Caught by the K factor: Vincent Duggleby finds a curious anomaly in the super-efficient new code governing untaxed income

REG MAYES is no tax expert, and when he received his new notice of coding from the Inland Revenue he was baffled by it. Mr Mayes, 69, from Ashstead in Surrey, is a pensioner and one of 700,000 taxpayers allocated the new Inland Revenue 'K' codes.

The idea behind the new code, which takes effect from 6 April, is for tax to be collected under PAYE from people whose untaxed income from pensions, interest or benefits such as a company car adds up to more than their personal tax allowance. In the case of pensioners it will replace the old 'F' code, which caused confusion by quoting rates of tax deduction of anything up to 55 per cent.

There are eight PAYE codes, of which the most common is 'L', which entitles the taxpayer to the single personal allowance ( pounds 3,445), and 'H', which covers the single and married allowance ( pounds 1,720). The corresponding codes for pensioners aged between 65 and 74 are 'P' ( pounds 4,200) and 'V' ( pounds 6,665). The allowances under these four codes can be changed automatically after the Budget without the Revenue having to notify every taxpayer individually.

What the Revenue could not do up to now was collect the extra tax on benefits above the personal allowances from employees under PAYE. For example, a single person with a car and other benefits worth pounds 5,645 and an allowance of pounds 3,445 would have a tax liability on the extra pounds 2,200, but the Revenue could not issue a negative code.

Instead these taxpayers were coded 'OT', meaning that no allowances were available against pay, and they could get a nasty surprise when a bill for pounds 550 or more arrived at the end of the tax year.

The new 'K' code, in this case K219, means that the value of the benefits can be notionally added to pay each month by the employer to determine the extra tax: pounds 2,190 divided by 12 equals pounds 182.50, 25 per cent of which is pounds 45.62.

The main problem for pensioners is that tax is not deducted at source from the basic state pension, and therefore any liability has to be collected as far as possible from the pension paid by former employers.

Mr Mayes has an Electricity Board pension and his code has been calculated from his basic state earnings-related and graduated pensions totalling pounds 3,487, which add up to pounds 42 more than his single personal allowance of pounds 3,445. The resulting K3 code is arrived at by taking the first digit of the excess (4) and subtracting 1. The employer adds a nought (30) and divides by 12, and Mr Mayes will find that a notional pounds 2.50 is added to his monthly Electricity Board pension, and an extra 62p tax will be deducted.

Mr Mayes burst into laughter at this explanation, and he was even more amused to be told that this liability would probably be wiped out by the indexed Budget increase in personal allowances. Unfortunately it is not possible for 'K' codes to be adjusted automatically to allow for Budget changes to personal allowances, as happens with the 'H', 'L', 'P' and 'V' codes. So Mr Mayes will have to wait for an individual amendment.

The Revenue argues that the new system, which can be followed from the notes accompanying the notice of coding, will lead to fewer complaints and misunderstandings by the 100,000 pensioners involved than were raised by the old 'F' codes. This is because the Revenue no longer has to estimate the size of an occupational pension and then enter the percentage rate of tax to be deducted from it.

In Mr Mayes' case it would have been only fractionally above the 25 per cent basic rate, but some pensioners suffered deductions of 40 per cent or 50 per cent and mistakenly thought of themselves as higher rate taxpayers.

In fact, all the Revenue is trying to do is recover tax in the most convenient way possible from income not taxed at source. It involves less guesswork in advance, and it enables employers to make adjustments for pay and pension increases during the year.

(Photograph omitted)