Cracking the code

HMRC launched ‘dynamic coding’ in July 2017 and its impact will be felt even more as they issue tax codes for the new tax year, what is there to look out for?

The ‘dynamic’ in the title refers to using more data sources in-year to try to ensure PAYE does the best possible job to take the right amount of tax within the tax year. HMRC change their estimate of what will be earned (so called estimated pay) when the taxpayer tells them about changes in income or they receive information about benefits in kind. When estimated pay changes, so does the tax code if that’s what’s needed to collect the right tax in-year, although they won’t action in-year changes from January to March each year as there are too few months left to collect a whole year’s tax, so they’ll roll an underpayment forward to 2018/19 as had been the case before dynamic coding.

We therefore must encourage employees to activate their personal tax account (PTA), so they can check if their estimated pay is accurate. It won’t be if any income sources, allowances or benefits in kind aren’t correct. There is still the assumption by the vast majority of the UK’s 40m taxpayers that the code issued by HMRC is always correct and the employer will receive that combination of letters and numbers and hey presto all will be well by 5th April each year. Of course, the large number of P800s each year – 2m underpaid, 4.7m overpaid for 2016/17, are testament to the fact the PAYE can’t always get it right given the complexities of the labour market today with multiple income sources, and a myriad of allowances and reliefs to apportion.

There is also the misguided belief that employers can sort out or even explain why a code has been conceived and allocated – they can’t, and equally they aren’t unpaid accountants for those 40m taxpayers. If your financial affairs are complex and you need advice to ensure you understand what the appropriate amount of tax for your circumstances is, then you need an accountant, just as you don’t service your own car if you’re not a trained car mechanic!

Employers will often say to me ‘but why do we need to cascade information about the PTA, after all we are just the employer and our role is to act on HMRC instructions’.  However, if the employee only finds out about an incorrect code when they open their payslip they will almost certainly blame the employer and want support to sort things out. Cascading information about dynamic coding will ensure that employees take ownership for what HMRC have done with the data that they, or the employer, has provided and correct it when central government systems have misinterpreted it.

Sadly, there are some wrinkles in dynamic coding as you’d expect with any new system that can lead HMRC to make incorrect assumptions. For example, if 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, HMRC try to collect all the tax on the new benefit in the months left before the end of tax year and assume the spike is a permanent salary increase and extrapolate this as the new earnings until the end of the year. If employees know this can happen and employers remind them to check their PTA at the appropriate time the estimated pay can be reduced to the appropriate value.

This is crucial at the moment because HMRC use the estimated pay, benefits and reliefs shown on the PTA as at the middle of January to inform the code for 2018/19. As codes begin to be issued to employees and employers for the new tax year it’s even more important that individuals look out for the very obvious coding oddities:

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