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HMRC internal manual

PAYE Manual

HM Revenue & Customs
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Coding: codes: how they are used and calculated: introduction

A tax code reflects an individual’s allowances and deductions, liability to lower or higher rates of tax and can also take into account any other sources of income he or she may have. Each code sets the level at which the employer must start to deduct tax from pay. In this way we can collect roughly the total tax due from the payments made in a year.

Tax is charged at different rates on bands of taxable income. Under the PAYE system it is the employer’s responsibility to deduct tax from pay and other earnings at the time of payment. To deduct the correct amount of tax due at each rate, the employer needs a set of Tax Tables and a code for each employee.

From 6 April 2016 there will be separate income tax rates for England, Wales & Northern Ireland (known internally as the rest of the UK (rUK)) and Scotland. The total rate for Scottish taxpayers is the amount of income tax a Scottish taxpayer will pay on their non-savings and non-dividend income.

The Scottish rate of income tax will apply where an individual is a resident in the UK for tax purposes but their sole or main place of residence is in Scotland for more of the tax year than in another part of the UK.

Further information is given at PAYE100035

You can use the system to check or amend most tax codes. The system will use the income, allowances, benefits and deductions and indicators held on the individual’s record to work out the code. It can send a notice of the code to the individual (form P2) and the employer (form P6).

Most employees first get a code when they start work. The employer decides this code by following fixed rules. If the employee’s pay is above the limit for tax deduction, the employer should tell you. PAYE Service rules will then decide if the first code used by the employer is correct. Under certain circumstances when a primary employment record is created, an automatic tax code will be calculated and issued according to business rules. See PAYE63030. Where a secondary employment record is automatically created, the PAYE Service will also calculate any unused allowances and allocate them in the correct order, see PAYE11055. If a tax code is wrong you will need to issue an amended code. You will also have to review codes at other times

  • In day to day work, when you know an employee’s circumstances have changed
  • At Annual / Budget Coding, to make any changes needed for the next year, including those arising from the Budget proposals
  • At the automatic National Insurance benefit review

Each time you update an item in the coding, or review a code because of updated information about income you must always

  • Consider information already on the record that is not directly related to the correspondence such as work item notes and Contact History
  • Consider the indicators
  • Consider the knock on effect to other items, for example when reducing or increasing estimated income, estimated pay, higher rate adjustments or other coding items that may be affected
  • Consider using the User Calculation Assistant (UCA) to reduce action time
  • Review the code(s) in operation at any secondary source(s)
  • Review the CY+1 position