HM Revenue & Customs are about to start sending out 1.2 million letters telling people they have underpaid tax in the 2010-11 tax year, and millions more telling people they are due a refund dating back as far as 2003/04. The CIOT's team of experts have put together this helpful Q&A explaining what it's all about and what you should do if you get a letter.
NB. This updates the Q&A posted on 29 June 2011. The information in this post may be quoted elsewhere provided there is clear attribution to the Chartered Institute of Taxation. We regret that the CIOT does not have the resources to advise individual taxpayers but there are links to other sources of advice at the bottom of this post.
PAYE Reconciliation - questions and answers
Part One: The Reconciliation Process
What's going on?
There are two separate processes at work here
• the end of year PAYE reconciliation for last year (2010-11); and
• the clearing of a backlog of PAYE reconciliations for the years 2003-4 to 2007-8.
PAYE (Pay-As-You-Earn) is the way most people in work pay income tax and national insurance, by having it deducted from their wages (or other income such as a pension) through the year. This usually works fine if you have one stable source of income through the year, but if you have multiple income sources, change jobs, move in and out of work through the year or receive benefits in kind (eg a company car) it can get complicated and you can end up paying too much or too little tax.
The reconciliation process is when HMRC look at all the information they have on your income and tax over the past year and, if necessary, send you a demand or a refund.
The overpayment (tax refund) letters for 2010-11 have now gone out. The underpayment (tax demand) letters for 2010-11 are about to start going out. Additionally HMRC have just announced that a large number of ‘historic’ overpayment (tax refund) letters for earlier years will be going out between now and the end of 2012.
How many people are affected?
According to HMRC, 3.5 million for 2010-11, consisting of:
• 1.2 million people who will get tax underpayment letters for the 2010-11 tax year, telling them they owe an average of £600 each. This includes 146,000 pensioners who will be contacted from 24 October 2011 for tax on their state pension.
• 2.3 million people who have already had letters over the summer telling them they have a refund for 2010-11. The average refund is about £300.
In addition, approximately six million letters will be going out between now and the end of next year telling people they overpaid tax in the years 2003-4 to 2007-8. The number of people involved is likely to be smaller as some people will get rebates for more than one year. These have been generated automatically by bringing together all PAYE data in one place for the first time when HMRC’s new NPS computer system was introduced last year. The average refund is about £400 per person.
Why are some pensioners being taxed on their state pension?
The state pension is taxable, but unfortunately this was omitted from some pensioners’ codes in previous years. Most pensioners in receipt of the state pension with total income in excess of their personal allowance should pay some tax.
HMRC have stressed that they will not pursue underpaid tax on the state pension cases from before 6 April 2010. In addition, they say that they have put these customers on the right footing for 2011-12, by including the state pension in their tax code.
Where a pensioner has underpaid tax for 2010-11, HMRC will automatically code out that underpayment over a period of three years from April 2012 without the pensioner needing to contact HMRC and will also write to the individuals to apologise, explain why the underpayment happened and how it will be collected.
Is this everything?
Not quite. There are a further 6.7 million cases from the 2008-9 and 2009-10 tax years that cannot be reconciled through the NPS as HMRC lack some of the relevant information. HMRC are going through these manually. Stephen Banyard, HMRC’s acting Director General of Personal Tax, told the House of Commons Public Accounts Committee on 17 October 2011 that HMRC is 39% of the way through these cases and is on target to complete them by the end of March 2012. Most of these cases are expected to show that the correct amount of tax was raised but some will result in a refund or a request for tax owed. Most 2007/8 cases should by now be cleared.
Before the introduction of the NPS computer system HMRC had to manually reconcile around 16-17 million cases a year. Under the new system they expect to have to reconcile 3-4 million cases a year, with the rest of the work done automatically by the computer.
Why have so many people paid the wrong amount of tax? Whose fault is it?
In most cases there is no ‘fault’. So long as PAYE exists, there will always be a need for a reconciliation process, as there will always be some people with unpredictable incomes or whose circumstances change through the year.
However in some cases errors may be due to taxpayers or their employers not informing HMRC they have a second job when they should have done and so getting a tax allowance two or more times, and/or paying basic rate tax on two jobs when they should have been paying higher rate tax on at least part of one of their incomes. And in some cases it may be HMRC’s fault, if they had this information but failed to process it or match it up (though this should be less of a problem with the new integrated computer system than it was under the old system).
Essentially, the PAYE system relies on several factors including:
• the correct personal allowance (the amount you can earn free of tax, which was £6,475 for most people of working age last year) being applied once, and only once; and
• if a taxpayer crosses the threshold for the 40p income tax rate, once all their taxable income has been added together, the correct amount of tax being taken.
Although 3.5 million is a lot of people, the number of people getting under or overpayment letters from HMRC for 2010-11 will be fewer than the previous year's 5.7 million (though that was for two years processed together).
So this isn't another 'HMRC blunder’?
No. PAYE sorts most things for most people, but end of year reconciliations (and self-assessment) are needed to finalise the tax situation of many people. People need to take an interest in their tax situation, especially if they are moving in and out of work or have multiple or erratic sources of income.
That said, HMRC’s systems are a long way from perfect and there will undoubtedly be people in the reconciliation process who will feel legitimately aggrieved that, if HMRC had processed information promptly and accurately, they would have paid the right amount of tax in the first place.
What about the backlog?
HMRC deserve criticism for letting such a huge backlog build up. Significant amounts of money have had to be written off, at a substantial cost to the Exchequer. (No further automatic tax underpayment letters are going out for 2003-4 to 2006-7 – in most cases the period for claiming this has expired and HMRC is writing these sums off.) Some taxpayers will have waited eight years for amounts owed to them.
However the six million rebates starting to go out are a sign of progress, showing that HMRC are getting to grips with these historic cases. Nevertheless there is a lot of work still to be done if HMRC are to achieve their target of competing the processing of the backlog by the end of 2012.
Will there always be so many people paying the wrong amount of tax?
No, it should happen less in the years ahead.
Firstly the build up of a huge backlog should not be repeated. HMRC have a new computer system. Although it had a few teething problems (ie many people received incorrect tax codes in its first year), it now does most of the reconciliation work automatically and means backlogs should be unlikely in the future.
In addition, as part of the move towards Universal Credit HMRC are developing a new system of ‘Real Time Information’ (RTI). From 2013 employers will be required to submit PAYE information to HMRC on a weekly or monthly basis, instead of the current annual returns. Once this system is working well it is expected that the information will feed into employees’ accounts with HMRC, enabling them to update coding notices in a more timely way, helping taxpayers pay nearer the right amount of tax in-year.
Additionally HMRC are getting better at matching up records on their system – things like spotting that records for Robert Smith, Bob Smith and R Smith are all for the same person, but employers too need to ensure they use correct data for employees including the full name of employees, the correct National Insurance number and addresses etc. However, there will still inevitably be a need for a reconciliation process at the end of the year for some people.
Anything else HMRC should be doing?
There is a lot more HMRC, employers and employees themselves can do to increase the number of people paying the right amount of tax in year. As well as improving their matching up of taxpayer records (see above), HMRC should work more with employers to educate them about the importance of having accurate and up to date employee records, explaining what they need to check and why. The general public also needs to be educated so that they can take more responsibility for their own tax affairs and don’t just assume that their employer and HMRC will ‘get it right’. They should be able to check their PAYE codes and contact HMRC if they don’t think they are right or don’t understand them.
Part Two: Advice for PAYE taxpayers
Will I get a letter?
HMRC say more than 80 per cent of people who pay tax through PAYE have paid the right amount of tax on that income through the year and will not get a letter.
Those likely to get a letter include people who:
• have more than one source of income, including the retired with multiple pensions;
• have unpredictable income, reliefs or taxable benefits;
• receive benefits in kind from their employer – such as a company car – where the value of the benefit might not be known until the end of the tax year; or
• have overlapping employments – eg because they start a new job before they finish the old one.
People who change jobs during the tax year but who have a P45 from the old job, which they pass to their new employer before the last payment of the tax year should not normally be affected – it depends whether the new employer gets the right information about previous earnings and uses it in a timely fashion. Similarly people with only one source of income through the year, even if they get a pay rise mid-year, are unlikely to be affected.
What should I do if I get a letter?
Read it carefully, check the figures and ensure all your income has been included! The letter (technically a form P800) represents an informal calculation only, not a demand for tax. That may not be immediately obvious. If the calculations are not understood they should be queried and HMRC asked for a detailed explanation of how they were reached. Make sure you check which year the calculation is for.
What about if it is a rebate – presumably I don’t need to do anything?
Again you should check the figures to ensure they are both complete and accurate. If so, and if it is a rebate, and you are satisfied it is correct, you do not need to do anything. You should get the rebate, with interest (if applicable), automatically without having to call HMRC. If you think the repayment should be more, eg because you have had tax deducted from other income such as taxed interest, which HMRC do not know about, that can be covered by your personal allowance, you will still need to make a repayment claim. You can ask HMRC for a form R40 to make a claim – call the number on the letter sent to you.
If you think HMRC have made an error in your favour you should still tell them. Their penalty system works both ways – if they think you were careless in not spotting the over-repayment, they can charge you.
If I owe money, do I have to pay it straightaway?
If you owe money, don’t panic. If the amount is under £3,000, the standard procedure is for HMRC to ‘code it out’ over the next financial year (ie 2012-13 for the letters about to go out). This means paying extra tax in each month of the year. If you feel this will cause hardship you can ask to have it taken over a longer period of up to three years. Taxpayers can resist any attempts to force them to pay in a lump sum within 30 days or less (such tactics have unfortunately been observed over the past year), unless of course they wish to pay immediately. But they should equally bear in mind that spreading repayments might involve clocking up additional interest charges.
What if it was my employer’s fault?
If you have underpaid tax and you think it was your employer’s or pension provider’s fault for not operating the code given them by HMRC correctly or through making some other mistake, then in strict law HMRC must first call upon your employer or pension provider to make good the shortfall. (See the underpayments section of http://tinyurl.com/paye2011 for further explanation.)
What if I, or my employer, told HMRC and they did not act on the information?
‘Extra-statutory Concession A19’ states that in certain circumstances where there are delays by HMRC in using information, HMRC may write off tax arrears owing to it. However the speedy issue of the 2010-11 tax underpayment letters means it is unlikely to apply to most recipients.
It will only apply in relation to this year’s 2010-11 reconciliation letters if the Revenue both ‘failed more than once to make proper use of the facts they had been given about one source of income’ and ‘allowed the arrears to build up over two whole tax years in succession by failing to make proper and timely use of information they had been given’.
This might in some circumstances apply to people with arrears going back over two or more years (eg 2008/09 and 2009/10) where the same failure to use information appears also in 2010/11. Where there are still underpayments due for 2008/09 and 2009/10, HMRC should have automatically written them off if they arose because the state pension was not properly reflected in the code. The same principle should apply to any other taxable state benefit (eg taxable incapacity benefit or ESA) but they will not be written off automatically – the taxpayer has to apply for ESC A19 treatment in those cases.
What about if I am on benefits?
Taxpayers who are on means-tested state benefits and who are notified that they owe tax should contact the DWP, as some benefits are calculated on net, after-tax, income. So the additional tax liability could mean you are entitled to more benefits. (There is more information at http://tinyurl.com/TaxBen).
Where can I get further advice from?
The Low Incomes Tax Reform Group website has lots of useful advice. There is guidance for people who receive overpayment (tax refund) letters at http://tinyurl.com/overpayments2011 and for people who receive underpayment (tax demand) letters at http://tinyurl.com/underpayments2011. The information on the latter is currently being updated and should be amended for the 2010-11 tax year in the next week.
If, after reading this, you think you need to get professional advice you can find a chartered tax adviser local to you at http://tinyurl.com/findcta. If you are not able to afford professional advice then, in limited circumstances, help may be available from the charities Tax Help for Older People (http://www.taxvol.org.uk - for pensioners) and Tax Aid (http://taxaid.org.uk).
CIOT External Relations Manager
Friday 21 October 2011