[Note – this article refers to legislation in the Finance Bill 2013, which is subject to possible amendment]
The penalty regime for failing to make payments on time is contained in Finance Act 2009, Sch 56. It was introduced for PAYE and various other purposes from 6 April 2010. Employers will generally be aware that monthly remittances of PAYE and NIC deductions must generally reach HMRC by the 19th of the following month, or by the 22nd of the following month if payment is made electronically (SI 2003/2682, reg 69(1)).
Penalties and default
For penalty purposes, there is a failure on each occasion in the tax year when a payment of PAYE and NIC deductions is received late by HMRC, or is not paid at all. The penalty rate is initially based on the number of defaults by the employer during the tax year. Those penalty rates are as follows (FA 2009, Sch 56, paras 6(4)-(6), 7, 8)):
In addition to the above, a further 5% penalty applies after 6 months, and another 5% penalty after 12 months.
However, the first failure to pay on time in the tax year does not count as a default. In other words, the first late payment of PAYE and NIC deductions in a tax year is not taken into account when determining the rate of penalty. However, there may still be a penalty if the payment is more than 6 months late (FA 2009, Sch 56, para 6(3)).
With regard to the 4% penalty, the legislation states that this percentage applies if there are 10 or more defaults during the tax year. However, for tax years before the introduction of changes introduced in Finance Bill 2013 (see below), following the First-tier Tribunal case Agar Ltd v Revenue & Customs  UKFTT 773 (TC) no penalty can be charged for month 12. There are two reasons for this. Firstly, penalty notices issued by HMRC generally relate to a particular tax year. The PAYE and NIC liability for month 12 is actually due in the following tax year. Secondly, if month 12 is paid late (i.e. after 19th or 22nd April), that will represent the first late payment in the following tax year, and as mentioned the first failure in the tax year is disregarded when calculating the rate of penalty.
Penalty reductions, etc
Where late payment penalties do apply, HMRC may allow a ‘special reduction’ if there are ‘special circumstances’ for the late payment. However, the ability to pay is not a special circumstance for these purposes (Sch 56, para 9). Penalties can also be suspended by HMRC if there is an agreement in place for deferred payment, commonly known as a ‘time to pay’ arrangement (Sch 56, para 10). In addition, there is no penalty if the employer satisfies HMRC (or the tribunal) that there is a ‘reasonable excuse’ for the late payment. However, insufficient funds is not a reasonable excuse unless it is due to events outside the employer's control (Sch 56, para 16). Finally, there is a right of appeal against HMRC’s decision that a penalty is due, and also as to the amount of the penalty (Sch 56, para 13).
In AJM Mansell Ltd v Revenue & Customs  UKFTT 602 (TC), the company was a pharmacy generating most of its income from the Department of Health. The company was issued with a penalty notice by HMRC for 2010/11, which was originally based on 12 defaults. However, the first default was not penalised due to the statutory exception for the first late payment in the tax year, and HMRC later reduced the penalty in respect of month 12 to take account of the decision in the Agar case mentioned earlier. Nevertheless, that left 10 defaults, resulting in a possible penalty rate of 4%.
The company appealed against the penalty. At the tribunal hearing, it was argued on the company’s behalf that HMRC had allocated the company’s PAYE payments to the previous tax month, whereas they could have been allocated to the current tax month instead, in order to reduce the level of penalties. The tribunal helpfully came up with the following example to illustrate this point.
Month 1 of the 2010/11 tax year ended on 5 May 2010. The due date for paying the PAYE electronically was 22 May 2010. Month 2 ended on 5 June 2010. The payment for month 2 was due on 22 June 2010. The company made a PAYE payment on 9 June 2010.
The PAYE payment made on 9 June 2010 was allocated to month 1, so it was 18 days late. It was argued for the company that had the payment made on 9 June 2010 been allocated to month 2 instead of month 1, it would have been paid well before the due date of 22 June 2010, and as a result, no penalty would have been charged for month 2.
In addition, if the same pattern of payment allocations had been followed throughout the tax year, the company would have had only one late payment, i.e. for month 1, in which case the company would have escaped penalties altogether.
Method of allocation
The tribunal looked at the common law on the issue of payment allocations, and referred to two cases in particular. The first was a 19th century case, The Mecca  AC 286. In that case, the judge held that a debtor may allocate payments to a creditor in any way he chooses. However, if the debtor does not allocate the payment when making it, the right of allocation passes to the creditor.
The tribunal also referred to another 19th century case, Clayton’s case  1 Mer 572, which is authority for the approach that where the debtor has a ‘running account’ with the creditor such as a bank account, payments received from the debtor are allocated to the earliest debt.
In the context of PAYE and NIC, the tribunal found that each month’s PAYE and NIC liability was a separate debt, and there was no ‘running account’. This meant that the rule in The Mecca applied, as opposed to the rule in Clayton’s case. In other words, the employer is allowed to allocate its PAYE and NIC payments in any way it chooses, provided that it does so before the money changes hands. Unfortunately for the company, the tribunal held on the evidence that no payment allocations were made by the company as in the example mentioned earlier. The tribunal also noted that the company's payroll costs varied. The inference was that these varying amounts were calculated based on employees’ earnings for the previous month. The tribunal found that, in fact, the company allocated its payments to the PAYE and NIC debts relating to the previous tax month. As a result, the company's payments were made late.
The tribunal then went on to consider whether HMRC was under an obligation to allocate payments differently, and/or to advise the company to allocate its payments in a more favourable manner. However, the tribunal had already decided that it was the company which had allocated the payments to the previous tax month. Following The Mecca case as mentioned earlier, HMRC had no power to reallocate payments, and were simply unable under common law to act as the company had wanted.
Finally, the tribunal considered whether the company had a ‘reasonable excuse’ for the late payments. The tribunal did not accept on the evidence that there was an insufficiency of funds due to events outside the company's control, and therefore held that there was no reasonable excuse for the late payments.
It is perhaps difficult not to have some sympathy with the company on this final point, because as mentioned most of its income came from the Department of Health. Payments to the company by the Department of Health had apparently been paid late on a consistent basis. So it would seem that the company was being penalised by one government body for paying PAYE and NIC late, when it had consistently been paid late by another government body! Nevertheless, the tribunal's overall decision was to dismiss the company's appeal, and to confirm the penalty.
In another recent case, the appellant was rather more successful. In Kelcey and Hall Solicitors v Revenue & Customs  UKFTT 662 (TC), HMRC once again imposed a penalty for the late payment of PAYE in every month of the 2010/11 tax year. However, months 1 and 12 were excluded, due to the reasons explained earlier.
The appellant firm had been experiencing cashflow difficulties at the start of the tax year, because some of their clients had defaulted in paying them. Consequently, the firm did not have the money to make the PAYE payment for April 2010. It simply missed making the payment for that month. The firm made the PAYE payment for the month of May on 8 June 2010. However, because the April payment had been missed due to a lack of funds, HMRC allocated the May payment to April.
The firm’s procedure was to make its PAYE payments early in the month following payment of the salaries. Unfortunately, the effect of the missed payment for April, and HMRC’s allocation of the May payment to April, was that each subsequent month became late. HMRC started ringing the firm on a monthly basis chasing payment of the PAYE, but the firm didn’t realise the reason for this until later. Eventually, the missed PAYE liability for April was picked up, and payment by instalments was agreed with HMRC to clear that month.
During the calls with HMRC, the new penalty regime for late payments was discussed, but the HMRC staff did not know how penalties would be implemented in the first year of the new regime. In addition, the HMRC staff never mentioned that it would be in the firm’s best interests for the PAYE payments to be allocated in a different way, i.e. to the current months for which they were actually intended to apply. At the tribunal hearing, reference was also made to HMRC’s debt management and banking manual, which states the following (at DMBM210105):
“Where exceptionally you feel the customer’s allocation would not be in their best interests, for example because a different debt is about to be enforced, you can suggest to the customer that it would be in their best interests to allocate differently”.
The tribunal judge thought that the HMRC staff had misled and misinformed the firm in their monthly telephone calls to chase the PAYE payments. The tribunal decided that by the time of the monthly conversation with HMRC staff relating to the late payment for PAYE month 5, either the HMRC staff should have known that the penalty regime was being enforced immediately, or they should have suggested a different payment allocation, in accordance with DMBM210105.
The tribunal therefore held that there were ‘special circumstances’ in this case, and that the penalties should be reduced. The penalties in respect of month 5 onwards were cancelled. The first default (month 1) does not count towards penalties, so the firm was only liable to penalties for months 2, 3 and 4. This meant that the penalty rate was only 1% for those months, instead of the 4% penalty rate that the firm had originally faced for months 2 to 11 inclusive.
Following changes included in Finance Bill 2013, penalties are incurred for each late payment relating to a tax year, rather than for each payment due during a tax year. This change, which is due to apply from 2014/15 onwards (i.e. to defaults in relation to that tax year), would appear to allow a penalty to be charged in respect of month 12 of a tax year. A default for month 12 relates to that tax year, but the payment of deductions for month 12 is due in the following tax year. It would therefore seem to reverse the effect of the decision in the Agar case.
The severity of the late payment regime for PAYE in particular appears to have taken many employers by surprise, judging from the number of tribunal appeals against penalties for 2010/11. However, employees should remember that it can be possible for penalties to be suspended, reduced or eliminated, depending on agreeing ‘time to pay’ arrangements with HMRC, or if there are ‘special circumstances’, or if there is a ‘reasonable excuse’ for late payment. Employers should also bear in mind the principle from The Mecca case, if it becomes necessary to allocate PAYE payments to a particular month.
Finally, for employers who are experiencing cashflow difficulties, if PAYE payments are going to be made late or missed completely, it is important to remember to contact HMRC before the normal due date and arrange for time to pay so that penalties can be suspended, and perhaps also so that payments can be allocated in a way that might be more beneficial to the employer.