PAYE and Making Tax Digital

HMRC’s Making Tax Digital project is about to make inroads into the PAYE system. Employers will see an increase in the number of tax codes being issued during the tax year. Hopefully that will turn out to be a good thing for employees but only time will tell.

PAYE started to operate from 6 April 1944 as a means of spreading an employee’s tax liabilities over the tax year and allowing the amount of tax deducted to vary with variations in weekly or monthly employment income. The tax code was the means by which tax allowances were spread over the course of the year. The system worked well for many years in an era when many employees only had one job and did not frequently change jobs.

The system has however been creaking for some time. Employees may have more than one job, or receive a pension whilst still working. In addition the reductions in the tax free allowance code to estimate taxation of benefits and non-employment income, give rise to many employees paying the wrong amount of tax by the end of each tax year. PAYE now applies to around 41 million individuals – around eight million end the year having either over or underpaid tax. Two thirds of these employees overpay tax and many of these are the lowest paid, earning under £15,000 a year.

What is changing?

The use of the Real Time Information system by employers means HMRC receive employee data much earlier than formerly. According to HMRC:

  • Millions (of taxpayers) will pay less tax on a monthly basis by the end of the tax year because we will catch any overpayments sooner and prevent them from building up.
  • A smaller number, who previously would have had an unexpected bill at the end of the year, will pay the right tax from the moment their circumstances change, so they will be able to manage their tax payments better.

Does an employee have to do anything?

No, not in the short term. When HMRC is aware of a change in an individual’s circumstances, it will issue a new tax code and will write to the employee regarding the change.

If employees don’t understand the change, the letter from HMRC will encourage them to use their Personal Tax Account. This is where the Making Tax Digital project comes in. Personal Tax Accounts have been linked to HMRC internal systems so that they will be pre-populated with income and tax details that HMRC already hold. This includes employment income, PAYE and NIC and any state retirement pension.

From April 2018, it is intended that interest paid by banks and building societies will be included in digital tax accounts. In order for this to happen, banks and building societies will be required to provide information to HMRC earlier, and more frequently, than currently. Taxpayers will also be able to report any additional sources of income through their digital tax accounts in 2018.

Does an employer have to do anything?

Employers will see an increase in the number of tax codes being issued during the tax year but the way they are received does not change. The revised tax codes need to be applied before the next payroll is run. There is a brief employer information pack available at: https://goo.gl/P74Gyt.

The pack includes an employee section and, if you are an employer, you can direct employees to this guide. It explains to an employee the benefits of using their Personal Tax Account and how to access it.