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KEY POINTS
- Much media comment has been incorrect.
- There are a further 18 million cases to reconcile from years before 2008/09.
- How to change taxpayer perceptions that PAYE will always calculate the correct liability.
- The application of ESC A19.
The mainstream media havs got a lot wrong in its reporting of the recent PAYE fracas. It is not evidence that the new National Payment System (NPS) computer is a failure; rather it is evidence, as the under and over-payments are discovered, that the previous system of twelve separate regional computers was no longer fit for purpose.
There is nothing new about carrying out reconciliations, they have always been part of PAYE; the key issue here is that the reconciliation for 2008/09 was not carried out because it was considered more important to get NPS up and running.
Don’t care, won’t care
However, there is one area where the media has got it absolutely right, and HMRC have got it wrong. Paradoxically, it is an example of how good our PAYE system is in international terms: ‘the envy of the world’, as Dave Hartnett described it to the Treasury Select Committee last week.
It is summed up in this fragment of an exchange between Andrea Leadsom MP and Dame Lesley Strathie, HMRC’s CEO, at the same select committee hearing (according to the uncorrected transcript of the oral evidence):
‘Andrea Leadsom: What percentage of people, according to your forecast, have themselves made an error leading to this end-of-year reconciliation, and what percentage are errors due to record keeping and so on at HMRC? What percentage is the customer’s fault?
'Dame Lesley Strathie: The short answer again is that we don’t know because you have to make an assumption that everyone understands the tax that they ought to pay.’
That may be the correct answer under self assessment, but it is not how the public understands it. Unlike, say, the Americans, most UK employees simply do not expect to have much to do with the tax system at all. They know they have a code number, but they don’t really understand how it works, despite being sent guidance notes.
More to the point, they don’t expect to have to understand how it works; they expect their tax to be sorted out between HMRC and their employer’s payroll department.
With the reduction in the number of allowances that can be claimed, employees are no longer contacting HMRC to claim allowances for children or interest payments, which only reinforces their view that our PAYE system gets everyone’s tax right automatically. The fact that it doesn’t always do so throws up two major issues.
Worse to come
Although an updated computer system should reduce the number of problems, and should certainly mean in future that they are identified within a few months of the tax year end, there are still going to be significant numbers of reconciliations in the future.
Now that the issue of reconciliations has hit the headlines, it is going to continue to do so each year, particularly since the reconciliations are likely to be done in the summer and early autumn, which is often a slow time for news.
HMRC can therefore expect ‘PAYE gets it wrong again’ stories for some years to come. There are several ways this could be dealt with, but none of them looks as if it is entirely promising.
The first is simply that once NPS is fully working, with a clean database, it should have a single record for each taxpayer. That should mean that some of the more obvious errors will be avoided – giving personal allowances in both codes for an employer with two sources of income, for example.
To be set against that is the worrying statistic also highlighted in the evidence to the Treasury Select Committee (although it is not new information) that in addition to the six million cases to be dealt with before the end of this year, which relate to 2008/09 and 2009/10, there are a further 18 million cases requiring reconciliation from previous years which were identified as the old systems were closed down and the data transferred to the NPS.
Not all of them will result in either an under- or over-payment, but many of them will. HMRC’s ambition is to deal with them by the end of 2012, during which period they will also presumably handle the reconciliation of 2010/11 and 2011/12 PAYE cases.
So it is going to get a lot worse before it gets better. It was reassuring to see the Treasury Select Committee members beginning to seriously probe the effect of staff cuts on the department’s ability to handle this.
Managing expectations
So if there is going to be an ongoing problem, albeit possibly a smaller one after the end of 2012, what can be done to deal with the mismatch between this reality and the taxpayer’s expectation that he or she does not have to worry about tax because their employer and HMRC will sort it out between them?
The obvious answer, raised by Lesley Strathie, is to educate taxpayers more, but I am not convinced that taxpayers can be cajoled into taking a greater interest by education alone.
Another alternative is to require them to take greater responsibility, by some form of universal filing. It is possible that the NPS could be the basis for a comparatively painless way of introducing this, since the existence of a single customer record should mean that the NPS computer could populate a return with all the data it holds and then just ask the taxpayer to add in anything else and confirm its accuracy.
Taxpayers might not want to have to take that level of responsibility, but it would at least be a clear redrawing of the purpose of PAYE as a first step in the process of tax collection, not a final determination of liability.
Then there is the knee-jerk solution put forward by the so-called TaxPayers’ Alliance (I’m a taxpayer, and they certainly don’t represent me), which said the answer was to simplify the tax system.
The problem does not arise from legislative complexity, it arises from people having two jobs, or starting to receive a taxable benefit from their employer. The now largely discredited flat-rate system, put forward as a model of simplicity, would have exactly the same problems of PAYE reconciliation.
Finally there is the answer proposed by the latest consultation on PAYE, which is unfortunately going to be overshadowed by the current fracas: a greater degree of real-time reporting by employers.
The Government seems already to be back-tracking on the more extreme version of the plan, which would have HMRC acting as the country’s payroll department, receiving the gross pay and paying out the net to every employee.
However, the more moderate version which would ensure that the PAYE system knew month by month exactly which employee had received what pay, and how much tax had been deducted, seems to have a lot more merit, and could solve many of the problems.
ESC A19
I said the exchange I reported at the start of this article threw up two major issues. So far I have discussed the problem that taxpayers do not expect to have to understand the tax system.
The remaining issue is that, as evidenced by Lesley Strathie’s reply, HMRC expect them to understand it; which brings us to the very practical question of whether the demands currently being made should be written off under ESC A19.
The terms of the concession are that the failure to make ‘proper and timely use’ of information from a taxpayer, employer or the DWP (about a state pension) should result in HMRC not collecting the arrears.
The conditions are normally that the taxpayer could reasonably have believed that his or her tax affairs were in order, and was notified of the arrears more than twelve months after the end of the tax year in which HMRC received the information indicating that more tax was due.
There is a further part to the concession, which gives up tax notified within twelve months from the end of the tax year if HMRC:
- ‘failed more than once to make proper use of the facts they had been given about one source of income
- ‘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’.
HMRC accept that ‘one source of income’ is too restrictive, and in the guidance quoted in Taxation last week, they break the first bullet point into two, and refer to ‘the same relief, deduction or allowance’.
It also appears they accept the two bullet points above are alternatives, even though some references in the manuals suggest they both need to be met before the concession will apply (see for example PAYE95070).
However, this still leaves the requirement that A19 can only apply when the taxpayer ‘could reasonably have believed that his or her tax affairs were in order’.
Which brings us back to where we started. According to Lesley Strathie, ‘You have to make an assumption that everyone understands the tax that they ought to pay’.
HMRC’s own manual, at PAYE95081, suggests for example that while an incorrect code issued by HMRC might be grounds for A19 to apply, ‘an incorrect code may continue without change beyond the point where it is reasonable for a taxpayer to believe that their tax affairs are in order’, and that if an employee moves from one job to another with a roughly equivalent level of salary but pays significantly less tax, he should have questioned why.
Really? I have talked to perfectly intelligent people who did not understand that higher rate tax was only paid on the excess over the higher-rate threshold, rather than on their whole income.
HMRC are a victim of their own success with PAYE; when the system has in the past seemed to operate without the need for taxpayer involvement, it is unreasonable to then turn round and tell those same taxpayers that they should still have been keeping a watchful eye on it.
