Mitigating interest and penalties for late payment of tax

Where a client has a number of outstanding liabilities of which some are interest-bearing or may give rise to penalties and some (such as interest itself) don’t, the way in which payments are allocated can be very important. Too important to be left to chance, perhaps. There are some rules.

The first rule is that a taxpayer has the absolute right to tell HMRC how he wants the payment allocated if he tells HMRC at the time of payment. So where allocation matters you need to tell HMRC. It’s important that you tell HMRC at the time of payment because if HMRC allocate it themselves (which we deal with below) that allocation is final and non-appealable once they have notified you of it.

The second rule is that if they aren’t told anything different HMRC have the right to decide for themselves how to allocate payments against liabilities. This is where it gets a bit muddled. Their internal guidance does give an order of allocation, which is shown below:

Type of debt	Details
1. European Union (EU) duties and levies	Customs duties and agricultural duties / levies imported from non-EU countries. (These debts are all worked centrally by the EEC Team in Liverpool. They are not tax debts referred to under the MARD arrangements which are treated like the equivalent UK tax debts)  Includes
2. Debts already subject to enforcement action	Distraint already levied Summary Proceedings (SP) order made County Court Judgment (CCJ) entered Statutory demand or Bankruptcy petition pending Winding up petition served in England, Wales and Northern Ireland Ordinary Cause or Summary Warrant in Scotland Clear enforceable fees and costs before duty
3. Class 2 NICs
4. Interest-bearing debts
5. Non interest-bearing debts (excluding Class 2 NICs)	Includes enforcement

Within each category the instructions are to allocate against oldest debts first.

This question came up in the recent Tribunal case of John Francis [2013] UKFTT 477 (TC). The taxpayer owed both tax for 2010/11 and also interest for earlier years: he paid an amount which exceeded the tax but HMRC allocated part against the interest resulting in a 5% late payment penalty for the amount of tax “unpaid”. As it happens, he won his subsequent appeal, but on grounds which aren’t likely to be of wide application so are best ignored for present purposes.

One might have thought, based on the table above, that HMRC’s own instructions would have required them to allocate the payment primarily to the “interest bearing” 2010/11 liability rather than to the “non interest bearing” debt for the old interest: but in fact they didn’t, and the point wasn’t raised at the Tribunal so remains obscure.

But the key point is this: it isn’t safe to rely on HMRC allocating payments in the most advantageous way or even (it seems) in the way their guidance suggests. So if there is any risk at all, you should always tell HMRC how you want the payments allocated.

How do you do that in practice? Well, if you’re paying by cheque, you can either state the required allocation in a covering letter or write it on the back of the cheque (or both, if you are of the “belt and braces” persuasion, as we are – whether anyone actually reads the back of a cheque nowadays must be open to doubt); if you’re paying electronically you will need to write to HMRC at the same time as the transfer is made, setting out the required allocation.