The Government forecast this year for people who will pay income tax is almost 30 million. Taking the self-employed and people who live on investments out of the equation, this still leaves around 25 million who pay most of their tax under PAYE. Or to put it another way, that’s in excess of half the adult population.

Is your PAYE coding notice correct?

If your coding notice is incorrect, it is not your employer's fault if it takes off too much tax, and don't expect the taxman to be sympathetic.

At the end of every year your employer will give you a form P60, which tells you how much income tax has been taken from you. Unless you are asked to complete a self-assessment tax return, that will probably be the end of it, and you could go on for years paying too much without realising it.

This 2006/07 tax year, the most common tax code will be 503L. Ignore the letter for the moment and multiply the number by 10. This gives the amount – £5,030 – that your employer will let you receive this year without paying tax. The personal allowance is actually £5,035, but the number is always rounded down, meaning that basic-rate taxpayers automatically pay an extra £1.10 in tax each year.

Your coding notice is split into three boxes, A, B and C. In box A you should have your single personal allowance. In box B there should be a list of any income you receive that has not been taxed, such as employee benefits, untaxed interest or possibly a state pension. The difference between these numbers is then shown in box C. Knock off the last digit and that is the number in your tax code.

The taxman may have used an estimate for your benefits, such as your company car or private medical insurance, and this may not be up-to-date. You may have chosen a ‘greener’ car, or no longer receive private medical cover. Unless you say so, you may go on for several years paying tax on a benefit that you no longer receive.

If you pay tax at the basic rate and receive bank interest taxed at source, this should not feature in your tax code. If, on the other hand, you are a higher-rate taxpayer, the tax code will need to include a number that picks up sufficient extra tax. If you have underpaid tax from an earlier year, you may have agreed that this should be collected through PAYE.

You may also get confused if your coding notice is worked out on the assumption that you are a higher-rate taxpayer but it turns out that you are not. It may go the other way, of course, when you do not pay enough tax.

Tax and retirement

During your working life, you may have been employed by an organisation that now provides you with an occupational pension. You may have worked for several employers and have two or three company pensions in retirement. On top of that, you will have a state pension and possibly some income from savings. The PAYE system has to cope with all this.

The taxman will normally identify your largest company pension and issue a coding notice to its trustees, who will then operate PAYE in much the same way as if you were still employed. HM Revenue & Customs will ask your other company pension schemes to collect tax at the basic rate without any allowances. If you are a higher-rate taxpayer, the taxman will want 40 per cent to be deducted from the other pensions.

Sometimes your state pension and untaxed income can be greater than your personal allowance. In that case the coding notice works in reverse, with an amount added onto the pension you actually receive before the amount of tax is worked out. If this is the case, your code would start with a letter K.

If you have several sources of income, you could be pulled into higher rates of tax without this being apparent to your main pension provider. In that case you may inadvertently end up paying insufficient tax. It can come as a nasty surprise to find some years later that the taxman then wants not only the extra tax but interest as well. The interest rate is 7.5 per cent – considerably greater than the after-tax return you are likely to be getting on your savings – so it acts as a penalty even though you may have done nothing wrong.

If you think the complications end there, what about the extra personal allowance you can get if you are aged 65 or over? Between 65 and 74 this allowance is £7,280, rising to £7,420 at age 75. Unfortunately, this extra allowance can be taken away again if you have an annual income of more than £20,100. The allowances are reduced by £1 for every £2 of income above this limit. This means that your personal allowance can be anything between £5,035 and £7,420.

If you have overpaid tax, it will probably never get picked up. If you have underpaid, it probably will be, and you will have the privilege of paying tax as well as interest at a penal rate.

Employee fuel benefit tax

One of the most common benefits is fuel used for private or business motoring. Having your employer pay for all of your private fuel does sound like something worth having. However, it can be expensive in tax bills, particularly if you do less than the average private mileage – about 8,700 miles – in a year.

The benefit of fuel is taxed on an all-or-nothing basis: whether you drive one private mile or 10,000, the benefit charge remains the same. The fuel benefit charge is calculated by taking a set figure (currently £14,400) and multiplying it by a percentage. The percentage is calculated according to the carbon dioxide emissions rating of the car. In some cases, the tax on the fuel benefit can exceed the cost of the fuel if you paid for it yourself.

Claiming tax relief

Under current rules, an employer can reimburse, regardless of a car's engine size, up to 40p per mile tax-free for the first 10,000 business miles travelled. The rate then drops to 25p a mile. Employers can reimburse an additional 5p per mile where a colleague has travelled with the claimant. These are the maximum rates that can be reimbursed free from tax and NI.

What is not widely known is that the employee is entitled to claim tax relief for the difference between what their employer does reimburse and what HM Revenue & Customs allows.

The same applies to any genuine and allowable business expenses that you have incurred for which you are partly reimbursed or not reimbursed at all. The important thing is to retain all relevant records to support any claims for tax relief.

If you require any more information on this subject or would like to review your current situation, please e-mail or contact us for more information.

Levels and bases of, and reliefs from, taxation are subject to change.
Article date: March 2007