Is 0T the appropriate tax code to apply when an employee checks Statement C? (Part 1)Thursday, October 28th, 2010
Readers may have noticed that there should have been a news item in last week’s newsletter, but it was inadvertently omitted. However, another week has given us the opportunity to consider more closely the implications of HMRC’s decision to require tax code 0T to be used instead of BR when a new employee checks Statement C on form P46.
This was first mentioned, almost in passing, in the recent issue of Notes for Payroll Software Developers and was most unexpected. One of the principal objectives of Statement C is to ensure that a new employee taking a second job does not benefit twice from the personal allowance. The employee has a suffix code in the primary job and the use of tax code BR in the secondary job achieves that objective.
But, what BR does not do, in situations where the employee is already paying tax at 40% or 50% in the primary job, is to deduct tax in the secondary job at the employee’s marginal tax rate. Taking an extreme example; an employee with earnings in excess of £150,000 p.a. in the primary job will pay only 20% on all earnings in the secondary job and, at the end of the year, will have been under-taxed by 30% of all earnings in the secondary job.
The statutory PAYE rules and HMRC’s published rules only allow code BR to be used in this situation. In practice, however, HMRC’s technical validation rules for online filing of in-year forms by Internet or EDI allow almost any tax code to be entered as the “Tax Code in Use” on the P46, including suffix codes other than the emergency tax code, K codes and codes NT, D0 and D1. We understand that many employers take advantage of this flexibility and often submit D0 instead of BR in response to Statement C. The latest versions of the validation, however, prevent that from being done by specifying that only BR and 0T are acceptable codes where Statement C is checked.
Some clarification has recently been given in an email circulated by the HMRC’s Software Developers Support Team. With reference to the statutory rule for Statement C, the message stated:
“This rule currently applies even where it is evident that the employee is liable to tax at the Higher Rate. As a consequence this leads to higher paid employees paying much less tax than they are due to and this can continue for a number of years. From April 2011 we have changed the code we authorise employers to operate in these circumstances from BR to 0T. Code 0T will deduct tax at basic, higher or additional rates as necessary. The validations on P46 box C submissions have been changed so that from April only code BR or 0T is permitted.”
It is clear, however, that the use of 0T does not resolve the real problem of how to tax an employee in a secondary job at the employee’s marginal rate of pay. We have therefore, written to HMRC’s policy department to try to prompt a different resolution to the problem. This is what we have written:
“The reference in the most recent Notes for Payroll Software Developers created some confusion for me and my writer/lecturer colleagues as the 0T solution did not appear to resolve the issues created by the current requirement to apply only tax code BR. The recent explanation circulated by Pam Barber of the SDS Team has helped but, following further discussions with my colleagues, we are still unable to see that the use of 0T is going to be a satisfactory solution.
The issue that is repeatedly raised with us by payroll professionals is that a new employee, who has a suffix tax code and pays 40% tax in another employment, is allocated tax code BR by the second employer and is thereby under-taxed. The second employer is aware of the situation and knows that the only correct way of deducting tax at the employee’s marginal rate is to use tax code D0. However, PAYE procedures do not permit the application of D0 in this situation. In some cases, it is the new employee who asks to be given tax code D0 in order to avoid a future tax bill.
Our exploration of what codes are currently permitted using the various online facilities has left us very confused. HMRC’s own online service automatically allocates BR in the “box C” situation, with no other options. We have not been able to find the current Internet PAYE validation rules, but the latest version (24/9/10) of the EDI PAYE validation rules (document EB5(PAYE)/P46) is very confusing. It allows the P46 to submit as the “tax code in use” (1) any suffix code of any value (including V codes which are no longer in use), (2) any K code of any value, (3) BR, 0T, NT, or FT, (4) D0 or D1, (5) only BR or 0T if statement C is checked. The statutory PAYE rules allow only three possible responses to statement A, B and C, namely the emergency code on either a cumulative or non-cumulative basis, or BR. The validation rules therefore indicate that all sorts of entries are actually permitted under EDI (although we don’t know the situation under Internet) that are not allowed by the PAYE rules.
Putting most of that to one side and returning to the point of this email, those rules do limit the response to box C to BR or 0T, as recently notified to developers.
We are pleased to see that HMRC has addressed the situation and the use of 0T instead of BR will certainly calculate tax more accurately simply in the context of the second job. However, it does not help at all in addressing the problem we are trying to resolve – how to deduct tax at the employee’s marginal rate in the second job. If we assume that the new job is not the new employee’s primary employment, it may be expected that the earnings in the new secondary job will not reach the basic rate limit. As a result, tax in the new job will continue to be deducted at 20%, just as it is using the current BR code. In the case of an employee paying 50% tax in the primary employment, it is highly unlikely that the earnings in the secondary job will reach the higher rate limit, so the use of 0T will also seriously under-deduct tax.
Consequently, our view is that the use of tax code 0T does not resolve the problem as we understand it and should not be used, at least as the only option. The employees that we are concerned about will continue to have tax deducted at a rate considerably lower than their marginal rate.
The decision to use code 0T is also inconsistent with the key objective of the Real Time Information proposals, namely to reduce considerably the situations where tax is under-deducted and employees receive unexpected tax bills.
We appreciate the problems that could arise if employers were to be given a choice of tax codes to apply in the “box C” situation, especially as the new employer cannot know with authority the new employee’s employment status elsewhere. We think, therefore, that the responsibility for a decision to apply D0 or D1 should be given to the employee. Our recommendation, therefore, is that employers be given the option of applying BR (or 0T), D0 or D1 as appropriate, but with the use of D0 or D1 only allowed if the employer has obtained explicit written approval from the employee concerned.”
We will, or course, keep you informed about HMRC’s response to our proposals.