 1998 turnover was wrong: the accounting was chaotic. He accepted that in auditing there is some margin for materiality.
- Mr Pearson said that he had not visited the Appellant's premises himself but had information from officers who had done so together with and the material provided by PWC.
- He said that he did not impugn Mr Anderson's auditing expertise. He accepted that Mr Anderson had made an adjustment of £3.639 million but said that he would like to see the written evidence on which it was made.
- Mr Pearson said that if B&Q had withheld £1.8 million that would be recognised as income. Withholding is not the same as disputing. He considered that the £1.252 million should have been treated as a bad debt : it was a balancing figure to tidy up the accounts because the payment was not received and B&Q did not accept liability. B&Q may simply have reneged.
Submissions for Customs
- Mr Hyam said that the Tribunal should focus on whether the assessments were fair taking account of the Commissioners' judgment and any points raised before the Tribunal by the Appellant, see per Carnwath J in Rahman v Customs and Excise Commissioners [1998] STC 826 at [42] and Murat v Customs and Excise Commissioners [1998] STC 923 per Collins J. He said that the burden of proof is on the Appellant. Here there is an absence of evidence of primary facts. Customs had sought documents throughout without success. Nothing had been produced regarding B&Q except the journal entry.
- He said that Mr Anderson's role was to audit the accounts. He had a duty to ensure that there was evidence of the assets. He concluded that the figure for debtors was excessive and had to balance that. However no express adjustment was made. It was cloaked by the disclaimer in the 1999 accounts:
"we are unable to form an opinion as to whether the profit and loss account gives a true and fair view of the company's loss for the year ended 31 December 1999."
This was hardly strong evidence for adjustment of the assessments for 1998.
- According to the journal, there was a contract with B&Q for £4.122 million, however proforma invoices had been raised in 1997 for £5.963 million. There had been no explanation as to what happened to the balance. Mr Anderson had said that were £10 million of transactions with B&Q. At the end of 1988 PWC had been told that the B&Q rollout was complete but that £1.8 million was being withheld.
- Mr Hyam said that there had been no explanation for the transfer of £2.5 million from debtors to leased assets. If a finance company had bought the assets turnover would not have been affected. There was no satisfactory evidence from which to infer that £1.252 million represented dummy invoices wrongly attributed to finance leases and not to B&Q. As auditor Mr Anderson had a duty not to over-declare turnover or debtors. Mr Hyan said that the 1998 accounts based on the records before the move from Harlow to High Wycombe were more likely to be accurate. If PWC missed material in 1998, he asked why it should be assumed that there was other material in 1999 after the move.
- Mr Hyam said that the Appellant had not shown on the balance of probabilities that the assessments were substantially incorrect and should be reduced.
Appellant's submissions
- Mr Scorey submitted that Customs having made the assessments on the basis of the turnover shown in the audited accounts for 1998, the assessments should be reduced because the auditor had concluded that £1,567,942 had been wrongly included in the 1998 turnover. If the adjustment had been upwards, Customs would have been entitled to make a further assessment; logic and fairness required that there should be a downward adjustment.
- He said that when he included £3.639 million from 1997 in the 1998 accounts, Mr Anderson did not know that £1.252 million due from B&Q was included in a different ledger account from debtors. Mr Anderson had candidly admitted that the 1998 turnover was wrong, being based on what Mr Midani has told him. Subsequently he discovered that at least £1.568 million of turnover had not been received and was not owed to the Appellant. Mr Anderson had explained in his second statement that the directors considered that the contract with B&Q had been varied. Because of this the adjustment to turnover was made as a current year adjustment in 1999 and not as a prior year adjustment for 1998. However the fact was that £1,567,942 had been incorrectly included in the 1998 turnover. No adjustment was sought for the balance of the £4.5 million adjustment to 1999 turnover because the evidence as to when the balance had been credited to turnover was insufficient.
Conclusions
- The duty of the Tribunal is to consider all the material and evidence placed before it by both parties and to decide for itself what is the correct amount, see per Collins J in Murat at page 926. The burden is on the Appellant to show that the assessment should be reduced.
- In the present case the Appellant seeks a specific adjustment namely the deduction of the VAT on £1,567,942 on the basis that it was incorrectly included in turnover in the 1998 statutory accounts. Apart from this, no challenge is made to the use of turnover in the accounts to compute the assessments.
- It is necessary therefore to consider the factual basis on which this adjustment is sought and more specifically the reasons why Mr Anderson concluded that the
turnover was in fact lower. Against that we have to consider the evidence and submissions for Customs.
- The Tribunal does not have the primary source material as to the composition of the £1,567,942. Indeed the problem has arisen out of the lack of evidence as to the correct turnover in 1998. If there had been clear evidence as to 1998 turnover presumably no error would have been made and no adjustment would have been necessary.
- It should of course have been possible to ascertain the outputs form the VAT invoices issued, just as the turnover should have been adequately documented. The fact is that the VAT invoicing was not reliable and the turnover was not adequately documented.
- In the absence of the primary source material we have to decide whether we are satisfied on the balance of probabilities that the adjustment should be made. We are entitled to consider the evidence of Mr Anderson, however it is only secondly evidence.
- When certifying the 1999 accounts Mr Anderson as auditor was in a position to report that the balance sheet gave a true and fair view of the company's state of affairs at 31 December 1999. The certificate thus covered the assets including debtors and the liabilities. He was unable to certify the profit and loss account for 1999 and gave evidence which we accept that it was not possible to establish a reliable figure for a prior year adjustment.
- The £1,567,942 reduction in turnover for 1998 for which Mr Anderson contends is of course only part of the overall trial balance adjustment to 1999 turnover. We recognise the difficulty in making a prior year adjustment of £1,567,942 if the auditor considered that a correct adjustment would have been greater. The prior year adjustment itself would need to have been qualified.
- Concentrating on the figure of £1,567,942, the Appellant produced no direct evidence of the composition of the trade debtor figure at 31 December 1998, in particular that for B & Q. While we accept that material was lost in the move to Harlow and hence to High Wycombe, there must have been some source for the figure used in the 1998 accounts even if only a computer printout of the ledger. We were told that the B & Q debtors had reduced to £292,000 at the end of 1999 but we were not told the figure at the end of 1998 although it must have included the £3,639,109 deferred from 1997. Nor was there any primary evidence of the transfer in 1999 to finance lease assets of £1,252,172 relating to B & Q debtors.
- It may be that Mr Anderson is correct in concluding that £1,567,942 was incorrectly attributed to turnover in the 1998 accounts, however the Appellant has not produced the material to satisfy the Tribunal on the balance of probabilities that this is the case. The fact that that Mr Anderson concluded that the turnover was overstated is not sufficient of itself without examining the basis on which he came to his conclusion. The material produced is not in our view sufficient to discharge the burden of proof. The appeal is dismissed
THEODORE WALLACE
CHAIRMAN
RELEASED: 16 June 2005
LON/01/465
