In Year Adjustments to Tax Codes

We recently wrote a post about Tax Codes and How They Work. If you haven’t already read it and would like to know more, you can read it here.

You won’t need us to remind you if you work in payroll, that tax codes are at the core of everything you do. Getting them wrong can cause disruption, but one thing that increases the challenge when it comes to tax codes is In Year Adjustments (IYAs).

The In Year Adjustment (IYA) backstory

IYAs date back to July 2017 when HMRC introduced a way of updating coding to increase the effectiveness of Real Time Information (RTI). The system was called dynamic coding and it was put in place to help the overall efficiency and effectiveness of RTI.

The idea was that HMRC would use third-party information from pension providers and Personal Tax Accounts (PTA) to update tax information throughout the year. The notion was that underpayments would be highlighted, enabling IYAs to be issued. This meant that rather than rolling underpayments over to the following year, they could be dealt with in real time. In theory, this would mean that Week-1/Month-1 basis codes would be used less, and tax refunds would be speeded up. On the face of it, this was a welcome change, but it didn’t all pan out as planned.

How IYAs worked

In order to issue an IYA, HMRC needed some sort of indicator that a change was required and they decided to rely on two key indicators – firstly estimated pay and second a trigger point. This system means that HMRC will then issue an IYA to the tax code if there is a trigger point. Trigger points could come about because someone has changed their PTA or because their employer has made a change notification in their Full Payment Submission (FPS).

The problems with the IYA system

HMRC uses estimates to see if IYAs are needed. The way they work out their estimates is to take the information provided following a trigger to estimate the employee’s earnings over the full year. There is obviously the assumption in this calculation that pay accrues evenly throughout the year. It is this assumption that has caused problems in the IYA system.

The likes of bonus payments make these pro rata calculations and assumptions unrealistic and result in over-estimations of annual income. This means that the tax codes generated by IYAs are asking for too much tax to be paid. Add to this, the fact that the system has been known to generate several new tax codes in the same month, for the same employee and you start to see where this system’s weaknesses appear.

Even payroll experts can be thrown by these multiple IYAs. They cause confusion in their system and mean they have to face queries from disgruntled employees who ended up paying far too much tax (usually) due to a bonus payment. The effect of HMRC’s assumptions was particularly felt by people who were paid a bonus early in the tax year.

All of this came about because HMRC was unable to differentiate between regular payments and one-off payments. And the bad news is, that their proposed solution was to suggest that employees needed to update their estimated annual income on their PTA when they received a bonus. Needless to say, this sort of demand flew in the face of the promises that were made about dynamic coding. HMRC worked with industry experts and has now come up with a new solution to make sure employees have the right code and end the year having paid the right amount of tax.

Recent improvements in how In Year Adjustments are issued

HMRC has recently announced that they will introduce two significant improvements to this system. The first is the Tax Code Comparison Trigger and the second, the Significant Pay Difference Trigger.

Tax Code Comparison Trigger

This trigger looks at the tax code held by HMRC and the one shown in the latest employer submission. There are certain rules attached to this comparison, but essentially, once the rules have been applied, if the tax codes don’t match, a new tax code is calculated.

What happens is this – once the calculation has been made, if the tax code to be issued is the same as HMRC’s code, then a P6 Coding Notice will be sent to the employer. If the codes don’t match, then a P6 notice will go to the employer and a P2 notice to the employee.

It is likely that there will be some period of adjustment required for this system to bed down, but HMRC is hopeful that after a short transition period, that volumes of code changes should stabilise.

Significant Pay Difference Trigger

Bonus payments are difficult for HMRC’s system to deal with, but they are optimistic that the Significant Pay Difference Trigger will go some way to easing the problem. The way this trigger works is that each time a submission is made by the same employer for the same employee, a comparison is made with the previous submission. The system then looks for a significant difference between the two. Significant is currently defined as a payment of 50% more in the current period. Again, there are specific rules in place to streamline this process and aim to make the system more and more efficient.

These improvements were announced at the end of 2018, but the date from which they will come into effect is still unclear. Some experts are predicting there will be no changes before May 2019.

Dealing with IYAs in-house

The inefficiencies and subsequent issues raised by IYAs are troublesome (to say the least) for payroll professionals. Needless to say, for business owners who are trying to deal with these sorts of issues without support, the situation can become unmanageable very quickly.

What to do if you need help

If you’re facing a barrage of In Year Adjustments that you suspect mightn’t be right, or you’ve received your first one and you’re not sure what to do, it’s time to get the professionals on board. Knowing how to manage these transitions isn’t easy, but when you have the right team onside, things become a whole lot simpler. At Payplus we are your team.