I am hoping that forum members can help with what seems to be a basic question but one for which I can’t find a definitive answer.
IHTM31753 says that “the general rule is that you should apply the deposit against tax first and then against interest charges” and then further on, “If the taxpayer or agent has not given instructions on how the deposit should be used, apply it in the way which would be most beneficial for them”.
The section specifically addresses situations where there is eg IOP and NIOP but I can’t see why the principles stated should not apply in all cases. I can’t see any further commentary on the application of deposited funds in the manual.
I am assisting with the accounting for an estate where the deposits made to date total more than the tax payable. The deposits were made after interest started running and a large amount of interest has accrued. From the wording of IHTM31753 I think you would expect each deposit to be applied against the principal tax due until all the principal tax was paid. Further deposits would then be applied against interest.
In the estate in question, it is clear from the assessments that HMRC have applied deposits partly against principal and partly against interest. Some of the principal liability remains unpaid so interest continues to accrue. That is obviously to the detriment of the taxpayer because interest is payable on outstanding tax, not on unpaid interest.
I am sure that HMRC’s software does not allow for caseworker discretion over how deposits are applied but I can’t find authority (other than IHTM31753) for the rules or conventions that are followed.
These instructions seem to be in tune with HMRC’s general practice in the DMBM and the general law. The legal position of a deposit is perhaps not as straightforward as a specific payment against a notified liability, at least not when it is made to stop interest running in principle rather than to pay a specific liability. HMRC seem to be slightly more generous than the strict law.
The law of appropriation of payments is that the debtor has the first choice of allocating to liabilities owed to the same creditor but if that clear choice is not made at the time of payment the choice reverts to the creditor. HMRC seem to be prepared in some circumstances to allow the creditor to choose after a payment and even to allow a debtor to reallocate after HMRC as creditor has made its own choice. A deposit may be paid at a time when liabilities are uncrystallised, rendering impossible a contemporaneous choice by the debtor. HMRC however do not seem to insist on the debtor being unable to make such a choice but they will not wait indefinitely.
As ever their own words are what matters, not a commentator’s. See DMBM210100-30. As to IHT in particular IHTM31751-4. Your quotation from 31753 is indeed arguable more generous than the strict law, reflecting that a general deposit is not, or is not necessarily a payment of crystallised liability payment of which the creditor could demand (whether or not the debtor disputes it). 31754 is indicative of their attitude to deposits.
I am not sure I follow their distinction between NIOP and IOP liabilities. It seems to me that this is a single liability with the same debtor and creditor, simply not all payable at the same time. And interest on some IOP liabilities only accrues on overdue instalments. I have not fully researched the law but it might be that a “deposit” remains a payment which, if not allocated by the debtor at the time, cannot then be allocated later unless the creditor agrees. HMRC seem to be saying that they will generally do that, up to a point: DMBM210120.
The common law of appropriation of payments is about multiple debts with the same debtor and creditor. I have to say that I have not conclusively run down whether interest accrued due and payable on debt principal is a separate debt or two. I doubt it is two.
Appropriation clauses in contracts often supplement or override the common law. They often give the creditor the right to choose. Significantly, they often break down into different categories the diverse amounts which may become payable under the contract, including on default, so resolving the point contractually. The exceptional treatment of bank accounts, the rule in Clayton’s case, seems to do that as interest, charges etc are individual account debits (though here the contract may provide and prevail).
HMRC are not in a contractual relationship with the taxpayer (apart from contract settlements: EM6001). They seem to acknowledge that common law applies. The debtor will presumably never prioritise interest, which in the absence of any contract or statute to the contrary, is simple interest; CHB140260. (Tax debts can also give rise to surcharges, penalties, and interest on them, but there is never interest on interest: CHB140160). Can and will HMRC? Whatever the legal position it seems they will in practice appropriate in a way that minimises accruing interest. The law is not clear (at least not to me) so JR may be the only remedy if they do not do so.
I am sure what we as advisers want is consistency above all else, both between (1) the wording of 31753 and assessments in practice and (2) from one estate to another. On 31753 I have found on several recent assessments that HMRC seem to have applied deposits in the following order:
NIOP principal
NIOP interest
IOP principal
IOP interest
Applying deposits against interest before principal in the case of NIOP interest is not consistent with 31753 where the default instruction is to apply deposits in a way which is most beneficial to the taxpayer.
But even more confusingly, after upwards corrections were reported in the estate I am looking at, HMRC reallocated the deposits but did not fill the NIOP interest bucket before moving on to IOP.
To add another layer of uncertainty, 31751 suggests that HMRC caseworkers may have some of their own agency in matters. It refers to registry staff contacting the caseworker when a deposit arrives so that “[the caseworker] can consider how to deal with it.” It surely can’t be up to a caseworker as to whether a deposit is applied against principal or capital. If nothing else, with rates now at 8% that would result in large disparities in outcome between one taxpayer and another.