Taxman's error...

Hundreds of thousands of people who work or who get a pension from an employer may have paid the wrong amount of tax due to an error by the Inland Revenue. The mistake highlights how important it is for anyone who works or draws a company pension to check the amount of tax that has been automatically deducted from their pay or pension during the tax year.

In November tax officials admitted that they had been deleting the records of pay and pensions before doing final checks on whether the correct amount of tax had been deducted. A full enquiry is now under way. But Saga Magazine has learned that the people affected worked in the tax year 2002/03 or earlier; gave up their job during a tax year; and did not restart work or draw a pension before the end of that tax year. For example, a man who stopped work in July 2000 at the age of 64 and then claimed his state and company pensions when he reached 65 in the following May would have automatically paid too much tax in 2000/01. Similarly, a woman who stopped work aged 54 in November 2001 and still has not returned to work would have paid too much tax in 2001/02 and may not have had it paid back to her. If the local office did not spot these overpayments, then the tax will not have been refunded.

The error came to light during a routine examination of the Inland Revenue accounts by the National Audit Office – the financial inspectors who make sure that the Government gets good value for money for the tax we pay. In its latest report the NAO revealed that the Inland Revenue ‘became aware’ late in 2003 that it had been routinely deleting taxpayer records ‘for a number of years’ before doing the final checks which are intended to ensure that no under or over-payment of tax had occurred in the tax year. The result is that people in those tax years who stopped work but did not start again or draw a company pension until a later tax year may well have paid too much tax.

PAYE
The problem is caused by the way tax is deducted from your wages or a pension paid by a previous employer. It is called PAYE or Pay As You Earn and the tax is taken straight off your pay or pension before you see it. As long as the right amount of tax is deducted it suits both sides. We do not have to pay a hefty tax bill at the end of the tax year. And the Government gets the tax it is owed automatically in a steady stream throughout the year. The trouble is there are many circumstances when the amount of tax that is collected is wrong because although PAYE is an excellent way of collecting tax, it is not a way of assessing it and is always approximate.

To make sure the right amount of tax was collected the Inland Revenue used to have a two stage process. At the end of every tax year the local tax office that deals with each individual checked to see if the amount deducted under PAYE seemed right. Then the records were checked again at a central PAYE office. But at some point in the past that second check was abandoned, apparently as part of an update in the computer system. If the taxpayer stopped paying tax through PAYE, instead of making a check, the Inland Revenue deleted the record.

The Inland Revenue covered up the error for nine months only revealing it to the NAO in July 2004. The information became public in October when its report was presented to a powerful group of MPs – the Public Accounts Committee. They have now demanded a full enquiry. It will be some time before that is finished and longer still until it is published. Meanwhile the Inland Revenue is refusing to reveal any other details to the press or public.

Check your tax
Everyone should check that the tax they have paid through PAYE is correct because, quite apart from this latest revelation, mistakes are common. The system works well when income remains constant throughout the whole tax year and when there is no untaxed income from other sources. But PAYE does not deduct tax accurately in other circumstances. Among the things that can make the calculation wrong are starting or leaving a job, moving from work to a pension, getting a married couple’s allowance, having income which is paid without tax being deducted – such as a state pension or interest on some National Savings income bonds – and which changes during the tax year, or reaching 65 or 75.

So how does this strange system work? Each year we are allowed a certain amount of money before tax is due. For someone aged under 65 that amount is £4745 in 2004/05 and normally £6830 if you are aged 65 and £6950 once you reach 75 (however these higher allowances are reduced if your annual income exceeds £18,900). The allowance is for the whole tax year but of course our pay or pension is paid each month or week. The PAYE system divides that allowance up so you get a twelfth of that allowance off their monthly pay or company pension. In other words if you are under 65 the first £395.41 a month is free of tax and the rest is taxed. By the end of the tax year £4745 of income will have been paid free of tax. But the system breaks down if someone leaves work before the end of the tax year. Their income stops, but they will only have been allowed part of their tax free allowance.

For example, Mary Smith stopped work in October and then does not return to work that tax year. She will only have been paid for six months in the tax year and has been allowed to keep 6 x £395.41 = £2372.50 of the money she has earned tax free. The rest will have been taxed. But she should have had £4745 of her money free of tax. So the taxman will owe her the tax wrongly paid on another £2372.50 which at the basic rate is just over £521. Normally the tax office would send her that money. Or, if she started worked again or drew her pension, it would adjust the tax taken off that. But mistakes are made and, now that the old records have been wiped, she may not get it unless she asks.

Employers and pension providers are told how much tax to deduct by your ‘tax code’. This is normally three numbers and a letter such as 474L. The numbers are the amount of tax –free income you are allowed each year divided by ten. So if your allowance is 4745 it is ‘474’. The ‘L’ applies to almost everyone under 65. Over that age you might have a P or a Y.

If you get a state pension then the amount you get is taxable but it is paid without tax being deducted. So the amount of tax-free income you can have on top of your pension is limited. For example, someone aged 67 has a tax-free allowance of £6830. If their state pension is £92 a week or £4784 a year that uses up a lot of the money they are allowed to have tax-free. It leaves just £2046 and the tax code will be 204P. The ‘P’ simply means you get the higher allowance for someone over 65.

Problems
Some married men still get the married couples allowance which is in fact a straight £560 off his tax bill. The way this affects the tax code is complex and anyone who gets this allowance should check that the right amount of tax has been deducted during the year. To qualify for the allowance, at least one of the spouses must have been born before 6 April 1935. It is normally given to the man though it can be shared.

If you have significant income that is paid to you without tax being deducted, such as interest on some products from National Savings & Investments, then PAYE works as long as that income does not change during the tax year. But if it does – for example your income bonds come to an end and you put your money in something else – then the wrong amount of tax will be deducted.

So if you are taxed through PAYE it is important at the end of every tax year to check that the amount deducted has been correct, especially now that the Inland Revenue has wiped so many computer records. Checking your tax can be difficult. Your local tax enquiry office will help if you feel the tax that has been deducted is wrong.

More information: Understanding Your Tax Code P3 (2004) is available from Inland Revenue Enquiry Centres, online or by phone 08459 000 404 Check Your Tax is also available online from Help the Aged.

January 2005

e-mail Paul Lewis on paul@paullewis.co.uk