Make allowance for errors in your tax code

Another milestone has been reached in the Inland Revenue's march to become more consumer friendly. New PAYE notices are being sent to millions whose tax is deducted at source under Pay As You Earn.

This includes employees (but not the self-employed) and those receiving a pension from a former employer or from a personal pension plan. The notices tell you how much tax-free pay (or pension) you are entitled to.

Individual tax codes are sent direct by the Inland Revenue to employers and pension providers so that they deduct the right amount. Individual taxpayers may be sent a coding notice, giving a breakdown of how their code has been worked out.

Not everyone on PAYE receives a coding notice: if, for example, you receive only the basic personal allowance and do not pay higher-rate tax, you probably will not be sent one. But if you do, scrutinise it. The forms may now be easier to understand but there is still the problem that your code may be based on incorrect information about your circumstances, in which case you may pay too much tax.

Anecdotal evidence suggests that a good proportion are wrong: one reader from Herefordshire reports a discrepancy of pounds 4,700 on a coding notice which, if not spotted, would have led to a tax overcharge of pounds 1,900. If you reckon your code is wrong, get in touch with your tax office. Your tax code can be adjusted retrospectively.

The coding notices now going out relate to the coming 1997-1998 tax-year beginning on 6 April. Your code will be based on an educated guess about your income and circumstances. On the left-hand side of the notice are your tax allowances, income on which you do not have to pay tax. On the right-hand side are the amounts (other than your basic pay or pension) which need to be taxed and which are taken away from your allowances.

Your tax office deducts the total in the right-hand column from the total in the left-hand column to get a figure for your tax-free income for the coming tax year. The last figure of the tax-free amount is removed to give your code. For many, though not all, this is a three-figure number.

One complicated area is that of allowance restrictions. These are given to taxpayers who are entitled to the married couple's allowance, the additional personal allowance, the widow's bereavement allowance or tax relief for maintenance payments. Unlike other allowances that save you tax at your highest rate, the saving with these allowances is restricted to 15p in the pound. To bring this about, you are given the full allowance in the left-hand column and then have a restriction in the right-hand one.

For those whose highest rate is 20 per cent, the restriction is 457. For basic-rate taxpayers it is 630 and for higher rate taxpayers it is 1,143.

The basic rate of tax is 23 per cent from 6 April. So a basic-rate taxpayer would save 23 per cent of the basic married couple's allowance of pounds 1,830, that is, pounds 420.90, without a restriction.

But the allowance is worth only 15 per cent of pounds 1,830, that is, pounds 274.50. The allowance restriction of 630 reduces the value of the allowance from pounds 1,830 to pounds 1,200. The tax saving on pounds 1,200, at 23 per cent is pounds 276, the correct tax saving, with a little rounding in the taxpayer's favour.

But these standard restrictions do not work for everyone. Those who are 65 or over, and who receive higher age-related allowances, will have higher restrictions.

Another thing to look at closely is benefits-in-kind from your employer such as company cars, luncheon vouchers, subsidised sports club membership, and so on. Has there been a change in your company car? Or will your existing company car become four years old by 5 April 1998? If so, its taxable value will be lower from 6 April 1997.

It is well worth skimming through a booklet called Understanding your tax code, which is sent out with coding notices to see if anything applies to you. Finally, check that your employer is using the code that has been set by your tax office.

KEY TO THE CODING NOTICE

1. Personal allowance. This taxpayer gets the full higher personal allowance for people aged 65 to 74. The extra allowance will be reduced for those whose total income exceeds pounds 15,600. In that case, the coding notice will include an estimate of your likely total income.

2. Married allowance. This taxpayer gets the higher married couple's allowance for those aged 65 to 74.

3. State pensions/state benefits. The state pension and some state benefits are taxable. But they are paid without deduction of tax. The tax code (used here to deduct tax from a pension paid by a former employer) is reduced to collect the tax on the state pension.

4. Allowance restriction. This taxpayer has a top rate of tax of 23 per cent (the basic rate). The restriction ensures that the tax saving on his married couple's allowance is kept to 15p in the pound.

5. Tax underpaid. This taxpayer owes pounds 102.10 from a previous tax year. Bringing another pounds 444 into tax at 23 per cent will collect this.

6. Tax Free Amount. Total allowances (pounds 8,405) less total deductions (pounds 5,154) come to pounds 3251.

7. The tax code. The tax-free amount with the last number lopped off. The letter V indicates that the taxpayer gets full higher allowances for those aged 65 to 74.