PAYE: Cracking the code

Dynamic coding was launched in July 2017, but its impact will be felt by even more taxpayers as HMRC issues tax codes for 2018/19. What is there to look out for?

More data sources

The ‘dynamic’ part of dynamic coding refers to using more data sources in-year to ensure PAYE does the best possible job when collecting the right amount of tax within the tax year. HMRC changes its estimate of what will be earned (so-called estimated pay) when the taxpayer tells it about changes in income or it receives information about benefits in kind.

When estimated pay changes, so does the tax code, if that is what is needed to collect the right tax in-year. However, HMRC won’t action in-year changes from January to March as there are too few months left in the tax year to collect a whole year’s worth of tax. In that situation, HMRC will roll an underpayment forward to 2018/19 as had been the case before dynamic coding.

Vital to visit PTA

We must encourage employees to activate their personal tax account (PTA) so they can check if their estimated pay is accurate. It won't be correct if any income sources, allowances or benefits in kind are missing or wrong.

The vast majority of the UK’s 40 million taxpayers still assume that the PAYE code issued by HMRC is always correct; the employer will receive that combination of letters and numbers and hey presto all will be well by 5 April each year.

The large number of P800s issued each year – two million were underpaid, and 4.7 million overpaid for 2016/17, are testament to the fact that PAYE can’t always get it right. This is not surprising given the complexities of the labour market today, so taxpayers may have multiple income sources and a myriad of allowances and reliefs to apportion.

Employers and tax agents will often say to me: “Why do we need to cascade information about the PTA? We are just the employer and our role is to act on HMRC instructions”.

If the employee only finds out about an incorrect PAYE code when they open their payslip they will almost certainly blame the employer, who in turn blames the tax agent and asks for support (non-chargeable time) to sort things out.

Cascading information about dynamic coding to employees will help those employees take ownership for what HMRC has done with the data that they, or the employer, have provided. The employee may even be empowered to correct their tax code through their PTA when central government systems have misinterpreted the data. There is a friendly video to watch which helps explain the PTA to individuals.

Teething problems

Sadly, there are some wrinkles in the dynamic coding process as you would expect with any new system, which can lead HMRC to make incorrect assumptions.

Say an employer or employee reports a change in benefits in kind and this coincides with a spike in earnings, perhaps due to commission or a bonus being paid that pay period. In that case, HMRC will alter the code to collect all the tax on the new benefit in the months left before the end of tax year. But HMRC will also assume the spike in earnings is a permanent salary increase, and extrapolate the ‘pay spike’ as the new earnings up to the end of the year. This can happen, for example, when a bonus is paid in August which coincides with the P11D being processed. If employers know this can happen, agents can encourage employers to remind employees to check their PTA at the appropriate time, so the estimated pay can be reduced to the appropriate value.

Annual coding run

Right now HMRC is using the estimated pay, benefits and reliefs shown on the taxpayer’s PTA in mid-January, to inform their PAYE code for 2018/19. As codes begin to be issued to employees and employers for the 2018/19, it is important that individuals look out for the following coding oddities:

• BR code operated against their main income source, rather than a personal allowance of £11,850. 
• Pension tax relief is missing
• Income sources are still showing that are no longer live
• Duplicated employments (they do happen despite the best efforts of agents, employers and HMRC)
• Scottish taxpayers without ‘S’ prefix codes
• Marriage allowance election is not shown
• Benefits in kind missing, or included when no longer provided, or incorrect as the benefit is now taxed via the payroll