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HMRC internal manual

Business Income Manual

Specific receipts: unclaimed balances: overpayments

The overpayments category represents one of the most commonly encountered unclaimed balances.

An overpayment, payment by mistake or double payment which relates to an underlying trading transaction is taxable if it arises out of the trade. This is essentially a question of fact to be determined by establishing the scope of the trade and the background to the payment.

In businesses with large customer bases, it is more or less inevitable that there will be mistakes one way or another. At a basic level, just as the loss incurred by giving a customer too much change is allowable as a deduction from trading profits, the surplus when too little change is given is taxable.

Full details of the case law on the tax treatment of overpayments is given below. See BIM40245 for an example.

Pertemps Recruitment Partnership Ltd case

The taxability of sums paid to a trader by mistake was considered in the Upper Tribunal case of Pertemps Recruitment Partnership Ltd v RCC [2011] UKUT 272 (TCC). Pertemps traded as an agency providing either temporary or permanent workers to its customers. Customers were invoiced on a monthly basis and all payments, whether reconciled to invoices or not, were credited directly to Pertemps’ bank account. Pertemps tried to match payments to outstanding customer liabilities. In most instances, Pertemps was able to offset the payment against a liability or repay the customer. In a minority of cases some payments were neither offset nor repaid. At six monthly intervals Pertemps reviewed the unreconciled balances in the sales ledger and transferred any over six months old to a balance sheet account. At the end of the financial year, Pertemps released the balance sheet account to profit and loss. This accounting treatment gave a true and fair view and was in accordance with GAAP. If a customer could show that they had made an overpayment, Pertemps’ policy was to refund even if the amount in question had been transferred to a balance sheet account or been released to profit and loss. There was a factual link between the receipt of the overpayment and the issue, real or in one case imagined, of an invoice for trading services rendered to the customer by Pertemps. There was no separation or immediate identification in its bank accounts of a mistaken overpayment. Some unreconciled receipts were offset against another trading liability of that customer

Pertemps did not know why customers made payments in error, the behavioural drivers behind the customers’ actions was not important, but they fell into three categories:

  1. payments were made against invoices, notwithstanding that the invoice had already been reversed by a credit note
  2. invoices were paid twice, perhaps because a credit note was mistaken for an invoice
  3. in one case the receipt could not be linked to an underlying supply or invoice, although there may have been a previous customer relationship

The First-tier Tribunal found as a fact that each of the overpayments was made by a customer under a mistaken belief that it owed money to Pertemps for services Pertemps had supplied to it. In this sense, the payments were not wholly gratuitous and the payments derived from the business relationship that had existed between Pertemps and its customers. The payments were of sums of money to which, on receipt, Pertemps was not entitled in the sense that the customer could, and indeed did, claim a full refund and Pertemps was obliged to make such a full refund. However this was not determinative of their trade or non-trade status as receipts. Furthermore, Pertemps did not carry out any specific trading activity to earn or encourage the mistaken payments. Given the scale on which Pertemps operated, it was inevitable that mistakes would occur from time to time, and therefore the receipt of the mistaken payments was an unavoidable incident of Pertemps’ trade. In this sense, the true source of the payments was the trade and not the mistake.

The above facts should not be seen as hurdles or stepping stones to be met in every case before a decision is made regarding the trade or non-trade status of a mistaken overpayment. Rather they are merely indicia, which collectively point to a conclusion that the payments arise out of a trade.

Pertemps argued:

  1. a receipt was to be judged once and for all at the time of receipt, and
  2. a payment cannot be a trading receipt unless the trader has a legal entitlement to receive it at that time

Arnold J rejected both arguments in the Upper Tier Tribunal (see below).

Nature of receipt fixed once and for all?

In Pertemps, at para 25, Arnold J said that Sir Wilfred Greene MR’s remarks in Morley v Tattersall [1938] 22 TC 51 (that the nature of a receipt was fixed once and for all at the time of receipt) were being taken out of context:

‘ …a classic example of a judicial statement which is broader than was necessary… and subsequently requires qualification.’

At para 30, Arnold J went on to say:

‘…there can be circumstances in which money which is not a trading receipt at the time of receipt subsequently becomes a trading receipt because something occurs which changes its character. In the present case, however, this point does not seem to me to be material, for the simple reason that HMRC are not contending that receipts which were not originally trading receipts became trading receipts by virtue of some later event. On the contrary, HMRC contend that the mistaken payments were trading receipts from the moment they were received by Pertemps.’

The circumstance specifically referred to by Arnold J was the case of Jay’s the Jewellers Ltd v CIR [1947] 29 TC 274 (see BIM40230). This case had an almost unique fact pattern and involved a trade which was governed by specific legislation. Thus, whilst it is correct to say that there is no binding rule that the nature of a receipt is fixed at the time of receipt, it is easier to argue for trading status of a receipt where it has such a status at the time of receipt.

Taxpayer only taxed on receipts to which they are legally entitled?

Pertemps argued that Morley v Tattersall was the authority for the proposition that, in general, a receipt is not a trading receipt unless the trader has a legal entitlement to receive the money, and it is this entitlement which connects the receipt to the trade. Arnold J gave four reasons for rejecting Pertemps’ argument:

  1. there is nothing in the statutory provision that requires the trader to be legally entitled to the receipts making up their profits
  2. Greene MR in Morley v Tattersall did not say that there was such a requirement; just because Tattersall had no legal title to their clients’ money, it does not follow that legal entitlement is essential for a trading receipt
  3. cases such as Commissioner of Income Tax v Savundranayagam [1957] 67 TC 239, Simpson v John Reynolds & Co (Insurances) Ltd [1974] 49 TC 693 and CIR v Falkirk Ice Rink Ltd [1975] 51 TC 42 establish that legal entitlement is not a prerequisite
  4. the fact that a payment is made in circumstances that the payer has a restitutionary claim to repayment of that sum does not mean that the recipient is not legally entitled to receive it - on the contrary, the recipient is legally entitled to receive and keep the money unless and until a claim for repayment is made (and established)

Clients’ money ‘in a business sense’

Pertemps, relying on Morley v Tattersall, argued that the mistaken payments belonged to Pertemps’ clients ‘in a business sense’, albeit not in a legal sense, and thus were not trading receipts. They went on to argue that Sempra Metals Ltd v CIR [2007] UKHL 34 illustrated the convergence of remedies available both under common law restitution and as proprietary claims.

Arnold J rejected the argument because, in Tattersall, the facts clearly established that the sums in question were callable at will by Tattersall’s clients (the auctioneers merely had custody of the sums), whereas, in Pertemps, the mistaken payments were Pertemps’ property, meaning that Pertemps had power over and possession of them, albeit subject to possible disgorgement of benefit if customers could establish a restitutionary remedy on the grounds that Pertemps had been unjustly enriched as the result of a mistake.

The purpose of the payments

Pertemps argued that the purpose of the mistaken payments was not such as to make them trading receipts. Arnold J disagreed at para 84:

‘…the mistaken payments derived from the business relationship between Pertemps and its customers. The payments were made by the customers in the mistaken belief that they owed money to Pertemps for services supplied by Pertemps and were an unavoidable incident of Pertemps’ trade.’

If you are unable then to reach agreement that overpayments by customers are taxable, refer to CTISA (Technical) with a full report of the facts and copies of all supporting documentation.

Health warning

This page is part of the section of the Business Income Manual on unclaimed balances. You should read the whole section to understand this topic. See the contents page at BIM40200.