Overpayments from customers

A common scenario – a customer overpays your client and you pick this up when preparing the year end accounts. The client is not sure what action to take as the customer has not contacted them and seems oblivious to the error. What advice do you give?

The obvious initial reaction is that the money does not belong to the client and should be returned. However, it may not be so straightforward. For instance, the client may have made some attempt to contact the customer without success or they may be claiming that they want to hold on to the money as security against potential future sales to the same customer. The last thing that the client wants is the advice to return the money. The accountant is now in an awkward position as to what advice to give and how to treat the amounts in the accounts.

Areas to consider when advising include the following.

There have been a number of cases considered by various tribunals on the subject of overpayments and a famous one concerning NCP car parks decided that in some cases retained overpayments would constitute further consideration for their services supplied to the parking site owner and are subject to VAT.

This leads to the guidance HMRC has included in its internal manual (supply and consideration):

Consideration – payments that are not consideration: overpayments

The value of a supply is not affected if a supplier receives payment twice for a single supply due to a mistake by the customer. The value remains the original advertised price and cannot be increased simply because of an overpayment and so the additional payment is outside the scope of VAT. This applies whether or not the supplier makes provision to return the overpayment.

However, if the overpayment is not returned and is used to pay or part-pay a future supply then it becomes consideration for a supply. So in some cases this may mean that VAT is due on the overpayment. The inference would be that if it is carried forward then this would not attract VAT.

There are several tax related cases which indicate that tax may be charged on overpayments especially when written off to the profit and loss account. Two of the main ones are:

Smart v Lincolnshire Sugar Co Ltd  illustrates the fact that even though a customer may have a claim against the taxpayer (for repayment of the original overpayment) this does not prevent the payment representing trading profits.

A major case which suggests the above is the Pertemps case. This was a first tier tribunal case where the facts (briefly) were:

• money was mistakenly paid over by the customer
• the unclaimed amounts were transferred to a separate balance sheet account and subsequently released to the profit & loss account.

The main issue that the tribunal was asked to conclude on was whether these payments constituted trading receipts accruing or arising from trade for tax purposes.  The tribunal decided that they were for the following main reasons:

1. The tribunal agreed with HMRC's submission that a mistaken payment for services has the same characteristic in the hands of the recipient trader as a payment made not in error – if the payment is made because the customer makes a mistake about owing something for services or for a trading transaction, the mistaken payment accrues from the trade of the recipient.
   
   
2. The payments were made by customers in the mistaken belief that they owed money to Pertemps for services Pertemps had supplied to them in the course of Pertemps' trade. Even though Pertemps did not carry on any specific activity which might be said to earn or encourage the receipt of these mistaken payments, their receipt is an inevitable and unavoidable incident of Pertemps' trade.  Pertemps did not segregate the mistaken payments from its other receipts, and treated the mistaken payments as its own money, as indeed they were.  The fact that the payments were unilateral or that customers may have an entitlement to claim the money back does not prevent the payments from being trading profits.

So despite the fact that the customers mistakenly made the payments and may be due the money back, the receipt may be a taxable receipt.

It may be the above considerations for VAT and tax are simply not relevant because the client’s actions in relation to the overpayment are illegal in the first place. Have a look at the Theft Act 1968 definitions:

Basic definition of theft

1. A person is guilty of theft if he dishonestly appropriates property belonging to another with the intention of permanently depriving the other of it; and “thief” and “steal” shall be construed accordingly.
2. It is immaterial whether the appropriation is made with a view to gain, or is made for the thief’s own benefit.

‘Appropriates’ is basically defined as:

Any assumption by a person of the rights of an owner amounts to an appropriation, and this includes, where he has come by the property (innocently or not) without stealing it, any later assumption of a right to it by keeping or dealing with it as owner.

So could the fact that the client makes no attempt to repay the money and /or ignores it in communications with the customer mean that it is deemed to be theft?

Consideration should also be taken on the timing of any transfer. The Limitations Act 1980 would need to be considered as the relevant limitation periods for a claim in relation to debt arising under statute as set out in the Limitation Act 1980 is six years.

Most clients’ sales ledgers will contain some overpayments and the reasons behind them will be many and varied. But the treatment of these might incur VAT, tax and in fact accusations of theft!

To make matters worse the spectre of a suspicious activity report to NCA under the money laundering regulations may loom depending on the client’s subsequent actions.

So the clear advice to the client must be to contact the customer, make them very aware of the issue and agree how the overpayment will be used in the future.