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	United Kingdom VAT & Duties Tribunals Decisions
You are here: BAILII >> Databases >> United Kingdom VAT & Duties Tribunals Decisions >> Tekelemariam v Revenue & Customs [2006] UKVAT V19963 (14 December 2006) URL: http://www.bailii.org/uk/cases/UKVAT/2006/V19963.html Cite as: [2006] UKVAT V19963

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19963

Value Added Tax – Best judgment – s.73(1) VATA 1994 – Whether two assessments on restaurant receipts reasonable and method of calculating receipts provides reasonable conclusions – Appeal partly dismissed

LONDON TRIBUNAL CENTRE

B TEKLEMARIAM Appellant

and –

THE COMMISSIONERS FOR HER MAJESTY'S REVENUE & CUSTOMS Respondents

Tribunal: DR KAMEEL KHAN (Chairman)

MR A J RING FTII ATT

Sitting in public in London on 21 September 2006

Mr S Zubairi, accountant, for the Appellant

Ms P Crinnion, Advocate, HMRC, for the Respondents

© CROWN COPYRIGHT 2006


 


DECISION

The Appeals

1. The disputed decision of the Commissioners of HM Revenue and Customs (the "HMRC") refers to two assessments. The first assessment dated 29 April (Reference 4042 7900 499) for the period 02/04 (01.08.03 to 29.02.04) for the sum of £5,631 tax plus £26 interest. The second assessment dated 8 December 2004 (Reference 412 089 01302) for the periods 02/04 (01.08.03 to 29.02.04 increasing the assessment for the same period under the first assessment), 05/04 (01.03.04 to 31.05.04), 08/04 (01.06.04 to 31.08.04) for the sum of £15,920 tax and £589.98 interest totalling £16,509.98. There is also a misdeclaration penalty dated 17 December 2004 in the sum of £2,387.00.
2. The Appellant has submitted VAT declarations up to and including 08/05. The current debt on file, is £27,442.19 which relates to two assessments plus interest and the misdeclaration penalty.

The law

Power to Assess

3. Under s.73 VATA 1994

"73(1) Where a person has failed to make any returns required under this Act (or under any provision repealed by this Act) or to keep any documents and afford the facilities necessary to verify such returns or where it appears to the Commissioners that such returns are incomplete or incorrect, they may assess the amount of VAT due from him to the best of their judgment and notify it to him."

Best Judgment

This has been covered in the decision in the cases of Van Boeckel v Commissioners and Rahman 1 and Rahman 2 v Commissioners (see below). It is covered in the statutory provision of s.73(1) VATA 1994.

Duty to keep Records

Under Schedule 11 VATA 1994

"6(1) Every taxable person shall keep records as the Commissioners may by regulations require, and

6(3) the Commissioners may require any records kept in pursuance of his paragraph to be preserved for such period not exceeding 6 years as they may require."

Records relating to a taxable person are set out in Regulation 31 of VAT Regulations 1995

Time Limits for the making of Assessments

Under s.73(6) and s.77(1) VATA 1994

"73(6) An assessment under subsection (1), (2) or (3) above of an amount of VAT due for any prescribed accounting period must be made within the time limits provided for in section 77 and shall not be made after the later of the following –

(a) 2 years after the end of the prescribed accounting period; or

(b) one year after evidence of the facts, sufficient in the opinion of the Commissioners to justify the making of the assessment, comes to their knowledge,

but (subject to that section) where further such evidence comes to the Commissioners' knowledge after the making of an assessment under subsection (1), (2) or (3) above, another assessment may be made under that subsection, in addition to any earlier assessment."

Under section 77(1) subject to the following provisions of this section, an assessment under section 73, 75 or 76, shall not be made –

(a) more than 3 years after the end of the prescribed accounting period …"

Misdeclaration penalty

Under section 63 VATA 1994, the Commissioners will impose a penalty for misdeclaration or neglect.

"Section 63(1) In any case where, for a prescribed accounting period –

(a) a return is made which understates a person's liability to VAT or overstates his entitlement to a VAT credit, or

(b) an assessment is made which understates a person's liability to VAT and, at the end of a period of 30 days beginning on the date of the assessment, he has not taken all such steps as are reasonable to draw the understatement to the attention of the Commissioners, and the circumstances are as set out in subsection (2) below, the person concerned shall be liable, subject to subsections (10) and (11) below, to a penalty equal to 15% of the VAT which would have been lost if the inaccuracy had not been discovered.

Section 63(2) The circumstances referred to in subsection (1) above are that the VAT for the period concerned which would have been lost if the inaccuracy had not been discovered equals or exceeds whichever is the lesser of £1,000,000 and 30 per cent of the relevant amount for that period."

The Issues

4. The central issue is whether the tax assessment under appeal has been made to HMRC's best judgment within the meaning of section 73(1) VATA 1994.

The Facts

5. Bedelu Teklemariam T/A Addis Ethiopian Restaurant was registered for VAT under the number 831 0802 67, with effect from 1 August 2003. The Appellant was registered as a sole proprietor; the business trades as a restaurant and takeaway, from premises at 40-42 Caledonian Road, London N1 9DT. The opening times of the restaurant were 12.00 noon to 3.00pm for lunches Mondays-Saturdays and 6.00pm to 11.00pm 7 days a week. It was closed on Sunday lunchtime.
6. The Appellant had submitted VAT declarations up to and including 08/05. The debt on file at 28 November 2004 is £27,442.19 and relates to two assessments plus interest and misdeclaration penalty.
7. Mr Teklemariam purchased the business from Meroe Ltd and became registered under the Transfer of a Business as a Going Concern (TOGC) with effect from 1 August 2003; Meroe Ltd had been registered under 802 5517 56 but the number was not transferred to the Appellant. Meroe Ltd was a Caribbean restaurant.
8. On 20 March 2004, the Appellant's accountant contacted the National Advice Service (NAS) to request a duplicate return for the first period, 1 August 2003 to 29 February 2004. On 22 April 2004, the Appellant telephoned the NAS to query why he had received an assessment for period 2/04 when he had rendered his return. It was explained that it had not been received and if a copy was now received the central assessment would be withdrawn.
9. On 26 April 2004, Mr Anthony Davis, an officer based at Thomas Paine House, The Angel, London, issued a letter to the Appellant in which he stated that the first period return 29 February 2004 had not been received and a central assessment had been issued by Southend for £1,206.00. Mr Davis had reviewed the case and noticed that the estimated annual turnover stated by the Appellant on the Application for VAT Registration was £75,000. Annual expected VAT would be £13,125.00 and for the outstanding 7 month return output tax due would be £7,656.25. Mr Davis also stated that he had visited the Appellant's premises on two occasions in March and April 2004, to hold meetings with the previous owner Meroe Ltd and the Appellant was present. During these visits, Mr Davis's notes stated that he was "able to observe the size and capacity of the restaurant, some of the staff, the prices of the menu and lunchtime customers". He stated that "the number of customers in a day would not be less than about 24 (12pairs) and could regularly at weekends be 36 (18 pairs), or more. At roughly £10 per head I am satisfied that the turnover cannot be less than £100,000 per year" (or £2,000 per week). He further stated that this was a credible turnover for the business. Based on these figures he proposed to alter the centrally issued assessment. His calculations for the assessment were:

7/12 x 100,000 = 58,333.33 gross takings

Output tax due = £58,333.33 x 7/47 = 8687.94

less input tax allowed on similar restaurants in the local area = £1,850

Net tax due = £6,837.94

Central assessment = £1,206.00

Additional assessment = £5,631

On 16 and 29 April, HMRC notified the Appellant of tax assessments totalling £6,837.00 (Ref. 40427/9/00499) in respect of the tax period 02/04 since no tax return had been received.

10. On 6 May 2004, the Commissioners received a duplicate VAT return for period 02/04. This recorded inclusive sales for the 7 months period of £16,319.55 approximately £582 per week. HMRC reviewed the return and issued a letter dated 25 May 2004 which stated that the Commissioners had received the first period return but until the return could be verified against the business records the return would not be accepted as accurate. The officer requested the Appellant or his accountant to arrange a meeting to discuss the business activities and review the full business records.
11. On 16 June the officer issued a further letter to the Appellant since no visit appointment or payment of the outstanding tax had been made. The Appellant was informed that he had 30 days to pay.
12. On 5 July 2004, Mr Cheria, the Appellant's then accountant, contacted the officer and offered to fax the relevant records. The officer refused, stating that the figures were incredible and there was the need to interview the Appellant in person. In reply to the officer's question – whether he had completed the VAT return, he said "Probably not". The accountant said that the takings for the period came to £29,935 and the zero-rated purchases £28,000, which meant that the figure on the return was wrong. A visit was arranged for 14 July 2004, later changed to 28 July 2004. A letter was issued on 7 July 2004 explaining exactly what records would be inspected and for which period.
13. On 28 July Mr Davis and his colleague Mr Dennis, visited the Appellant's premises and interviewed the Appellant in the presence of his accountant. The Appellant did not retain meal bills or a record of takings. The officer's comment was that there "was little or no audit trail on the sales side". The Appellant had stated that all sales were keyed into the till but the officers were not convinced that the Z reading slips were accurate and reflected the true takings of the business. The officers uplifted the business records for further examination. The Appellant was instructed to retain all the meal tickets and to maintain a full audit trail from the point of ordering to the record of daily gross takings. A full record of all restaurant and takeaway sales to also be maintained.
14. On 2 August 2004, HMRC wrote to the Appellant stating that the business records and audit trail were inadequate and unsatisfactory for VAT purposes. A drinks menu was requested. HMRC gave detailed guidance on the type of documentation they would require in future.
15. On 25 August 2004, HMRC served a Notice of Requirement too provide security on the Appellant.
16. Following the uplift of the records, the officer examined the documentation in detail at his office. The officer found the following:

The Z readings showed a large imbalance between the purchases of drinks (alcoholic and soft) and the claimed total sales of drinks as recorded in the Z readings.

The purchases of drinks appeared to be 3 to 4 times greater than the claimed sales.

The officer undertook an analysis of all drinks purchased over the months and then using the Appellant's drinks menu calculated the total expected retail selling price. Then the officer established the percentage of drinks represented on the Z reading of total sales, and using the expected total sales from the purchase analyses, he calculated the total sales of the business. The figure included zero-rated sales of Injeras (Ethiopian Bread) as the Appellant stated that these were not always keyed into the till.

17. On 19 November 2004, the uplifted records were returned to the Appellant. During their visit the Appellant stated that there were no broken or damaged bottles of wine or other drinks; he sells all that he buys.
18. On 23 November, HMRC issued a letter to the Appellant in which their findings and the basis and schedule of the proposed assessments were explained. The Appellant was invited to contact the officer after consulting his accountant. The assessment was issued on 10 December 2004.
19. A letter dated 13 December 2004 was sent by the Appellant's accountant, Sameeh Zubairi & Co, to HMRC, which made the following comments:

(a) 60% of total sales were Injera which is sold as takeaway.

(b) Injera sales were keyed into the till using any key since there was no specific key for Injera.

(c) You visited the place a couple of times and you yourself noticed so much so that you "joked" saying that the proprietor had possibly told all the potential customers not to visit the restaurant on that day.

(d) Although the premises are known as a restaurant most of the sales are takeaways.

(e) In the light of the above comments the officer's comments and calculations were misleading and irrelevant.

20. HMRC replied on 16 December 2004 stating that they did not believe that a majority of sales were takeaway but that they were in the restaurant. They said that the issue of credibility and viability of the returns was not addressed and asked about the Appellant's financial position
21. On 17 December 2004, HMRC issued a Notice of Assessment of a Misdeclaration Penalty for £2,387.00.
22. On 21 December 2004, a further visit was undertaken to the Appellant's premises to discuss his assessment with the Appellant and his accountant. Records for the period 08/04 were uplifted and a receipt given.
23. On 23 February 2005 HMRC Debt management Unit at Southampton received a letter dated 21 February 2005, which stated that from the Appellant's accountant the Appellant wished to appeal against the outstanding moneys due to HMRC. On 31 March 2005 a formal appeal against the officer's assessment was received.

The Evidence

24. HMRC produced two bundles of papers including all correspondence between the parties, notes of meetings, VAT returns, contact centre enquiry, as well as their calculations of how the assessments were made.
25. The Appellant produced a file of 41 pages showing their VAT calculations, sales, purchases, expenses, bank reconciliation and profit and loss account for the period 1 August 2003 to 31 August 2004.

There were three witnesses; the Appellant, Mr B Teklemariam and Mr A A Davis, officer, HMRC and Mr S Zubairi, Appellant's accountant.

02/04 Assessment (First Assessment)

The assessment of 02/04 was due before detailed books and records were uplifted on 28 July 2004. The calculation of the 02/04 assessment was explained in a letter from HMRC dated 26 April 2004 to the Appellant.

26. The central assessment was for £1,206 but Mr Davis did not believe this was a reasonable estimate of the Appellant's true tax liability for the 7 months first period. He said that from recent visits (two visits on 18 March and 22 April) to the premises, mainly in connection with the previous business entity, Meroe Ltd, he had been able to see the "size and capacity of the restaurant, some of the staff, the prices of the meals on the menu, and the number of customers that you have at lunchtime." He concluded from these that the turnover cannot be less than £2,000 per week (roughly £100,000) which taking £10 per head (price of main course plus drink) (per customer) as the average cost of a meal is less than 30 customers per day. The calculation which followed from these figures were as given previously (on page 6)

It seems that all figures were arrived at from observation/visits. The visit of 22/04 lasted from 10.50am to 1.10pm.

02/02 to 08/04 Assessment (Second Assessment)

The assessment for the above period (which includes a further assessment for 02/04) was done after the till rolls and other records were obtained from the Appellant. The Schedule of Calculations of Underdeclared takings and output tax for the periods 02/04 to 08/04 used by HMRC in their assessment are as follows:

Schedule of Calculations of Underdeclared takings and Output Tax for periods 02/04 to 08/04

Declared takings on till rolls

Total Drinks Food

December 2003 £4,471.87 £1,045.50 £3,426.37

January 2004 £5,261.35 £1,265.00 £3,996.35

February 2004 £5,675.11 £1,534.25 £4,141.46

£15,408.93 £3,844.75 £11,564.18

24.95% 75.05%

From other sheets true expected drinks sales for period 02/04 are £29,794.50

£29,794.50/24.95% x 100 = £119,416.83 in expected total standard rated sales

£119.416.83 x 7/47 = £17,785.49 output tax

Declared output tax = £2,115.55

Underdeclaration assessment = £15,669.94

Overdeclaration assessment = £219.74

Period 05/04

Expected true drinks sales in this period = £7,646.50

£7,646.50/24.95% x 100 = £30,647.29

£3,0647.29 x 7/47 = expected output tax of £4,564.49

Declared output tax = £1,364.18

Underdeclaration assessment = £3,200.31

Overdeclaration assessment = £90.76

Period 08/04

You could not supply me with your records for this period, as your other periods' records were supplied to me at about the time 08/04 was finishing.

However, I find the figures declared on this return for outputs and output tax just as totally lacking credibility as in the previous 2 returns.

On the assumption that the input tax for period 08/04 is largely on drinks as in the 2 earlier periods I must assess the likely takings for this period thus:

Corrected input tax for period 05/04 = £580.89

Input tax declared for period 08/04 = £638.79

Calculated drinks sales takings in period 05/04 = £7,646.50

Calculated drinks sales takings in period 05/04 = £8,408.66

£8,408.66/24.95% x 100 = £33,702.05 total expected standard rated takings

£33,702.05 x 7/47 = £5,019.45 expected output tax

Declared output tax = £1,707.88

Underdeclaration assessment = £3,311.57

These figures assume a sales split of 75% food and 25% drink. The figures are projections from the sales on the till roll since there was no actual observations or invigilations carried out by HMRC (we were told this was due to budgetary constraints).

Addis Ethiopian Restaurant

How officer calculated assessment

Parts to total Ratio

Drink sales from "Z" reads Total sales from "Z" reads

Dec. 03 £ 1,045.50 Dec. 03 £ 4,471.87

Jan. 04 £ 1,265.00 Jan. 04 5,261.35

Feb. 04 £ 1,534.25 Feb. 04 5,675.71

Total £ 3,844.75 Total £15,408.93

Ratio = £ 3,844.75 x 100 = 24.95%

£15,408.93

Expected takings extracted from purchases

Sep. 03

Beer 1104 units x £2.50 = £2,760.00

Soft drinks (small) 1032 units x £1.00 = 1,032.00

Wine (bottles) 45 bottles x £11.50 = 517.50

Spirits (70cl) 2 bottles = 56 shots x £2.59 = 145.00

Perrier (750ml) 60 bottles x £2.50 = 150.00

Perrier (330ml) 72 bottles x £1.25 = 90.00

Pineapple jce (1L) 6L x £1.50 = 9.00

Orange jce (1L) 12L x £1.50 = 18.00

Passion jce (1L) 12L x £1.50 = 18.00

Tonic Water (1L) 12L x £1.50 = 18.00

Champagne (bottle 2 bottles x £40.00 = 80.00

Total expected sales = £4,837.50

Oct 03

Beer 624 units x £2.50 = 1,560.00

Soft drinks (small) 56 units x £1.00 = 456.00

Wine (bottles) 97 bottles x £11.50 = 1,115.50

Spirits (70cl) 208 shots x £2.59 = 537.50

Perrier (750ml) 48 bottles x £2.50 = 120.00

Perrier (330ml) None

Pineapple jce (1L) None

Orange jce (1L) 24L x £1.50 = 36.00

Passion jce (1L) 12L x £1.50 = 18.00

Tonic Water (1L) 12L x £1.50 = 18.00

Bacardi Breezer (bot) 96 bottles x £3.00 = 72.00

Total expected sales = £3,915.00

Nov 03

Beer 1584 units x £2.50 = 3,960.00

Soft drinks (small) 96 units x £1.00 = 696.00

Wine (bottles) 96 bottles x £11.50 = 1,104.00

Spirits (70cl) 364 shots x £2.59 = 942.50

Perrier (750ml) 144 bottles x £2.50 = 360.00

Perrier (330ml) 96 bottles x £1.25 = 120.00

Pineapple jce (1L) None

Orange jce (1L) None

Passion jce (1L) None

Tonic Water (1L) 12L x £1.50 = 18.00

Bacardi Breezer (bot) 96 bottles x £3.00 = 72.00

Total expected sales = £7,272.50

Dec. 03

Beer 1128 units x £2.50 = 2,820.00

Soft drinks (small) 576 units x £1.00 = 576.00

Wine (bottles) 48 bottles x £11.50 = 552.00

Spirits (70cl) 392 shots x £2.59 = 1,015.00

Perrier (750ml) 96 bottles x £2.50 = 240.00

Perrier (330ml) 24 bottles x £1.25 = 30.00

Total expected sales = £ 4,188.50

Jan. 04

Beer 456 units x £2.50 = 1,140.00

Soft drinks (small) 696 units x £1.00 = 696.00

Wine (bottles) 56 bottles x £11.50 = 644.00

Spirits (70cl) 364 shots x £2.59 = 942.50

Perrier (750ml) 168 bottles x £2.50 = 420.00

Perrier (330ml) None

Pineapple jce (1L) 12L x £1.50 = 18.00

Orange jce (1L) 24L x £1.50 = 36.00

Passion jce (1L) 12L x £1.50 = 18.00

Tonic Water (1L) 12L x £1.50 = 18.00

Champagne (bottle 1 bottle x £40.00 = 40.00

Bacardi Breezer (bot) 72 bottles x £3.00 = 216.00

Total expected sales = £4,188.50

Feb. 04

Beer 840 units x £2.50 = 2,100.00

Soft drinks (small) 888 units x £1.00 = 888.00

Wine (bottles) 76 bottles x £11.50 = 874.00

Spirits (70cl) None

Perrier (750ml) 156 bottles x £2.50 = 390.00

Perrier (330ml) 48 bottles x £1.25 = 60.00

Pineapple jce (1L) 12L x £1.50 = 18.00

Orange jce (1L) 12L x £1.50 = 18.00

Total expected sales = £4,348.00

Therefore total expected sales period 02/04 = £29,794.50

Gross calculated standard rated

Expected sales £29,794.50/24.95% parts to total ratio x 100 = £119,416.83

Gross calculated standard rated sales = £119,416.83 x 7/47 =

£17,785.49 Output tax due

Output tax due £17,785.49

less

True input tax due 1,448.09

£16,337.40

less

Central Assessment 1,206.00

£15,131.40

less

Additional Assessment 5,631.00

Assessed under dec £ 9,500.40

Mar. 04

Beer 1080 units x £2.50 = £2,700.00

Wine (75 cl bottles) 109 bottles x £11.50 = 1,253.50

Wine (35 cl bottles) 48 ½ bottles x £6.00 = 288.00

Soft drinks (cans) 768 cans x £1.00 = 768.00

Spirits (70cl) 168 shots x £2.59 = 435.00

Total expected sales = £5,444.50

Apr. 04

Beer 312 units x £2.50 = £ 780.00

Wine (75 cl bottles) 60 bottles x £11.50 = 690.00

Wine (35 cl bottles) None

Soft drinks (cans) 456 cans x £1.00 = 456.00

Spirits (70cl) None

Total expected sales = £1,926.00

May 04

Beer None

Wine (75 cl bottles) None

Wine (35 cl bottles) 48 ½ bottles x £5.75 = £276.00

Soft drinks (cans) None

Spirits (70cl) None

Total expected sales = £ 276.00

Therefore total expected sales period 05/04 = £7,646.50

Expected sales £7,646.50/24.95% parts to total ratio x 100 = £30,647.29

Gross calculated standard rated sales = £30,647.29 x 7/47 =

£4,564.49 output tax due

Output tax due £4,564.49

Less

Output tax declared 1,364.18

Under dec £3,200.31

less

input tax under claim 90.76

Total under dec £3,109.55 period 05/04

No records available for period 08/04, therefore expected sales calculated as follows:

Input tax claimed 08/04 638.79 x £7,646.50 = £8,408.66 (expected drinks sales 08/04

Input tax due 05/04 580.89

Expected sales 8,408.66/24.95 parts to total ratio x 100 = £33,702.44 sales

Gross calculated standard rated sales = £33,702.04 x 7/47 =

£5,019.45 output tax due

Output tax due £5,019.45

Less

Output tax declared £1,707.88

Total under dec £3,311.57 period 08/04

A percentage is established for drinks takings and total sales calculated from those figures in arriving at the figures for the second assessment. The second assessment was based on actual "Z" reading records lifted by HMRC.

27. The first assessment was done on the basis of observations arising from two visits to the restaurant. One visit was a cold call and the second (on 22/4) lasting for half the lunch hour and related to the previous business entity (Meroe Ltd).

The second assessment was done on the basis of books and records. It was done by establishing a percentage for drinks sales out of total sales on the Z reading and then calculating the total expected sales for the entire business excluding zero-rated sales of Injera. The method of calculation used by HMRC assumes that the underdeclaration for food is three times as high, in cash terms, as that for drinks, without any clear evidence that this is the case. For example, more drinks could have been ordered by customers who had not ordered more food. More drinks sales does not necessarily mean more food sales. One can query whether this type of forward and backward extrapolation can be made from the figures. It also raises the question as to why there would be an underdeclaration of food given that the trader obtains a tax deduction for food sold.

The sale of Injera is both for takeaway and as part of meals eaten on the premises (see Time Out review and Restaurant Customer Menu). We were told that the only supplier of Injera is Engocha and purchases amounted to £19,135 in 7 months. We were also told that Injera retailed at 60p, a mark up of 50% i.e. cost 40p. This means that approximately 50,000 pieces of Injera would have been purchases by customers in the period. Using the assumption of 1 meal per head and 30 customers each day (HMRC's estimate) that would account for 6,300 pieces in the seven month period. It would have required roughly eight pieces of Injera to be purchased by each of the 30 daily customers in order for the total Injera purchased to have been sold on the premises.

28. The Appellant's accountant provided documents to the Tribunal largely containing figures of purchases, sales, profit and loss and VAT payments. In the Schedule of VAT return for the period 1 August 2003 to 29 February 2004, the total value of purchases is given as £36,503.57. The Schedule (9 pages) gives the tax point, supplier, net cost, VAT and total cost. The total value of sales is given as £29,435.90. The total purchases of Injera (from Engocha supplies) is £19,135. The total purchases of drinks approximately £10,000 (with a mark up at 200%) gives approximately 30k (£29,794.50) sales with food purchases at approximately 7k (£7,365). If these figures are correct, the maximum sales (with mark up) would be:

Injeras £19,135 x 150% (50% mark up) = £28,702

Drink = £29,794

Food £7,365 x 250% (150% mark up, estimate) = £18,412

Total sales £76,908

These are based on figures for the seven month period provided by the Appellant's accountant (rough calculations and addition by the Tribunal). The profit and loss figures for the entire period 1 August 2003 to 31 August 2004 gives gross sales as £88,126 with purchases of £65,659 and expenses at £42,880 with a net loss of £19,558.

29. HMRC under the first assessment, established the gross takings for the period 1 August 2003 to 29 February 2004 at £58,333.33 (turnover £100,000 p.a. or about £2,000 pw). In the second assessment, the drinks sales (£29,794) is grossed up at 24.95% to give an expected standard rated sale of £119,416.83. This figure is different from the total sales of £29,935.90 provided by the accountant. HMRC used the method of grossing up drinks sales to provide total sales for their figures to arrive at the second underdeclaration assessment and the second assessment figure (£9,500) for the 02/04 period and the underdeclaration assessments for 05/04 (sales £30,647.29 underdeclaration £3,200.31) and 08/04 (sales £33,702.05 underdeclaration £3,311.57).
30. HMRC also raised a point relating to wages. Mr Davis's written notes of his visit on 22 April 2004 gives the wages and drawings as £17,500 per year for 3 staff (Mr Tecklemariam and two others as given by the Appellant.) The profit and loss account (1 August 2003 to 31 August 2004) gives the figure as £5,960. Mr Davis, in sworn evidence, said that the profit and loss figures may have been understated and in particular the sales figures were underdeclared both there and in the VAT returns. HMRC also disputed the sales figures for zero-rated (takeaway) Injera sales. They said that the figures in the Profit and Loss account for bags and wrappers (£1,242) would not support the substantial takeaway trade the Appellant claims. HMRC said the evidence would support more restaurant sales at the standard rate. They say the Appellant's figures are not reliable.
31. The Appellant's accountant confirmed that the Profit and Loss figures were not accurate and that 25k had been added to the turnover.
32. The Appellant disputes the HMRC figures on takeaway sales. They say that Injera sales were as follows:

05/06 £13,844 (sales £30,749)

02/06 £ 9,975 (sales £26,342)

11/05 £11,121 (sales £25,727)

08/05 £10,080 (sales £23,361)

05/05 £ 8,883 (sales £21,213)

02/05 £ 8,111 (sales £18,948)

11/04 £ 6,591 (sales £16,426)

08/04 £ 7,290 (sales £18,723)

They say that 60% of sales relates to the takeaway business with the restaurant sales being the remainder.

33. Mr Davis, HMRC said that in his experience (33 years) the suggested profit margin of the Appellant's business (36%) was not realistic and this supported a finding of underdeclaration. It was more likely that the profit margin was between 50% to 60% with mark ups of 120% to 170%. He said in evidence that a figure for zero-rated takeaway sales (particularly all Injera) of approximately 50% of turnover was not credible. This may help to explain the underdeclaration of VAT since these sales were zero-rated.

Appellant's Case

34. The grounds of appeal are:-

(1) The method of calculating output VAT by HMRC is defective.

(2) The Appellant has also made the following representations in their letter to HMRC of 13 December 2004:

(a) 60% of the total sales comprised Injera which is sold as takeaway;

(b) no designated key was used to keep Injera sales;

(c) the officer visited the premises a couple of times and "joked" that the proprietor had possibly told all his potential customers not to visit the restaurant that day;

(d) although the premises are known as a restaurant, most of the sales were takeaway;

(3) The Appellant contends that the figures of HMRC which were used to calculate the assessment (second) are not accurate.

We outline below our views.

35. The tax assessments under appeal have to be made to HMRC's best judgment within the meaning of section 73(1) VATA 1994. Best judgment means to the best judgment of HMRC on available information. Woolf J (as he then was) in Van Boeckel v CCE [1981] STC 290 said best judgment meant the following:

"… the very use of the word "Judgment" makes it clear that the Commissioners are required to exercise their powers in such a way that they make a value judgment on the material which is before them. Clearly they must perform the function honestly and bona fide. It would be a misuse of that power if the Commissioners were to decide on a figure which they knew was, or thought was, in excess of the amount which could possibly be payable and then to leave it to the taxpayer to seek, on appeal, to reduce that assessment.

Secondly, clearly there must be some material before the Commissioners on which they could base their judgment. If there is no material at all it would be impossible to form a judgment as to what tax is due.

Thirdly, it should be recognised, particularly bearing in mind the primary obligation, to which I have made reference, of the taxpayer to make a return himself, that the Commissioners should not be required to do the work of the taxpayer in order to form a conclusion as to the amount of tax which, to the best of their judgment, is due. In the very nature of things frequently the relevant information would be readily available to the taxpayer, but it would be very difficult for the Commissioners to obtain that information without carrying out exhaustive investigations. What the words "best of their judgment" envisage, in my view, is that the Commissioners will fairly consider all material placed before them and, on that material, come to a decision which is one which is reasonable and not arbitrary as to the amount of tax which is due. As long as there is some material on which the Commissioners can reasonably act then they are not required to carry out investigations which may or may not result in further material being placed before them."

The Judge went on to say (at page 296) that:

"unless the situation is one where no material is before the Commissioners on which they can reasonably base an assessment, the Commissioners are not required to make investigations".

Carnwarth J (as he then was) in Rahman v Customs & Excise Commissioners [1998] STC 826 observed:

"… the Tribunal should not treat an assessment as invalid merely because it disagrees as to how the judgment should have been exercised. A much stronger finding is required : for example, that the assessment has been reached dishonestly or indistinctively or capriciously; or is a "spurious estimate or guess in which the elements of judgment are missing; or is "wholly unreasonable."

The point being made is that the Tribunal should not so much look at whether it agrees or disagrees with the judgment but look at the basis on which the judgment was founded and whether the elements of judgment are present.

The position of the taxpayer in challenging the exercise of judgment by HMRC was looked at by Dyson J (as he then was) in the case of McNicholas Construction Company Limited v Customs & Excise Commissioners [2000] STC 553 at 558, where he said:

"… the words "to the best of their judgment" permit the Commissioners a margin of discretion in making an assessment; a taxpayer may only challenge the assessment if he can show that the Commissioners acted outside the margin of their discretion, by acting in a way that no reasonable body of Commissioners could do. In order to succeed, the taxpayer must show that the assessment was wrong in a material respect and that if so, the mistake is such that the only fair inference is that the Commissioners did not apply best judgment, as explained by Woolf J in Van Boeckel v Customs & Excise Commissioners".

The taxpayer has to show that the assessment was not made to the best of HMRC's judgment.

The role of the Tribunal is explained in the case of Customs & Excise Commissioners v Pegasus Birds Limited [2004] STC 1509, where Carnwarth LJ said:

"Although the Tribunal's powers are not spelt out, it is implicit that it has power either to set aside the assessment or to reduce it to the correct figure … in my view the Tribunal faced with a "best of their judgment" challenge should not automatically treat it as an appeal against the assessment as such, rather than against the amount. Even if the process of assessment is found defective in some respect … the question remains whether the defect is so serious or fundamental that justice requires the whole assessment to be set aside, or whether justice can be done simply by correcting the amount to what the Tribunal finds to be a fair figure on the evidence before it. In the latter case, the Tribunal does not require to treat the assessment as a nullity, but should amend it accordingly."

The function of the Tribunal is supervisory. The Tribunal must not engage in a process that seeks to look at the information afresh, but should be satisfied that the assessment is correct in the light of available information. The Tribunal has to consider whether on a balance of probabilities, the Appellant has established that the assessment was not made by the HMRC to the best of their judgment. If it was not so made, the assessment would be set aside or reduced to the correct figure.

Let us look at the case before us in the light of the law as explained above.

The First Assessment

36. This assessment was an additional assessment after a central assessment had been made for £1,206. Mr Davis did not believe this had been a reasonable estimate of the Appellant's true tax liability for the first 7 months of trading. The Appellant had completed a duplicate return for the period 02/04 and recorded tax inclusive of sales for the first seven months of £16,319.55, approximately £582 per week. There were no real business records on which to base these figures. HMRC had received a call from Mr Cheria, the Appellant's accountant at that time, who stated that the takings for that period came to £29,935 and the zero-rated purchases to £28,000 but that the return had shown gross output of £16,319.55 and gross inputs of £9,476. This meant that the figures on the return were not correct. The accountant also confirmed that he had not completed the Appellants VAT return.

The assessment was done on the basis of observations from two visits to the Appellant's restaurant on 18 March 2004 and the 22 April 2004. The first visit was a cold call and the second visit was arranged by Mrs M Omer, a director of the previous restaurant, run by Meroe Limited. The notes of the visit by Mr Davis, were as follows:

"From these two visits I was able to observe the size and capacity of the restaurant, some of its staff, the prices on the menu and the lunchtime customers. 11 customers as seen on the 18 March 2004 and 8 on the 22 April 2004. However, on 22 April 2004 I was at the premises for about half the lunchtime to 1.10pm, so the total number of customers in a day could have been 12 or more. I am sure the number of customers in a day would not be less than about 24 (12 pairs), and would regularly at weekends by 38 (18 pairs), or more. At roughly £10 per head I am satisfied that the turnover cannot be less than £100,000 per year currently."

The takings for the seven month period 1 August 2003 to 29 February 2004 is put by HMRC at £58,333.33, (approximately 20k more than the figure given by the accountant and 42k more than declared on the VAT return).

The Appellant gave evidence that the takings from the restaurant were very low at the start; he had two or three customers per day. He also said there was significant wastage of Injera, which lasted for only one day after purchase, which contributed to his losses. The Injera was supplied daily but billed on a weekly basis. He further stated that the previous business was a Caribbean restaurant and he had made it into an Ethiopian restaurant where sales were difficult and slow at the start. He said that the takeaway business was more active than the restaurant business, which explained the higher zero-rated sales.

The Tribunal has to see whether, on the material placed before HMRC their assessment was reasonable and not arbitrary. There must be material to base the judgment and it must be sufficient to support the assessment which was made. It is not sufficient to merely have a suspicion of underdeclaration.

In looking at the first assessment the Tribunal finds that the observation records could not properly be relied upon to form the basis of an assessment. One would have expected the records to be properly laid out, perhaps in columns, showing the number of people entering, the time of entry, the length of time in the restaurant and time left and whether purchases were made or not. It is not clear whether all those entering the restaurant were customers. We would also have expected details of the number of members of staff, people doing collection and delivery and those who were non-dining customers who had not eaten a meal. The records should also have confirmed that there were seasonal variations (e.g. such as proximity to school holidays, bank or religious holidays or festivals). There were no evening visits to observe customers having the dinner menu and perhaps a greater number of drinks at that time. The record of the observation are terse. There is no information of food and drinks ordered, takeaway orders, Injera ordered on its own or with food and the proportion of eat in and take out food orders. There is no detail in the information, it seems to be based on quick observations recorded in a short visit. The second visit lasted one half of the lunch period (10.50am-1.10pm) and would not be sufficient to extrapolate figures on the number of customers over a seven month period. We find some difficulty with the use of the extrapolations of the figures from such poorly organised and recorded visits.

37. There was poor bookkeeping and little or no records of sales. The Appellant's accountant was able to provide figures to HMRC which were 23k below those of HMRC, and there is evidence that these figures were based on some verification of sales by the accountant although the returns were not completed by him, We believe that given the paucity of information available to HMRC, more input from the accountant would have been helpful. These figures should have been properly verified by HMRC with the accountants in arriving at the final assessment.
38. The Tribunal feels that the quality of the records and the very short period of observation by HMRC cannot be relied upon to form the basis of a valid assessment. We were told that there were not sufficient resources at HMRC to have a proper period of invigilation which would have provided more detailed information on the takings. This is unfortunate but cannot be used to the detriment of the taxpayer. While Mr Davis endeavoured to carry out the observations in the best way he thought, we do not believe that the information gathered has the degree of reliability to form the basis of an assessment for the period.

The Second Assessment

39. The second assessment was based on the books and records obtained from the business, declared turnover on the VAT 1 form, observation of business (previous entity), "Z" reading till slips, recorded purchases and sales, information and figures provided by the accountant. There was also a meeting with the accountant (21.12.04) where some of the information provided was explained by the company's accountant. HMRC also had a "Time Out" review of the business, the drinks menu and a copy of the restaurant food menu both of which included prices and the food menu explained in English and Ethiopian the dishes and what was included in the price.
40. HMRC main findings were that the declared outputs and output tax (takings and tax on takings), as shown on the VAT returns, were not credible for a restaurant business and the reasons for this were as follows:

(a) Lack of credibility in regard to overall mark up/profit margin which should be 120%-170% with profits of between 54%-63%.

(b) Lack of credibility in the drinks mark up which is more than 200% but not reflected by the output tax on restaurant food and drinks.

(c) Lack of credibility on the split between standard rate supplies and cold takeaway zero-rated supplies. The declared zero-rate supplies was put at 51.5% of turnover by the Appellant.

For those reasons, HMRC proceeded to do their own calculations in arriving at the turnover figures. As explained, their approach was to analyse all drinks purchases and then using the Appellant's drinks menu calculate the total expected retail selling price. Then, a percentage of drinks represented by the "Z" readings as total sales, and using the expected total sales from the purchase analysis, calculate the expected total sales for the business. The drinks to food sales was 25% to 75% approximately.

41. The HMRC approach assumes that the drinks to food ratio is correct and therefore three quarters of customers' bills were omitted in their entirety. There is no direct evidence of this nor any observation record to establish this position. Its is also possible that existing dining customers may have had second or third drinks without ordering food. There are thus tenable arguments against HMRC's position.
42. As explained earlier, based on the number of customers the Injera sales did not match their purchases. It is therefore difficult to accept the figures provided by the Appellant on zero-rated sales. It is more likely, as the HMRC argue that the zero-rated sales were less than claimed (50% of total sales) and more likely that Injera sales were with food eaten in the restaurant by customers having standard rated meals. It is unlikely that 60% of total sales were Injera which was sold as takeaway, as the Appellant contends or that most of the sales were takeaway. We believe that the figures given in the Profit and Loss account (03-04) for bags and wrappers (£1,242) would not support the substantial takeaway trade which the Appellant contends was made. We are also mindful that the Appellant's accountant admitted that the Profit and Loss figures were not accurate and 25k was added to the turnover. This admits underdeclaration by the Appellant and places in dispute the figures provided by the Appellant to HMRC.
43. The profit margin at 36% which the Appellant puts forward in their accounts, which cover a 13 month period is low. HMRC say that those margins should be between 54%-63%. Based on the figures presented to the Tribunal by HMRC, the gross mark up on drinks was 200%, Injera 50% and meals of 150%, with which the Appellant broadly agrees, it would be difficult to say that the profit margin would be as low as 36%. It is a more likely explanation that the zero-rated sales of Injera were increased and the standard rates sales of food and drink were suppressed to arrive at the 36% profit margin. Even making allowances for personal consumption, wastage, breakage and sales at prices lower than shown on the menu, the HMRC method of calculation based on records and books would show an underdeclaration. One may have to be cautious with their projections on food as extrapolated from the drinks sales but their calculations on the drinks sales are reasonable. On a balance of probabilities, we believe that HMRC have established their case with regard to the second assessment. The Appellants have admitted underdeclarations and have not established a clear rebuttal with regard to HMRC's figures or second assessment.
44. The methodology used by HMRC in their calculations, while not perfect and perhaps subject to criticism, provided reasonable conclusions from the information before them. Further, there was clear evidence of suppression by the Appellants and the Appellant's arguments did not show that the assessments were not made to HMRC's best judgment. It is not our job to look at the information afresh. We did draw conclusions from the information and outlined its shortcomings but, we found that the value judgment made by HMRC on the information before them was reasonable in spite of some possible errors which may be inherent in the extrapolations made on food purchases.
45. For the reasons given, we would allow this appeal in part. The first assessment would be rejected and the second assessment would be upheld.

KAMEEL KHAN

CHAIRMAN

RELEASED: 16 December 2006

LON/05/352