PAYE: Dynamic coding has landed

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On 2 July 2017 HMRC launched the new system of dynamic coding. Sarah Bradford explains what this means for taxpayers, with two worked examples.  

Refined codes

PAYE tax codes are becoming more refined. Under the system of dynamic coding, potential underpayments are replaced with in-year adjustments (IYAs). The tax codes are adjusted in-year to reflect changes in an employee’s circumstances as soon as HMRC becomes aware of the change. This is the ‘trigger point’ (see below). In the past, the potential underpayment was reflected in the tax code for the following tax year – under dynamic coding, the code is changed in the same tax year.

What is estimated pay?

The concept of ‘estimated pay’ is fundamental to this new system. Estimated pay is used to perform the coding calculation in order to arrive at the new tax code. Essentially, estimated pay is annualised year to date pay.

Example 1

A weekly paid employee has year to date pay of £8,000.

This is equivalent to average weekly pay of £400 per week (YTD pay at week 20 of £8000) and annual pay of £20,800 (52 x £400).

Estimated pay for the purposes of the coding calculation is therefore £20,800.

The same procedure is used for monthly paid employees, but based on average monthly income. The calculation is performed on a daily basis if the employee starts part way through the year.

Trigger point

The PAYE code will only be amended if there is a trigger to tell HMRC that the employee’s circumstances have changed. This may be the individual amending his or her personal tax account, or the employer telling HMRC that something has changed, for example via payroll reports or the P46(car). Kate Upcraft explored the possible trigger points in her article HMRC unlocks the mystery of PAYE codes.  

As we go forward, the FPS will increasingly be used as a means to notify changes to HMRC, and HMRC will also make more use of third party information.

Changing the code

Once a trigger event has occurred, dynamic coding will kick in and a new tax code will be calculated. This is best illustrated by an example:

Example 2

HMRC becomes aware on 31 October 2017 that Harry has been provided with a company car since the start of the 2017/18 tax year. The car has a cash equivalent value of £5,000.  

Harry is paid monthly and the FPS at that date (month 7) shows year to date pay of £14,583.33 and YTD tax of £1,573.80. Harry has had a tax code of 1150L.

Harry’s estimated pay for the year is £25,000 (12 x (£14,583.33 / 7)).

The dynamic pay calculator calculates Harry has underpaid tax at that date by £583.33 ((£5,000 @ 20%) x 7/12). This is the year to date tax on the car benefit.

As Harry is a basic rate taxpayer, this is equivalent to tax at 20% on income of £2,917 (£583.33 x 100/20).

The underpayment has to be collected over the remainder of the tax year, i.e. 157 days (1 November 2017 to 5 April 2018). The in year adjustment (IYA) produces an income figure of £6,781 (£2,917 x 365/157).

The amended tax code, which now includes the car benefit and the IYA is 27K, which is applied on a month 1 basis.

Personal allowance                                              £11,500

Less: car                                                               (£5,000)

Less: IYA                                                              (£6,781)

                                                                               ------------

                                                                                (£281)

                                                                                ------------

Applying the new code of 27K on a month 1 basis you get the following tax deduction:

Added pay for code K27 = £23.25

Monthly pay £2083.33 + 23.25 = taxable pay: £2106.58

Tax due at 20% x £2106.58 = £421.31

The tax due for the year is £3,700 = (20% ((£25,000 pay + £5,000 car) - £11,500 allowance)).

This is achieved by the following deductions under PAYE:

Months 1 to 7 (per FPS)                                         £1,573.80

Months 8 to 12 (5 x £421.31)                                 £2,106.55

                                                                               -------------

                                                                                £3,680.35

                                                                                ------------

Due to rounding there is a slight underpayment of less than £20.

Possible problems

Bonuses, particularly if paid early in the year, can cause problems as estimated pay may be considerably higher than actual pay. The estimated pay calculation assumes that pay accrues evenly throughout the year, and where a bonus has been paid, average weekly or monthly pay will be higher than normal. The estimated pay calculation is only performed when there is a trigger event – it is not revised each month following submission of the FPS.

Further, there needs to be a trigger event for the PAYE code to be revised. This may depend on the individuals updating their personal tax account which, although this is something that HMRC encourages, many individuals will not due.

About Sarah Bradford

Sarah Bradford

Sarah Bradford BA (Hons) ACA CTA (Fellow) is the director of Writetax Ltd (www.writetax.co.uk) and its sister company, Writetax Consultancy Services Ltd. She writes widely on tax and National Insurance contributions and is the author of National Insurance Contributions 2015/16 published by Bloomsbury Professional. She can be contacted at [email protected],

Replies

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25th Jul 2017 11:59

what does all this mean?

A weekly paid employee has year to date pay of £8,000.

This is equivalent to average weekly pay of £400 per week (£8,000 / 20wks) and annual pay of £20,800 (52 x £400).

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25th Jul 2017 12:03

and this

Further, there needs to be a trigger event for the PAYE code to be revised. This may depend on the individual updating their personal tax account which, although this is something that HMRC encourages, many individuals will not due.

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25th Jul 2017 17:46

We've amended the article, adding "YTD pay at week 20 of £8000" to example one.

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to Richard Hattersley
25th Jul 2017 18:17

slightly but not much better :-) how about changing the final word?

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26th Jul 2017 10:39

Wonder if this linked with PAYE codes disappearing from Agent self assessment client screens recently?

This was very handy to see what benefits and underpayments etc HMRC were fixing via tax codes.

Anyone know how to access the tax code breakdowns online now for clients on self assessment

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26th Jul 2017 10:57

So in short, it works in the exact same way as at present but take effect in the current uear rather than the subsequent one.

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26th Jul 2017 10:59

Give me strength. Another recipe for disaster. What about those who self-assess? Mixed income can result in Kcodes unless it is requested that the full allowance be used for PAYE and the tax on other income paid in January and July. All that will happen is that our time will be wasted even more in making objections(if valid) to constantly changing codes. Quite what the taxpayers will make of it remains to be seen.

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to david wilks
26th Jul 2017 11:04

Indeed, someone on flexible contracts with multiple employers, say someone who works whatever shifts available as a casual bar worker in a handful of pubs and clubs, going to have tax codes like yoyo's!

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to Smokoe Joe
26th Jul 2017 11:16

Oh - and 2016/2017 calculation fiasco. Can't wait for 2018/2019.

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26th Jul 2017 11:09

Not one for tautology , why not simply say HMRC will now try and collect potential underpayments within the same , rather than the subsequent , tax year .
Nothing particularly dynamic here. But then ....we are talking about HMRC.

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to Mr J Andrews
26th Jul 2017 11:15

Cynical, but possibly as much to do with not having a wadge of refunds to make from over taxing those who have been over taxed on a BR code on their many jobs.
I do applaud what they are trying to do, but we can phone up and get codes changed for clients, why not let us do that online ourselves. My biggest bugbear is a pair of higher rate directors who are on low salary, high dividend as is typical. They have pensions from previous employer, every time something is filed (trigger point) I have to phone up and re-set the pension tax code to D0 to avoid a large underpayment accruing!

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26th Jul 2017 11:11

When will we get to the sensible solution that the taxpayer can self adjust their tax code to suit themselves, rather than having it foisted on them by HMRC. It can't be that hard! HMRC can fix in P11D data to give an available free pay allowance that can be applied to whatever live employments the tax payer chooses.

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to Smokoe Joe
26th Jul 2017 11:36

Are you serious? If you let taxpayers choose their tax codes, there will be some who use it to defer paying any tax or greatly reduce their tax until HMRC spot the error or they submit their tax return. A 45% taxpayer could choose BR. This is about collecting money quicker and preventing unexpected underpayments, even if it means overpayments!

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By catlady
to Smokoe Joe
26th Jul 2017 11:43

The personal tax account is getting there! You can add/change P11D benefits mid year, adjust investment income etc.

The most irritating lack, at the moment, is not being able to adjust pension tax relief. Once that is there, I will able to control our tax codes with no phoning/writing to HMRC.

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to catlady
26th Jul 2017 11:57

But I thought agents were prohibited from accessing their clients' personal tax accounts.
(In any event, HMRC still won't let me access mine.)

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By catlady
to leon0001
26th Jul 2017 12:54

Sorry, I did not mean for clients. I mean only for myself and my partner. As he is employed, I can see much more of the functionalty that the employed tax payer gets. It is a shame an agent can not have the same access.

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By Fitzz
26th Jul 2017 11:24

My business pays bonuses in May, so this might create mayhem. Will there be a simple way to inform HMRC (for all employees) that YTD earnings are not indicative of annual pay in May, June, July, etc.? Or are we going to have to have multiple trigger points?

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By catlady
26th Jul 2017 11:36

I have already had fun with this via the tax account of my partner. His employer mucked up the FPS this month (long story), so it looked like he had underpaid tax by £1847. He is paid mid-month but is paid for the whole month. HMRC have calculated an in year adjustment but they have calculated the underpayment to be approx. £1,000 more but give no detail of how they came to the figure. A case of “We ‘think’ this, so we will help ourselves but we are not going to show you how we calculated it”. I am not going to look too deeply, as hopefully when the employer corrects their FPS, it will all sort itself out! It almost looks as if the tax has been pro-rated to be recovered over the remaining year, and then the restriction pro-rated again.

What is interesting is the underpayment restriction. It is calculated on a daily basis, so if I log onto is PTA it shows a tax code based at today, then tomorrow it will have an extra day added and the underpayment restriction increases. It does not appear to release this code to the employer each day, so I am assuming it will release a new code to the employer once it ties in to the correct pay frequency.

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to catlady
26th Jul 2017 11:59

If HMRC discover that you are logging onto another individual's PTA you are in trouble.
Streng Verboten!

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By catlady
to leon0001
26th Jul 2017 13:03

Hmmm....I am sure that couples often look after their 'other halves' tax stuff.... especially when one is an accountant. I am sure that HMRC have bigger fish to fry...I am saving them a fortune in not having to employ people to answer our telephone queries/letters!

If they come after me, I shall run to the Daily Mail and have one of those 'sad face' photo's taken about how they should be going after big business and not little ole me! LOL

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26th Jul 2017 11:55

So how (and when) will we agents know when our employed client's tax code has been changed like this?

And can we see a copy of their workings and assumptions?

Why does this new procedure give me a queasy feeling?

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26th Jul 2017 11:58

where are we on taxable benefits that are returned on P11d but can be claimed back as deductions on the tax return?

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26th Jul 2017 12:33

What is estimated pay?

This is where the trouble starts, however issuing a Paye coding is good as a lot of information can be taken from it.

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26th Jul 2017 12:36

The worked example has a change occurring at the beginning of the tax year, but HMRC not hearing about it until after month 7. So, from month 8 the employee must:

a) Pay extra tax on his ongoing benefit
AND
b) Pay off the arrears he built up through not paying the extra tax in months 1 to 7.

This results in his tax going up by about £196 per month for the final 5 months of the year, made up of:

a) £83 per month on the ongoing benefit and
b) £113 per month (to pay off 7 months' arrears over 5 months)

From the start of the following tax year, he should have no arrears and will pay only the ongoing £83 per month on his benefit.

Under the old system, the arrears would have been spread over the 12 months of the following tax year (at an extra £48 per month) instead of over the final 5 months of this year (at an extra £113 per month). So the old system was a bit more humane.

What really causes the damage here is the late notification by the employer, allowing 7 months of arrears to build up. If the employer notified promptly and HMRC acted promptly, then there should never be more than one or two months' arrears to pay off. But in the real world, delays happen.

I'd worry if, say, 10 months' arrears were being collected in the final 2 months of the tax year. Is there built-in protection to prevent unreasonably heavy deductions?

HMRC's calculations will also depend upon prompt application of the new code by the employer, and this won't always happen, so that people will still end the year with underpayments

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26th Jul 2017 13:08

More than a bit worrying, given HMRC's track record on coding changes.

My main worry with the K code example is that HMRC's system will fail to then issue the correct code to use in the following year and the taxpayer will end up paying too much in the first couple of months of the new tax year.

Also, the new system is very harsh as taxpayers will have to accelerate the repayment of underpayments.

I can't see it as being anything other than another pile of paperwork and a mess we will have to sort out.

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27th Jul 2017 08:49

Just got some tax codes for clients. Obviously HMRC has included dividends which in my view is illegal and certainly 100% wrong. I muts guess because HMRC will not tell me how arrived at.

So now dynamic? How the heck will they know dividends? Untill declared they do not exist. See above view.

Employees pay rarely changes much in the year so another pointless exercise.

HMRC should move to The Planet of Apes as obviouskly Earth is beyond them. Sorry a rant.

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By Freddo
27th Jul 2017 17:34

This is causing problems for those who are both employed PAYE and self-employed. A couple of my clients have received refunds of overpaid tax under PAYE for the year 2016/17 but they haven't yet completed their self-assessment tax return which is not yet due. When they do, they will probably have a tax bill to pay. When I queried one client who had been self employed under CIS but took a PAYE job for 6 months and then continued CIS, HMRC said that him becoming PAYE had triggered them to mark his account as no longer self-employed. There must be many people who work both PAYE and self-employed.

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28th Jul 2017 13:01

HMRC's IYA PAYE recode internal calculation is automatic following a "trigger" i.e. produces a Dynamic coding notice. Is that "estimated" calculation going to be added as an extra page to the P2 notice itself - so the client and I can readily check it i.e. see the HMRC annual figures arriving at the IYA shown on the P2?

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to rjwaberuk
31st Jul 2017 09:13

Responding to my own post - as, by coincidence, just received an e-mail from HMRC about my own PAYE code! - "Your Income Tax estimate has changed" - "go to the PAYE section of your PTA" - "for security reasons we have not included a link to this e-mail". Signed-in and went through the security checks to arrive at the PAYE section in my PTA - OK, followed the explanations - various pages - and IYA calculation etc. So, for a PTA holder who has signed up for non-paper looks like that individual can see the comp etc digitally .......do I take it therefore that, for everyone else, the P2 will NOT give the calculation to explain the Dynamic IYA? AND for the moment this includes agents.............

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