Select Committee on Public Accounts Minutes of Evidence

REPORT BY THE COMPTROLLER AND AUDITOR GENERAL: APPROPRIATION ACCOUNTS 2000-01 Volume 16: Class XVI Department of the Chancellor of the Exchequer (HC 3355-XVI) Audit of the Inland Revenue under section 2 of the Exchequer and Audit Departments Act 1921, Part 3 Tax credits

Correspondence to the Chairman of the Committee and a memorandum submitted by Sir Nicholas Montagu KCB, Chairman, Inland Revenue

  When I appeared before the Public Accounts Committee last year for a Hearing on the departmental accounts for 1999-2000, we spoke briefly about our plans for administering the payment of tax credits via employers—which only came into force in April 2000.

  Since I am due to appear before you again on 20 May to answer questions on our accounts for 2000-01, I thought you and the Committee might find it helpful to have a note from me on developments in this area , since that earlier hearing and also since the Comptroller and Auditor General's report on the 2000-01 accounts was published on 13 February 2002. I attach this, and should of course be happy to supply any further information which you or your Members would like to have in advance of the 20 May Hearing. I look forward (if that is the mot juste) to seeing you then.I am copying this letter and the note to the Comptroller and Auditor General.

National Audit Office (NAO) Report on Inland Revenue Accounts—tax credits

  1.  This note explains why we have made less progress than we had hoped in providing the Comptroller and Auditor-General (C&AG) with the level of assurance he expected on the value of tax credit payments made by employers (PVE) during 2000-01. One way for us to gain assurance that employers have only paid out to their employees the level of tax credit that we authorised is to reconcile the payments they declare they paid with our internal records of payments authorised. We hoped to be able to make this comparison for 2000-01, but it has turned out to be less straightforward than we thought. We have nevertheless found no evidence to suggest that the mismatches between records arise from anything other than genuine error. We have discussed these issues with the NAO and agreed to work together to improve the level of assurance in this area for 2001-02. I will be happy to report back to the Committee on progress.

  2.  I should also mention a factual error in the C&AG's report which we should have picked up before publication. The figure of 230 employers visited in paragraph 3.26 should be 199: we have already told the NAO about this.


  3.  Employers get instructions to pay tax credits to their employees at a daily rate; but they only have to make the payments at the same frequency and to cover the same period as their pay their wages. For example, if an employer who paid monthly in arrears on the last day of the month were told to pay £10 per day for 20[1] weeks starting on 15 March 2001, the first actual payment would be on 31 March; and the amount of tax credit included in the pay packet would be £170 (£10  17 days). The next month they would pay £300 on 30 April, in May they would pay £310 on 31st and so on every month thereafter. Employers tell us how much they pay out in tax credits to all their staff once a year when they submit their annual return of PAYE and NICs (the "P35"). In the example, the employer's P35 for the tax year 2000-01 would show that they had paid over £170 in tax credits in that tax year.

  4.  We received about 1.2 million P35s from employers for the tax year 2000-01 (of whom some 226,000 employers had been authorised to pay tax credits to their employees), and approximately 54 million associated individual returns (P14s) for their employees[2]. We process the majority of the returns by around the October/November following the end of the tax, so, we cannot include the actual figures from P35 returns in our accounts. The C&AG accept in the report both our consequent need to estimate the figures in our accounts and the method used to do so.


  5.  Although employers have to report the amounts paid out only once a year, we have other ways of monitoring their performance during the tax year. Every individual whose tax credit will be paid through their wage packet is told when their credit is awarded the daily rate their employer is required to pay and when the payments will start. So they can see at once if they get less than they should. Our staff in the Tax Credit Office always act promptly to deal with anyone reporting difficulty/delay in getting their payments, and we will step in to take over payment if an employer cannot or will not meet their responsibilities.

  6.  We also monitor employer performance in-year through the visits our employer compliance officers make to employers. The Tax Credit Office ask the compliance teams to visit a small number of employers, but we select many more for visits by using our national and local risk analysis—and responsibility for paying tax credits is one of the elements pointing towards the need for a visit. Where they visit an employer who pays tax credits, our employer compliance officers will check at least one employee's tax credit payments, and we keep a record of employers who made mistakes. We checked tax credit payments by an estimated 6,800 of the employers we visited in 2000-01, and found only 18 (0.26 per cent) where wrong payment resulted in our recovering any money.

  7.  After the end of the tax year, P35s can provide a cross-check against our records although this will always be fairly rough-and-ready. The example used at paragraph 3 may help again to explain this problem. The employer had to pay £10 per day from 15 March 2001, so that we would expect the tax credit paid over in the first year to be £220 (£10 per day until the end of the tax year on 5 April 2001). But the employer (because of paying monthly in arrears) only paid over the tax credits up to and including 31st March in that tax year and so only recorded £170 of payments on the P35. Because the £50 of tax credit to cover 1 to 5 April was included in the wage packet on 30 April, it would be recorded in the P35 for the following tax year. So comparing the entry on the first year's P35 could make it look as if the employer had underpaid in the first year. The next year it would look as if they had overpaid £50 when we made a similar comparison. This shows the difficulty of linking payments authorised for payment by an employer in any given tax year with the tax credits shown as paid on the P35.

  8.  Some employers do not collect enough tax and NICs from their employees to cover the tax credit payments we ask them to make. Throughout the year we provide funding to help them cover the credits due. When we process their returns we check them against the amount of funding we know we provided, so as to ensure that they took the funding payments fully into account.

CHECKING 2000-01 P35S

  9.  We checked all P35s for employers to whom we had provided funding to cover their tax credit payments as they came in. This did not reveal any significant problems.

  10.  Between October and December 2001 we also carried out a series of computer "runs" which compared the tax credit payments we recorded as authorised for payment by each employer with the value of tax credits they recorded on their P35 return. These produced a list of employers whose tax credit payments appeared to exceed their authorisations. We wanted to identify employers whose records should be examined by a compliance team to determine the cause of the discrepancy and to satisfy us that there was no fraud involved. We initially set tolerances to exclude the year end variances explained in paragraph 7, but the final run in December excluded all tolerances to give us a list of all those who appeared to have "overpaid" tax credits in 2000-01.

  11.  The list was far longer than we had expected, but we could not provide an explanation in time for the C&AGs report on our 2000-01 accounts. Since then our internal auditors and operational people have been working on the list, and we now have a clearer view of what has caused the problems. Of the 1.2 million P35s received around 27,000 showed an amount of tax credits paid out by the employer higher than our records led us to expect. The value of these discrepancies varied significantly, but the top 90 cases (those with a discrepancy in excess of £100,000) accounted for £38 million (over 50 per cent of the estimated total value of the discrepancies).

  12.  We looked at 50 of the cases, the 25 with the biggest discrepancies and 25 taken from those where the discrepancy ranged in value from 1p to £100,000, to try to see why so many mismatches were occurring. The results of this work show that in the majority of these cases the discrepancy has risen because of error either within the Inland Revenue or by the employer when completing the form. From our sample it seems that the causes of the discrepancies include:

    —  A mismatch between the employer reference held in our systems and the employer reference under which the employer is making payments. We believe that (although there are a small number of examples of changes during the year that rightly change the reference since the award was made) much of this was caused by our Tax Credit Office making mistakes in assigning the employer reference to the case when they processed the application for tax credits from the employee.

    —  Errors in the information on the P35 resulting from mistakes made either when we processed them or when employers completed them.

  13.  Many problems with the employer references arise because the individual applying for tax credits does not know their employer's reference. The staff at our Tax Credit Office have clear targets to process claims quickly to ensure that people get their credit paid as soon as possible. Where, for example, an applicant describes their employer as Smiths, Newsagent, High Street, Anytown, it can be difficult for us to differentiate between a sole trader running their own business and a local branch of a national concern. Similarly, many companies run several PAYE schemes and they may allocate employees to a particular scheme by location eg Midlands or NW England or by frequency of payment eg Weekly/Monthly Paid—so deciding which scheme to assign the payments to can be very difficult. Our performance in this area is improving and we have taken action to raise staff awareness of the importance of getting this right.

  14.  We have also found evidence of keying errors made when processing the P35: given the scale of our operations, it is inevitable that some of these will occur, but we aim to keep them to a minimum. And employers make all kinds of mistakes. We have seen several cases of their seeing the relevant "box on the form" as some sort of balancing item they need to complete even when they have no tax credits to pay. We have improved our guidance for the 2001-02 P35s which went out early in 2002 and have asked our Business Support and Employer Compliance teams to remind employers of the right way to complete the box when making their normal visits. We have also issued guidance to our people processing the forms to try and pick up some of the more obvious errors before we input the information. In addition I have asked my Head of Internal Audit to consider whether in the light of these results we should take a look at the information provided on P35s to see what risks are associated with the level of errors we and employers make.

  15.  Although we are working to improve the position, we know that there will still be problems with the forms received for 2001-02; so we are also considering:

    —  taking a sample of individual tax credit cases to track them from the original application to an entry on the employers' returns and vice versa; and

    —  running a series of comparisons through the year (as P35s come in) of tax credit entries with our records. This should allow us to identify some problems as soon as the P35s are processed and so make it easier to correct errors.

  16.  We believe both these steps will help us both to identify genuine "process" errors and problems which we can take steps to correct and to provide an assurance about how well the system is running and the level of employer compliance with their statutory obligations. We have already started to discuss with the NAO how best to approach this work.

  17.  As part of our continuing employer compliance work, we expect to carry out 32,500 visits during 2002-03. Although not all will be on employers paying tax credits, we should at least have an equivalent level of coverage to that in 2000-01.

  18.  We had to learn a great deal in a very short time during and from the first year of operating PVE—a major change by any standards—and there have been inevitable teething problems. While we have made less progress with some of our processes than we had originally hoped, my Internal Audit and operational people have to date found no evidence of anything other than genuine error. I am confident that the work we plan to undertake over the next few months will help to reduce further problems and will put us on a sounder footing, and I will report back to the Committee on our progress later in the year.

Sir Nicholas Montagu KCB


Inland Revenue

2 May 2002

1   An award normally lasts 26 weeks and where an employer pays monthly we will pay direct for the first six weeks to ensure that they have time to set up their systems to make the payments. Back

2   The number is so large because many employees have more than one employment in a single year. Back

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