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HMRC internal manual

PAYE Manual

Coding: codes: how they are used and calculated: potential underpayments

This subject is presented as follows

Calculation by system
System-calculated code basis altered
Individual is a Jobseeker’s Allowance claimant
Manual calculation of potential underpayment
Manual calculation of In Year Adjustment (IYA) from 31 May 2017

Note: From 6 April 2016 the Scottish Government will be responsible for setting it’s own income tax rates for basic, higher and additional rate bands. Where the Scottish rate of income tax is applicable it will include an S prefix to the tax code. 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.

All taxpayers will pay tax at the same rate on their savings and dividend income, regardless of their residency status, which is currently the savings and dividend rates. Everyone will also get the same Personal Saving Allowance.

Further information on the Scottish rate of income tax is held at PAYE100035.

NPS will use the correct rates of tax based on the individuals Income Tax Residency Status.

Calculation by system

When the system identifies a potential underpayment it takes into account the estimated pay and makes a calculation based on the individual’s highest rate of tax. The system will include a potential underpayment where the individual is liable to tax, if the individual is not liable the system will not calculate a potential underpayment.

In determining a potential underpayment, the system compares the new calculated code with either the last code recorded against a primary employment or, where there is no previous primary employment coding record, then the Start Tax Code recorded on the Employment Details screen. You will not be able to update a potential underpayment. Reconciliation at the end of the year will establish the actual amount of any underpayment.

Example 

The system assumes 10 days pass for codes with suffix T and prefix K and 31 days for cases with suffix L or Y before the new code operates. In this example the code for an individual with Estimated pay of £14,100 (liable at basic rate) is changed from 3756 (code 375T) to 3358 (code 335T) on 25 September.

Net coding allowances before amendment 3756
   
Less  
New net coding allowances 3358
Reduction in allowances 398

 

Reduction in allowances (398) x basic rate 20 per cent = Full year underpayment £79.60.

Full year underpayment x days since 6 April + 10 / 365 days (79.60 x 182 (172 + 10) / 365) = Potential underpayment to date £39.69.

The calculation will be the same for a Scottish taxpayer but the system will use the Scottish tax rates.

From 31 May 2017, when we amend a customer’s code we will carry out a full calculation for the year.  Where extra tax is due the new code will include an In Year Adjustment (IYA) and In Year Adjustment Restriction (IYAR) to collect the extra tax over the remaining weeks or months of the tax year. The tax code will be operated on a week 1 or month 1 basis. This should mean that most of our customers pay the right tax and will not be overpaid or underpaid at the end of the tax year.

From the above date we will not calculate any further Potential Underpayments (PUPs) in tax codes.  We will refer to the extra tax due as an In-Year Adjustment (IYA) and the coding restriction will be described as In-Year Adjustment Restriction (IYAR).

Reconciliation at the end of the year will check whether an individual is balanced, overpaid or underpaid.

Here is an example of how HMRC’s In-Year Calculator (IYC) will calculate the In-Year Adjustment (IYA) and how Dynamic Coding will convert this to an In-Year Restriction (IYR).

Example based on UK Rates of Income Tax

Example for 2017-18 year

Mr John Smith is a company salesman and has estimated pay of £25,000.  On 31 October 2017 John is provided with a company car with a cash value of £5,000 for the 2017-18 year.  This is the first time he has had a company benefit and John tells HMRC using his PTA (Personal Tax Account) on the same day.

1.    An event based trigger has happened by John using his PTA to tell us about his car benefit.

2.    HMRC’s In Year Calculator will look at all John’s RTI data up to this date in the year.  Here’s the information from the FPS (Full Payment Submission) sent in by John’s employer on 31 October 2017:

Pay to Date                 14,583.33

Tax paid to Date           1,573.80

Tax month                     7

Tax code                                1150L

The calculator will first estimate the yearly pay and do a full calculation for the year.  It will then do a tax table check using a new code including the new car benefit.  The result will show whether the customer is on track to pay the right amount of tax, overpaid or underpaid.  In this example the tax due to date including the benefit is £2,157.20.

The In-Year Adjustment is £583.40 (£2,157.20 - £1,573.80).

(This amount has arisen because of the tax due on the car benefit for the first 7 months of the tax year: £5,000 x 20% = £1,000 x 7/12 = £583.33).

Dynamic coding calculates an In-Year Restriction (IYR) in John’s code in an attempt to balance John by the end of the tax year.  This is how the In-Year Restriction (IYR) is calculated:

583.40 x 100/20 = 2917 x 365/157 = 6781 (31/10/2017 to 05/04/2018 = 157 days)

1.    Dynamic Coding will result in a new code for John as follows:

Personal Allowance              11500

Less Car Benefit                    5000

            Less IYR                                  6781

            Net Coding Allowances        -  281 Code K27 (Month 1)

Here is a liability check for the year to show how the correct tax will be paid during the year:           

Pay                                                 25,000

Car Benefit                                    5,000

Total Income                                30,000

Less Personal Allowance           11,500

                                                       18,500 x 20% = £3,700.00 (tax due for year)

Tax paid to month 7:                                                                £1,573.80

Tax on code K27 (Month 1) for months 8 – 12: 5 x £421.31 = £2,106.55

                                                                                                 £3,680.35

The small underpayment has arisen because of daily rounding in the calculation.

In the majority of cases, the whole of the In-Year Adjustment (IYA) will be collected in CY.  Where this is not possible because for example, the amended code would deduct more than the statutory 50% limit, the balance of the IYA will be collected in CY+1.

Whenever an event happens that triggers a coding change, the In-Year Calculator (IYC) will carry out a full calculation for the year.  The IYC will recalculate and replace any existing PUP or In-Year Adjustment (IYA) with a new IYA in an attempt to balance the individual by the end of the year. 

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{#}System-calculated code basis altered

If you alter the basis of a code calculated by the system, for instance, change a Week 1 basis to cumulative or vice versa, prior to 31 May 2017,  the system wouldrecalculate any potential underpayment, from 31 May 2017 the system will recalculate any IYA.

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{#}Individual is a Jobseeker’s Allowance claimant

The system will not calculate any potential underpayment prior to 31 May 2017 or any In Year Adjustments (IYA) from 31 May 2017 where the individual is a Jobseeker’s Allowance claimant.

The Benefit Office will automatically calculate any underpayment arising

  • When the claim ceases
  • Or
  • At 5 April

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{#}Manual calculation of potential underpayment prior to 31 May 2017

If you need to calculate a potential underpayment manually to give an explanation to an individual, follow the example below.

On 5 June the net coding allowances for a basic rate individual changes, from 3756 (Code 375L) to 3358 (Code 335L).

Net coding allowances before amendment 3756
   
Deduct  
Net coding allowances 3358
Excess allowances 398

 

Potential underpayment for full year (398 x 20 per cent) is £79.60.

Proportion from 6 April to date of change of code where Week 1 / Month 1 to be applied is £79.60 x 61 days + 31 days / 365 days = £20.06.

Remember that the system assumes 10 days pass for codes with suffix T and prefix K and 31 days for cases with suffix L or Y before the new code operates.

{#}Manual calculation of In Year Adjustment (IYA) from 31 May 2017

If you need to calculate an In-Year Adjustment (IYA) or In-Year Restriction manually to give an explanation to an individual, follow this example:

On 31 October a customer is provided with a company car with a cash value of £5,000 for the year. 

Our In-Year Calculator will first estimate the yearly pay and do a full calculation for the year.  It will then do a tax table check using a new code including the new car benefit.  In this example, the tax table check will work out the amount based on a change of code from 1150L to 650L at this date in the year.

In this example the amount due is broadly £5,000 x 20% = £1,000 x 7/12 = £583.33.  (The tax table check has the ability to calculate the right tax due where there have been multiple changes).

In-Year Adjustment (IYA) for full year (5000 x 20 per cent) is £1,000

Proportion of year that has elapsed from 6 April to date of change of code where Week 1 / Month 1 to be applied is £1,000 x 7/12 months = £583.33