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People across the UK could have been forgiven if they woke up this morning with mixed feelings towards their postman. For some, the news would be good but for others, the news would be horrendous. In the middle of one the deepest recessions for a generation, with jobless figures stuck at around 2 million, with government cuts threatening to make matters worse and with all but the wealthiest families being squeezed, HMRC have announced that 1.4 million PAYE workers have underpaid £2 billion. The first demands landed on taxpayers' doorsteps this morning.

So what went wrong?

Well, as we've reported here previously, over the last few years HMRC have been implementing a centralised system for PAYE and NIC records. When the records were originally set-up (over 60 years ago), most taxpayers worked one job and tended to remain in that job for many years; it was after all the era of a job for life. The result was that records were built up around employers and maintained in 12 regional centres. In recent times of course, taxpayers have tended to move jobs often and many now work more than one job at a time. The record system needed to be overhauled and rebuilt around the taxpayer rather than the employing company.

The problems with the new system implementation have been well documented, most recently by the National Audit Office (NAO) report on HMRC (see our earlier blog entry of the same name). The NAO also documented the fact that for the tax year 2008/09 the new system delays deferred the year end reconciliation of PAYE records. Had everything been running on time and as expected, these reconciliations would have been completed by October 2009 in time for any identified under/overpayments to be reflected in the coding notices** issued for the 2010/11 tax year. As the NAO reported:

To avoid breaching its 12.5 million capacity limit, the seven million potential over and underpayment items relating to the 08-09 end of year processing were removed from the Department’s new work management system. It now plans to begin the reconciliation of 2008-09 over and underpayments in August 2010.

The cock has now crowed and HMRC are reconciling the 2008/09 and 2009/10 records. We understand that the new IT system is much more efficient at identifying issues and with two years worth of under and over payments to deal with, the results are not pretty: 4.1 million PAYE taxpayers are due back £1.8 billion and 1.4 million owe £2 billion.

Is there another shoe to drop?

Well, actually there is. The NAO report included the following extraordinary statement:

“One consequence ...... the Department did not have the system capability to work the backlog of {18.2 million} un-reconciled cases from previous tax years.”

And these 18.2 million cases do not include the 7 million cases from 2008/09 and 2009/10. No; the 18.2 million cases predate 2008/09 and affect 15 million people. The NAO stated:

"Early analysis suggests it could in aggregate lead to tax repayments and recoveries of £3.0 billion and £1.4 billion respectively.

So in total, the amounts at stake are estimated as follows:

  • Overpaid (due to be refunded) 2008/09:  £1.8 billion - 4.1 million taxpayers
  • Overpaid (due to be refunded) 2007/08 and before: £3.0 billion - Unknown
  • Underpaid (due to be collected) 2008/09: £2.0 billion - 1.4 million taxpayers
  • Underpaid (due to be collected) 2007/08 and before: £1.4 billion - Unknown

Any more surprises?

Unfortunately yes. When HMRC used the new system to issue the coding notices for 2010/11 in early January this year they found that:

"A significant number of the codes generated were incorrect.... The Department was not fully aware of the extent and nature of the errors in coding notices until it started to receive more calls to its contact centre"

So basically, there are taxpayers all across the country whose employers are using incorrect coding notices. Without a shadow of a doubt taxpayers are going to be confronted with another spate of over/underpayments when HMRC reconciles 2010/11 after the tax year end.

Where to from here?

There is little doubt that HMRC is under more pressure now than it has been at any stage since the Revenue was merged with Customs about 5 years ago. By all accounts moral is at an all time low and there is no shortage of former employees who speak of "muddled reporting lines" and waves of management initiatives over taking each other. All of this we must remember is set against a backdrop of years of Labour cost cutting and "efficiency drives". Indeed, "efficiency" is so high that the NAO reported that 44 million calls to HMRC went unanswered during 2008/09 (that's almost half).

It is nothing but an unmitigated shame that the Inland Revenue, once a proud and pragmatic institution, has been hobbled by an unnecessary merger, consistent under investment and perhaps the most complex tax code in the world. Of course, that'll be of little solace or consequence to those who opened tax demands over their cornflakes this morning.

** Coding notices are issued to employers each year to inform them of how much tax to deduct from a taxpayer's salary via PAYE. Any identified under/over payments identified for a tax year are then normally collected via changes to the following years' coding notices. So for example, a 2008/09 under payment would be collected through 2010/11 PAYE, a 2009/10 underpayment would be collected via 2011/12 PAYE and so on.