Taxman may start chasing the low-paid for underpayments

Even though they are totally unaware of it now, many thousands of people are on course to receive demands for unpaid tax later on this year. Unless politicians intervene to soften the blow, some of these people would be required to start making repayments within a matter of weeks. To make matters worse, those affected will be mainly lower- paid workers, pensioners, students, temps and seasonal staff.

The problem has arisen because HM Revenue & Customs (HMRC) has, over the last year, introduced a new system of holding taxpayers' records. As HMRC explains, it "has one single record for each individual customer containing all their PAYE details". This system, called NPS (National Insurance & PAYE Service), replaces one where records were kept under employer or pension provider and where it was easier for an income source to be missed off an individual's tax liability.

Although it is clearly good news that HMRC is getting better at calculating the right tax bills for individuals, there is the short-term problem of how people should be treated if it emerges that, through no fault of their own, they underpaid in the past. Anita Monteith, technical manager in the tax faculty of the Institute of Chartered Accountants in England and Wales, does not want to see such people chased for repayments they cannot afford. "People who are on PAYE are used to their tax being more or less right and to any errors being corrected the next year," she says.

But it is totally unclear how HMRC and the new Government will proceed on the issue. HMRC has just confirmed to The Independent that it has the technological capability to start running checks to see if people's tax deductions match up correctly with their income sources from employers and pension providers. "The new IT facility for end of year reconciliation automated processing and on-line processing is in place," says HMRC in a statement.

The charity Tax Help for Older People expects the check will be run in August or September. "That is the time that the Revenue will start sending out demands for underpayments," says its chief executive, Paddy Millard. Many of the people who get a notice saying they underpaid in 2009-10 could find that they have been underpaying for previous years. "We don't know how far they are going to go back," says Mr Millard. "In theory, they could go back year after year."

Based on the experience of Tax Help for Older People so far, Mr Millard thinks that nationally "tens of thousands" of people could have potential liabilities for past underpayments. "It is going to be a widespread issue, it is going to affect substantial numbers of people," he says.

In a worst-case analysis, HMRC could start sending out demands for underpaid tax for 2009-10 and 2008-09 from late summer. Sums due for under £2,000 are usually repaid by the tax code system as the codes of individuals affected are reduced in the next year to get back the tax due. But larger sums become payable much quicker in the normal course of events. "The standard arrangement is to ask for payment in 30 days," says Kelly Sizer, technical officer of the charity Low Incomes Tax Reform Group.

Since the start of April HMRC has not been able to give out much information on this situation because its hands are tied when it does not have the usual government ministers in place to make policy decisions. There are some indications, however, that it would be amenable to being lenient if the new Conservative/Liberal Democrat administration allows it to be. In its statement to The Independent, HMRC says: "We are taking a cautious approach to rolling out the automated software for the first time to minimise any teething problems." And when asked how it would deal with taxpayers who had difficulties making repayments, HMRC struck a conciliatory tone: "We would normally include an underpayment in the code for the following year so it is repaid over the year. If this causes genuine difficulties the taxpayer should talk to us and we will do everything we can to help."

Against that, however, is HMRC's rather brutal record in requiring repayments from families which received too much in the way of tax credits. Citizens Advice, for instance, has repeatedly detailed how families who were forced to make tax credit repayments found themselves in "severe hardship as substantially reduced incomes lead to serious debt and threaten families' basic financial security".

These tax underpayment debts could, however, be written off completely. Under what is known as Extra Statutory Concession A19, HMRC can write off sums of tax due which are attributable to official error. The Low Incomes Tax Reform Group, Tax Help for Other People, Institute of Chartered Accountants and other organisations will be pressing for this.

This problem will not touch people who are in the self-assessment system as the fact that they send in a tax return each year means that they and HMRC are checking whether they have paid the right amount in tax. But an understaffed HMRC has for years been unable to handle a growing mountain of files for people on PAYE where the amount of tax they paid did not seem to match what they owed. One tax expert estimates that HMRC has 20 million of such files relating to the period up to April 2008. The new computerised system should, at the click of a mouse, highlight cases where people have underpaid and overpaid after that date. But manual checks would need to be performed to resolve cases before that date.

The biggest reason to hope that HMRC will not seek out underpayments before April 2008 is that it could cost them as much to perform the checks as they would get in repayments. Moreover, a new Lib Dem/ Conservative government may not want to be seen hounding low-paid workers and pensioners for relatively small sums of tax. Even so, the new government ministers will have to take decisions in this area, and it cannot be taken for granted that, with a huge public debt problem, ministers will be sympathetic.

"At the moment we are in the dark as to what they are going to do," says Kelly Sizer. "We are waiting until someone can make some decisions. This will be one issue on quite a long agenda. But it is an important one, and we will be pushing for it to be looked at. We would certainly want to try to find out more in the next month or so."

The change to the new NPS system has also produced a huge number of errors in tax codes this year, paving the way for many people to pay the wrong amount of tax in 2010-11 and, quite possibly, subsequent years. Tax advisers are urging people to check their tax codes and, if necessary, to clarify their position by asking to fill in a tax return. If people leave it unchallenged "they can be paying too much tax for quite some number of years," says Stephen Herring, tax partner at the accountancy firm BDO. One easy check is to compare the tax code and amount of tax that is deducted from income to last year's figures. Since tax allowances have not changed this year, many of us on stable incomes should be seeing only small changes on the amounts that were deducted last year.

For some people, the new NPS system will bring good news, of course. As well as producing underpayments of tax, the old system produced overpayments. People on PAYE who find out they have been overpaying tax can go back six years to get repayments made out in their favour.

Tax blunders: How mistakes happen

The typical underpayment of tax arises when a source of income – such as a part-time or temporary job or a pension – goes untaxed. If the employer or pension provider makes a mistake in processing the paperwork then the income source can simply stay untaxed.

This could happen, for instance, if someone has two low-paid jobs but each employer thinks the employee involved works only for them and so falls within the tax-free personal allowance.

If HM Revenue & Customs never manages to match the two income streams to the same person, they will not find out that the individual should have some tax deduced. Pensioners – who often have various sources of income from a number of pensions and, perhaps, a part-time job – are particularly prone to these mix-ups. People who change jobs often are also more likely to be subject to errors than those in permanent employment.

Case study 1

When Mr X got his tax code this year he found that a blind person's allowance had been included in his coding. This amounts to £1,890 and would have saved him £378 a year (assuming he pays tax at the basic rate of 20 per cent). However, he is not blind and has no problems with his vision. If he did not show HMRC its own mistake, he would build up a tax underpayment.

Paddy Millard, chief executive of Tax Help for Older People, has no idea how this allowance could have worked its way into Mr X's coding. "This just shows that the NPS [National Insurance and PAYE Service] is capable of wondrous things," he says, scratching his head.

Case study 2

Ms Y has been given a tax coding which is £3,000 bigger than the one she was given last year. The code that was sent to her for 2010/11 is 408P (meaning the allowance is £4,089) when the code she had in 2009/10 was 108P (giving an allowance of £1,089).

The change appears to be another of the mistakes thrown out by the new NPS system. A basic rate taxpayer, she needs to challenge it in order not to build up an underpayment of £600 this year.

20 million

Number of files held by HMRC for people on PAYE with a possible tax discrepancy. The Inland Revenue will now have one single record for each taxpayer, which will contain all PAYE details

For more information, contact:

* HM Revenue & Customs; www.hmrc.gov.uk

* Citizens Advice; www.citizensadvice.org.uk