Interest Paid on Underpaid and Overpaid Tax – HMRC consults on a new approach to interestMonday, June 30th, 2008
There are a number of different structures governing the interest that HMRC charges on late payments of tax and pays out on overpayments, the framework and legislation for which were inherited from the Inland Revenue and HM Customs and Excise. As many taxpayers, particularly businesses, interact with HMRC across a range of taxes, HMRC is concerned that the differences are viewed as adding unnecessary complexity and burdens to the tax system.
A new consultation document, entitled Interest – Working Towards a Harmonised Regime, was published by HMRC on 19 June 2008. This consultation considers ways on simplifying and harmonising how interest is charged and paid across tax regimes, rather than on making any changes to how the underlying tax regimes operate. All taxes administered by HMRC are in the scope of this review, including PAYE tax and NICs, but excluding tax credits, child benefit and customs duties.
For the 2006/07 financial period, HMRC collected around £496 billion and repaid around £73 billion. Around £64bn (15%) of tax receipts are paid late, though a significant proportion of these are paid within a few days of the due date.
The purpose of interest is to reinforce the fact that particular taxes are due for payment on particular dates and to bring a degree of fairness into the system where those payment dates are met by some taxpayers but not by others. It ensures that there is no advantage enjoyed by late payers. However, interest is not intended to be a penalty for late payment and neither is it intended to influence behaviour. If a payment is late, the taxpayer (having had use of the money and the Exchequer having been denied the use of the money) is charged interest as recompense. Nevertheless, if interest charges are not to be perceived as a penalty, the level at which interest rates are set need to follow closely changes in market rates.
For most direct taxes, interest is generally charged on late payment of any liability and paid automatically on any liability which has been overpaid. In the case of corporation tax it is also paid to the taxpayer on tax paid early.
One exception is PAYE tax, where interest is charged only after the end of the year on any amounts outstanding for that year. The legislation requires that payments of PAYE are made ‘in-year’ but, where these are late, interest is not currently charged. This means that the Government receives no recompense for these payments being made late. Also, the system does not provide fairness between taxpayers as, without interest, those who do meet their obligations in-year have a commercial disadvantage.
This absence of interest was commented upon by the Public Accounts Committee in a report published in October 2007. The report stated: “Nearly 50% of businesses do not pay PAYE/NICs on time. The Department (HMRC) cannot impose a penalty or interest for late monthly payments of PAYE/NICs during the year. It can do so only on balances due at the end of the tax year. It should seek to remedy this situation.”
Calculation of rates
All interest rates charged and paid out by HMRC are set by reference to statutory formulae. Each tax has its own formula and there are nine formulae in total. For example, the formula for calculating the rate to apply on late paid income tax, as defined in the Taxes (Interest Rate) Regulations 1989, is:
“Reference Rate” + 2.5%
Each of these formulae have the same starting point for calculating the interest rate. The legislation currently provides that this starting point, the “Basic Rate”, is an average of the basic lending rates applied by six of the UK’s banks. The figure generated is then used to calculate the “Reference Rate”, in most cases by rounding the “Basic Rate” to the nearest whole number (with ½% rounded down). However, beyond this starting point the formulae used are not consistent across all of the taxes that HMRC administers and there are, in fact, eight different rates that are used currently for charging and paying interest across the tax system.
Continuing with the example of interest on late paid income tax, the current rate since January 2008 is 7.5%, prompted by the reduction in the Bank of England (BoE) base rate in December 2007 to 5.5% and a corresponding reduction in the “Reference Rate” to 5%. Although the base rate has fallen twice since then, to 5.25% in February and to 5% in April, and all six banks reduced their basic lending rates accordingly, the statutory formula still results in the same 7.5% interest rate on late paid income tax. This is because, where the “Basic Rate” is 5.25% or 5%, the “Reference Rate” stays unchanged at 5%.
Although the rounding rules for interest rates mean less frequent changes and provide a degree of stability in the rates, some taxpayers have been unhappy when the changes made by the BoE are not reflected in the rates applied under the relevant legislation on late payments and overpayments. Taxpayers have found it confusing that interest rates charged (and applied to overpayments) do not move in line with the BoE bank rate. The rounding rules make it difficult to predict when changes will take place and the infrequency of the changes means that the level of recompense does not keep pace with changes to commercial rates.
The aspects of the current arrangements for which change is considered in the consultation document are
- the most appropriate starting point for the calculation formulae
- whether there should be a single interest rate instead of eight
- what the differential should be between late payment rates and overpayment rates
- the frequency at which the rates change
- whether simple or compound interest should be paid
- the special situation of employer payments of in-year PAYE tax.
Four optional starting points for the interest rate formulae are considered, namely,
- the “Reference Rate”, as used currently
- the BoE base rate
- the London Inter-Bank Offered Rate (LIBOR)
- the Government bond rate.
The consultation seeks views on which of these starting points would be the most appropriate to use and most readily understood by taxpayers. Although the document does not specify a preference, the pros and cons appear to indicate a preference for the BoE base rate.
The use of a single interest rate in place of the current eight rates is proposed. However, it is suggested that separate rates for late payment and for overpayments should be retained, but with the differential set to reflect the differences in interest rates used for borrowing and lending.
The key issue with regard to the frequency of change is whether it would be more acceptable to taxpayers for interest rates to be stable, which might indicate an annual review of rates, or for rates to be sensitive to bank interest rates, which would suggest more frequent review points. A compromise is suggested, with reviews taking place every three or six months.
HMRC currently charges and pays simple interest but is open to arguments that an element of compound interest should be introduced, as long as the rules and the rates are clear and not open to interpretation.
The issues arising for monthly and quarterly payments of PAYE tax collected by employers are the same as those discussed in the current consultation document on penalties for late filing and late payments. As employers only report their exact liabilities after the end of a tax year, it is not currently possible for HMRC to determine whether an employer has underpaid or even overpaid PAYE tax at any point in that tax year. The same three options are considered as are suggested in the “penalties” consultation document, namely,
- requiring employers to provide a monthly statement of PAYE liability, allowing interest for late payment to be calculated accurately each month.
- extending the statutory late payment surcharge arrangements for large employers to medium-sized employers, i.e. those with between 50 and 250 employees. This approach would require a new way of calculating interest and it is suggested that interest could be calculated on the number of days that each payment is late. However, that raises the problem of months in which no payment is made, as there would be no figure on which to calculate the interest.
- HMRC estimating the tax due each month and basing the interest charge for the late payment on that estimate.
All three options would involve significant changes for employers and HMRC is interested in views on these and any other ways in which interest could be charged on last payments of in-year PAYE.
The consultation document is available at the link given below. Comments should be received by 11 September 2008.
Interest – Working Towards a Harmonised Regime
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