Why we will have at least 3 years of 50p tax

As some politicians continue to talk about 'scrapping the 50p rate', I thought I'd add a postscript to my earlier pieces where I explained why the 50p rate is "not really raking in huge sums" YET.

Despite being announced in Budget 2009, the 50% top rate tax was first charged in the tax year 2010/11. Many people will not be paying the extra tax arising from the 50p rate until 31 January 2012. It is only after that date that anyone will be able to determine how much tax has been raised at 50%.

The 50% rate has also applied during the current tax year which ends on 5 April 2012. The 2012 Budget will need to be planned and will be announced before that date. These days it is almost impossible to introduce changes to the rates of income tax that take immediate effect. So even if the Chancellor decides to abolish the 50% rate (or reduce it to 45%) this will almost certainly not take effect until 6 April 2013. By which time the 50% rate will have been in operation for 3 tax years.

HMRC gets enough grief for the way the PAYE tax system operates without the extra challenge of trying to manage the impact of last minute changes to tax rates. This is why the 50% rate did not take effect immediately it was announced. Abolition will also be delayed a year so that HMRC's systems can be suitably modified.

HMRC are not the ones making the PAYE 'errors'

Here we go again. Today the papers are again full of stories alleging errors made by HMRC related to the tax paid through the PAYE system.

It's only 9 months since the last series of stories started along similar lines. Then, as I explained here, it was the first time HMRC had been able to reconcile their figures for some time. They were using a new computer system. Things are settling down and they have now reconciled the figures for 2009/10 - Not that any of the news reports explain this important point.

HMRC can only reconcile information that they have in their records. This includes tax returns and the last ones filed were for the 2009/10 tax year that ended on 5 April 2010. It is quite an achievement for HMRC to have completed their reconciliations within less than 6 months of the filing deadline for those tax returns (31 January 2011). It's never been done that fast before.

Journalists like to suggest that HMRC are incompetent. Sometimes they are. But it's the PAYE tax system that needs to change and HMRC are working on this. With the system as it stands there will ALAWYS be a need for annual reconciliations and there will ALWAYS be some people who have overpaid and some who have underpaid tax through PAYE.

As I have explained previously the PAYE system cannot be relied upon to ensure that the right amount of tax is deducted from earnings and pensions across the year. And HMRC know this. That's why they are keen to introduce 'Real Time Information' (RTI) reporting. It won't solve all the problems with the system but it would reduce the number of reconciliations required each year. It's going to be tested next year with the intention of introducing it in 2014. It would be a mistake to rush it or to add to the burdens of small employers by obliging them to report RTI. As it stands the intention is to only make this compulsory for larger employers.

So we will continue to have PAYE reconciliations each year - but hopefully these will affect fewer numbers of people each year. And yes, some HMRC staff will make some mistakes too. But the main problem is the PAYE system. As one tax official told me recently: It would be fine if taxpayers only ever had one job or pension at a time, only ever changed jobs at midnight on 5 April and never had any taxable benefits in kind. That, I do not think is ever going to happen!

50% tax rate announced in Budget 2009 but 2 years on and the self employed haven't paid it yet

For all the fuss about the impact of a new top rate of 50% income tax, no self employed person earning above the £150,000 threshold has yet paid tax at 50%. They need not have taken action to reduce their tax bills. It's just the way the tax system works.

Let me explain:

The new 50% rate was introduced by Alastair Darling in his 2009 Budget speech. As happens all the time now, the tax change did not take immediate effect. The first year’s taxable income to be affected was that for 2010/11 – the tax year that started on 6 April 2010 and ended on 5 April 2011.

The self employed and those living off rental or investment income pay their income tax in 3 instalments each year. When their tax liability increases it is only the final instalment that rises to reflect this. And for 2010/11 this tax will not be payable until 31 January 2012.

What about employees who pay tax through the PAYE system? Some of them also have yet to pay 50% tax. The Budget announcement in 2009 gave HMRC just a few months to establish systems to adapt PAYE codes. They were unable to do this for PAYE codes that employers used in 2010/11 where the individual had two or more employments. Instead HMRC added a note to their website for employees with income above £150,000:

"HMRC will work out how much tax you are actually due to pay when you send in your 2010-11 Self Assessment tax return. This may mean you'll owe some extra tax."

What does this mean?

I think it means that any research into the impact of the 50% rate would be premature. Some wealthy taxpayers may have taken steps to reduce their liability to tax at 50%. Beyond that the majority may well be thinking that it hasn't had much impact on them (yet). And that's because, despite being announced in April 2009, only high earning employees with just one job have so far paid any tax at 50%.

There is also every chance of a further uproar when unrepresented high earning employees file their tax returns and find that they owe thousands of pounds in tax. Someone earning £250,000 across two jobs for example might owe £10,000 despite paying tax through the PAYE system on both employments.

Tax tease: Inaccurate Footie Tax story resurrected as 'news'

The headline in today's Sunday Times is "Top footballers dodge millions in income tax". And that "Rooney pays 2% on some earnings." Other footballers are then mentioned too.

The report seems to simply confirm the predictions of a very similar story the Times published in May 2009.

Football stars plan to dodge 50p tax rate
Scheme being considered by Manchester United, Arsenal and Liverpool means players can get salaries as interest-free loans

The Press Association are reporting the 'new' story as leading to a "Crackdown on top rate tax loophole". As the Sunday Times report though HMRC have been trying to do this for years.

The footballers are using two tax avoidance schemes. One involves their clubs paying large chunks of their earnings as 'image rights' rather than as employment income. The other scheme involves the footballers taking loans rather than salaries or dividends from companies they own. I need to debunk a key element of this part of the story to make clear that it's not as effective as the press reports suggest.

For the avoidance of doubt I'm no fan of this tax avoidance. Regular readers of the TaxBuzz blog may recall I mentioned this in the context of the 7th of my '8 fallacies that undermine the UKuncut tax protests' last month.

Debunking

When someone, a footballer or otherwise, takes a loan from their company they initially pay very little income tax. Instead of being taxed on the full amount they only pay tax on the interest they should have been charged.

In 2009 the Times suggested the tax would be as little as 2.5%. It now seems to be just 2%. The reports miss the key point though that this tax is paid every year for as long as the loan lasts. So the longer the loan lasts the more tax is paid. If the loan lasts for ten years and interest rates rise the total tax paid could end up being more than the tax they hoped to avoid.

Eventually the company will at some stage have to pay salaries or dividends to the footballer to clear the loans. This income will be taxed at the top rate - in addition to the tax already paid on the 'beneficial loans'.

I mention all this to help discourage anyone from thinking that it's always tax effective to take loans rather than salaries or dividends from their company. It seems to be attractive for footballers as long as they do NOT own the company and as long as they will leave the UK permanently before the loans need to be repaid.

When your own company lends you money the company is required to (effectively) also lend money to HMRC. This reduces the cash available in the company. And this loan to the taxman is only repaid when the loan to which it relates is repaid.

Most people trying to copy the footie players' tax avoidance scheme will also have to pay a fortune to close down their companies using complex (and expensive) schemes without paying back the loans. When that happens they will still face years of sustained challenges from HMRC who will argue that the loans were a sham and subject to tax as earnings.

Can't say I have any sympathy for the footballers though.

Tax troubles: Seems there really has been a PAYE mess up after all

Seems there has been a real glitch in the PAYE system after all - at least in so far as it relates to the taxation of pensioners who have secondary pensions in addition to the state pension.

When the PAYE debacle became apparent over the summer I wrote a piece: The PAYE tax system is now working as it should...

I stand by the explanation I gave and continue to deplore the ill-informed and sensationalist reports in the media.

However, NOW it seems that there has been a real and widespread error on the part of HMRC. The reports I have seen so far seem to simply see it as more of the same. In fact it's much more fundamental.

The latest PAYE failing is an announcement that during 2008-9 and 2009-10 state pension income was omitted from the tax codes issued to 250,000 pensioners with second pensions or other earned income. The state pension is taxable; the tax due is normally collected through the tax code used to calculate the net income from their second pension. Where insufficient tax has been paid in such cases, the Government has announced that pensioners will not be asked to pay up.

This error may well be a symptom of the staff cutbacks imposed on HMRC by the previous Government. To reduce the burden on the remaining staff, HMRC started to write to taxpayers on PAYE saying that they need no longer file tax returns. This was welcomed by those who saw it as a chore. Accountants anticipated that it would mean that some taxpayers would miss out on tax repayments as no one would be checking whether they had under or over paid tax. What also seems to have happened is that someone somewhere in HMRC didn't programme the computer to include the state pension in PAYE codes for pensioners who no longer filed tax returns. Whoops!

Many people may have paid the wrong tax - why is that?

This is another post by reference to last night's Panorama - "Tax: Are you one of the six million?"

This rather confused TV programme suggested that as many as 1 in 3 people could have paid the wrong tax. Given the wide definitions used for 'wrong' this will come as no surprise to accountants and tax advisers.

Various contributors to the report suggested what needs to be done:

1. "There has to be a better way of paying tax"
2. "Too many staff cuts, too fast"
3. "Sack those at the top of HMRC"

Without going into great detail let's be clear:

1. The tax system is complex due, in part, to needless complications introduced by Gordon Brown who ignored advice from tax experts.
2. Many of those complications result in people paying too little or too much (ie: the 'wrong') tax.
3. The PAYE system worked fine when people typically only had one job or one pension.
4. A necessary annual reconciliation of PAYE records hasn't been possible for years. Having recognised this, HMRC commissioned a new computer system that would allow them to consolidate the tax records of all PAYE taxpayers - previously spread across a number of old systems.
5. The Coalition Government seems to genuinely want to find ways to simplify the tax system. This Chancellor will not be looking for ways to grandstand twice a year as did Mr Brown when he introduced and then defended poorly thought through tax changes. Many of these led to the complexities we have today.
6. The people at the top of HMRC may not be perfect but until recently their hands were tied by the previous Government and the staff cuts that were imposed on them in recent years. Dave Hartnett, for example, has never struck me as complacent or as being satisfied with the poor standards exhibited by some of his staff. On the contrary.
7. HMRC's staff cuts are not self imposed. They are a direct result of imposed severe staffing reductions imposed by the last Labour Government. To the extent that future staffing cuts occur the Coalition Government will be to blame.
8. The PAYE system will only rarely get anyone's tax right through in year tax deductions from salaries or pensions. This will generally only happen where someone has only one source of earned income each year, no benefits in kind and no investment or other income.

What struck me most though was the way that contributors to the programme, including Labour MP John Mann from the Treasury Select Committee, were so quick to blame HMRC for a failing tax system and for the staff cuts. Mr Mann in particular should know better.

I totally accept that HMRC screw up sometimes. But the basic PAYE system is not their fault. Nor are the staff cuts. The new computer system should avoid a recurrence of the PAYE debacle we saw this year - that was caused in part by the move onto the new system.

That the tax system needs to be simplified is in no doubt and I welcome the Government's reviews that are a small step in the right direction. As to how did we get here? I place the blame on Gordon Brown and, by definition, the Labour Party - and have done for many years. Indeed "An increasing degree of frustration with developments in tax legislation" was one of the key factors that led to me giving up tax advice myself after a 25 year career as a tax adviser.

It's "Pay As You Like" - if you're wealthy, says Panorama

This is the view of a so-called HMRC 'whistleblower' who investigates taxpayers with a net worth of over £20m. It was broadcast as part of last night's Panorama programme that started as a piece about the millions of PAYE demands in the press recently. It moved off target every now and then.

The 'whistleblower' claimed:

"We used to have dedicated teams that would tackle the top 40,000 taxpayers but as a result of rationalisation and a drive for efficiency they've now shed that down to 5,000 - so now we're only looking at the top 5,000."

"I would say we've lost the war... It's become Pay As You Like"

The programme then showed a message from HMRC which said there has been:

"no reduction in resources focused on the tax affairs of wealthy people"

and that HMRC will have £900m more for targeting [tax] evasion and fraud.

Who do you believe?

(Panorama's "Tax: Are you one of the 6 million?" is available on BBC iplayer until 15 November)

The PAYE tax system is now working as it should...

I was invited to appear on BBC 3 Counties radio twice yesterday to explain some of the facts behind the big PAYE tax news story. Sadly I could not get phone reception at either of the appropriate times but here are extracts from the notes I made in preparation for the interviews. I would never have been able to cover all of these points of course:

• No - this is not a deliberate attempt by HMRC to sting taxpayers as part of a 'let's collect as much money as we can' approach [A suggestion put to me by the researcher who had called]. More people are due refunds than appear to owe money to the taxman anyway.

• The new PAYE computer system has brought these errors to light. There have always been unders and overs as the PAYE system isn't perfect. This year we know about them all and the new system makes it more likely they will be resolved faster than in previous years. So in some ways its a good news story. HMRC changing their systems to try to get things less wrong than in the past!
  

• References to a figure of 10m people due tax rebates are wrong. HMRC have said 4.3m have overpaid in the last 2 years and 5.8m in earlier years. This is likely to be many of the same people.
  

• The PAYE tax system has been creaking for years. Not designed for people who change job more than once a year or who have more than one part time job at a time.

• Many of the people who owe money do so because they have a company car that was not properly taken into account in their tax code. And they probably know this and hoped they would get away with it.
  

• References to employers using the wrong tax code for an employee are a touch unfair. Employers use the tax codes issued by the taxman. If it's wrong it's because the taxman didn't have or didn't use the right information. Often the taxpayer hasn't told the taxman everything they need to know.

• Tax Codes are not something that the taxman and employers can work out between themselves. The taxman tells the employer what to do based on information given to them by the worker.
  

• PAYE is a simple idea - Pay as you Earn. It's a way of paying tax by instalments but it can only get to the right figure every year if your affairs are very straightforward. In most cases there will be unders and overs that get sorted out by an adjustment to your tax code the following year. This happens to millions of people every year. It always has done and always will do.
  

• To get everyone's tax spot on each year we would all have to file annual tax returns. In fact most people on PAYE don't do this. They can if they want to though....

• The previous Government added layers of complexity to the tax rules and calculations which the PAYE system was not capable of easily dealing with. (Tax codes can only charge 40% and not 50% tax if someone liable to the top rate has a second job, so they will always underpay tax through PAYE on that second job)

• Where you owe less than £2,000 any unpaid tax will normally be collected by adjusting your tax code for next year. So again, it's good news. If you do owe tax, instead of being asked to pay it back straight away you'll be given loads of time and the repayments will be spread over 12 months.

• Only a small proportion of the 1.4m PAYE taxpayers who owe money will be able to use what is being misleadingly called a 'loophole' to avoid repayment of any tax they have underpaid. It's a concession and not a statutory right. ESC A19 only authorises HMRC to write off the debt if the taxpayer can prove they have provided all relevant info and HMRC has evidently not used it AND taxpayer could reasonably have expected their tax deductions to be right.
  

• The taxman may well ask for a full tax return for the year before agreeing to write off a tax debt. Do you have any undeclared casual earnings, investment income or rental income?

• If your affairs are complicated or you have any undeclared sources of income, do take professional advice from a specialist tax adviser before contacting the tax man.

• You may also want to speak to a tax specialist if you are willing to pay for one-off advice rather than an accountant to help you every year.

Postscript: In the event I went on the show this morning and in 4 minutes of airtime I think I made 4 or 5 of the above points!