Memorandum submitted by the National Audit
Office
INTRODUCTION
1. The Treasury Sub Committee announced
on 26 October 2005 that it is undertaking an inquiry into the
administration of Tax Credits. This will include an examination
of HM Revenue and Customs (HMRC) recovery of overpayments of Tax
Credits and the difficulties encountered in administering the
payments system.
2. In recent years, the Comptroller and
Auditor General (C&AG) has reported annually on Tax Credits
as part of his Standard Report on the Accounts of the Inland Revenue.
The purpose of this Memorandum is to summarise the National Audit
Office's (NAO) recent work on Tax Credits that is relevant to
the Committee's inquiry. It is based on the C&AG's Standard
Reports for 2003, 2004 and 2005, which have examined HMRC's administration
of Tax Credits up to 31 March 2005 including the overpayments.
The main conclusions are set out in paragraphs 4 to 8.
3. There have been a number of recent developments
on Tax Credits and the NAO will be considering these in the context
of the C&AG's Standard Report for 2006, which is due for publication
in July 2006.
CONCLUSIONS
4. The design of the new Tax Credits system
necessarily results in overpayments. The scale of overpayments
is however higher than the Department anticipated when the schemes
were designed. (paragraphs 9 and 12)
5. To alleviate hardship, the Department
allows claimants to make repayments over several years. The full
recovery of overpayments from 2003-04 is expected to take at least
five years. (paragraph 16)
6. Although overpayments inevitably occur
due to the design of the scheme, there have been further unforeseen
overpayments, including those arising from software errors. (paragraph
10)
7. The Department has written off some £95
million of overpayments and, in preparing its Trust Statement
for 2004-05, made a provision of £961 million, representing
overpayments which, in its view, would eventually also be written
off. (paragraphs 14 and 15)
8. The Department's interim findings of
an investigation into the levels of claimant error and fraud in
2003-04 indicated that it overpaid 3.4% by value (£460 million).
The final results are likely to show an increase in these figures.
The C&AG qualified his opinion on the Department's Trust Statement
accounts for 2003-04 and 2004-05 because of an unacceptably high
level of error and fraud. (paragraphs 23 and 25)
OVERPAYMENTS
Inherent overpayments
9. The design of the new Tax Credits system
necessarily results in overpayments. A Tax Credit award is provisionally
based on a family's income and circumstances from the preceding
tax year. The award is finalised after the end of the tax year
once income and circumstances are known for certain. The final
award will be lower than the provisional award where incomes increase,
although the first £2,500 of any income increase is disregarded.
The Department estimates that the final entitlement to Tax Credits
would have been £800 million lower without the £2,500
disregard.
Other causes of overpayments
10. Although the design of the new Tax Credits
necessarily results in overpayments, there have also been unforeseen
overpayments. For example, software errors resulted in overpayments
of £184 million in 2003-04 and 2004-05. The Department is
continuing to investigate the reasons for further incorrect payments
caused by system miscalculations. Departmental error can also
lead to many overpayments.
Total overpayments and recovery
11. The Department identified that some
£2.2 billion was overpaid in 2003-04, affecting some 1.9
million families. The Department does not yet know the level of
overpayments for 2004-05 awards, but estimates that these are
likely to be similar to those for 2003-04.
12. The scale of overpayments is higher
than anticipated when the schemes were designed. The Government
expected one million awards to be reassessed as a result of rises
in income in the first year of Tax Credits, falling to around
750,000 in subsequent years. The Department explained that this
was because the extent of income rises in excess of the £2,500
threshold was greater than anticipated and that many families
overestimate how much their income has fallen or is likely to
fall when notifying the Department of a change in circumstances.
13. Figure One shows the distribution of
these underpayments and overpayments for 2003-04. These are based
on the department's initial figures for overpayments of £1.9
billion.
Tax Credit awards can be backdated and subsequent
payments made in 2004-05 relating to 2003-04 brought the total
overpayments for the year to £2.2 billion.
Figure One
FINALISED 2003-04 AWARDS UNDERPAID OR OVERPAID
AT 5 APRIL 2004
|
| Banding | Underpayment
| Overpayment
|
|
| Awards (000s)
| £m | awards
| £m |
| £10 to £50 | 82
| 2 | 134
| 4 |
| £50 to £100 | 81
| 6 | 121
| 9 |
| £100 to £200 | 111
| 16 | 193
| 28 |
| £200 to £500 | 170
| 56 | 414
| 141 |
| £500 to £1,000 | 124
| 88 | 388
| 280 |
| £1,000 to £2,000 | 92
| 129 | 347
| 493 |
| £2,000 to £5,000 | 47
| 136 | 243
| 725 |
| £5,000 and above | 5
| 29 | 40
| 252 |
| Total | 713
| 464 | 1,879
| 1,931 |
|
Source: HMRC.
14. Some £391 million overpayments were recovered
in 2004-05 either directly from claimants or through adjustments
to Tax Credit payments later in the year. The Department also
wrote off some £95 million of overpayments. Looking forward,
some overpayments that the Department is currently seeking to
recover might become irrecoverable because claimants successfully
contended that they could not repay because of hardship, or because
the Department had difficulty in tracing claimants no longer entitled
to receive Tax Credits.
15. In preparing its Trust Statement for 2004-05, the
Department had to form a view on what further tax credit debt
would eventually have to be remitted or written off. The Department
concluded that a total provision of £961 million (£481
million for each of 2003-04 and 2004-05) was appropriate.
16. The Department does not ask claimants to pay off
overpayments in a lump sum if they are continuing to receive Tax
Credit payments. To alleviate hardship, the Department allows
claimants to make repayments over several years. The full recovery
of the remaining £1.3 billion overpayments from 2003-04 is
expected to take at least five years as shown in Figure Two.
Figure Two
EXPECTED YEAR OF RECOVERY OF 2003-04 AWARD OVERPAYMENTS
OUTSTANDING AT APRIL 2005
|
| Expected year of recovery: | £bn
|
|
| 2005-06 | 0.5
|
| 2006-07 | 0.4
|
| 2007-08 | 0.1
|
| 2008-09 | 0.1
|
| Later | 0.2
|
| Total overpayment for recovery | 1.3
|
|
Source: HMRC.
17. Overpayments for 2004-05 are likely to be similar
to 2003-04. The Department therefore expects the amounts needing
to be recovered to grow, as a result of overpayments for further
cycles.
18. In 2004-05 the Department received 217,000 disputes
against recovery of overpayments. It struggled to manage this
level of work and introduced new streamlined procedures from April
2005 for dealing with "official error relief", where
an overpayment is due to a mistake by the Department and if it
was reasonable for the claimant to think that the award was right.
These procedures were likely to be more generous to claimants
in many situations and at that time the Department estimated that
the new procedures were likely to result in a net loss of £46.5
million.
19. The recovery of overpayments was automated and the
Tax Credit computer system could not stop the recovery while staff
considered hardship cases. We understand that the Department has
subsequently developed a manual workaround to stop this automatic
recovery from November 2005. It intends to have a computer based
solution in place by the end of 2006.
20. The Department's Code of Practice on Tax Credits
overpayments (COP26) is being reviewed as part of the measures
that the PMG has asked the Department to take forward.
CHANGES ANNOUNCED
IN THE
DECEMBER 2005 PRE-BUDGET
REPORT
21. A number of important changes were announced in the
December 2005 Pre-Budget Report. These are designed to provide
applicants with more certainty as to their award and will reduce
the level of overpayments. The main changes were:
— From 2006-07, the Department will disregard
increases in income between one year and the next of up to £25,000
(previously £2,500).
— From November 2006, claimants will be required
to report, within three months, any changes in their circumstances
which will reduce their level of entitlement. This limit will
be reduced to one month in April 2007.
— From November 2006, recovery of overpayments
during the year of award will be at the same rate as recoveries
made after that year.
— From April 2007, lump sum back payments will
no longer be made when awards are increased following an in-year
reduction in estimated income.
— From August 2006, the renewal deadline will
be advanced by one month.
— From 2007-08, provisional payments will be
based on more up to date family income.
ADMINISTRATION OF
THE PAYMENTS
SYSTEMS
22. This section looks at a number of issues relevant
to the administration of the payments system. These are:
— Computer problems on the introduction of
tax credits;
— Controls over payments;
— Tax Credits targets; and
Error and fraud
23. The C&AG qualified his opinion on the Inland
Revenue Trust Statement Accounts for 2003-04 and 2004-05 because
of an unacceptably high level of applicant error and fraud.
24. A Departmental exercise in 2000-01 identified that
they had overpaid some 10-14% by value of the former tax credits
because of claimant error and fraud. In December 2003 told the
Committee of Public Accounts that it envisaged that error rates
would be halved with the introduction of the new Tax Credits.
25. The Department's work to identify the level of error
and fraud in 2003-04 awards is not due to be completed until Spring
2006. In July 2005, it announced interim findings which indicated
that it overpaid 3.4% by value (£460 million) because of
claimant error and fraud. These results are subject to a wide
margin of error as they based on an initial sample and are likely
to involve the more compliant cases. The final results are likely
to show an increase in the proportion of cases involving claimant
error and fraud.
26. Tax Credits have been targeted by organised criminals
and the Department closed the Tax Credit internet facility on
2 December because of attempts to defraud the system. A recent
estimate by the Department shows losses to the exchequer of some
£15 million due to organised fraud. This figure relates to
the losses to date in some 25 cases of significant organised fraud,
defined as those involving more than £25,000. As a result
of the further work on tackling organised fraud, the Department
believes that the £15 million figure will increase, but it
is too early to give a firm estimate at the moment.
27. The Department has acknowledged that better checks
could have been made where claimants notify them of changes of
circumstances which affect their award. Measures designed to improve
compliance were announced in the Pre-Budget Report in December
2005.
Computer Problems on the introduction on tax credits
28. The administration of payments suffered from the
serious problems with the computer systems during the introduction
of Tax Credits in April 2003. These both delayed the processing
of claims and led to incorrect payments being made. These problems
continued to have ramifications in 2004-05.
29. On 22 November 2005 the Department announced a settlement
of £71.25 million had been agreed with EDS for the problems
experienced with these systems.
Software errors
30. Although the design of the new Tax Credits necessarily
results in overpayments, there have also been overpayments resulting
from software errors. These resulted in overpayments of £184
million in 2003-04 and 2004-05.
31. The Department is continuing to investigate the reasons
for other incorrect payments caused by system miscalculations.
Controls over payments
32. The C&AG's Standard Report has also drawn attention
to various aspects of HMRC's controls over Tax Credits payments,
including:
— controls to ensure that only authorised payments
are actually made;
— the reconciliation of the Department's records
of payments made with those paid by its Bank; and
— the validity of Tax Credit payments made
by employers.
33. Since the introduction of Tax Credits in April 2003,
the Department has not been able to perform the important control
of a daily reconciliation of payments authorised with payments
made. Checks are instead carried out in bulk some time after payments
have been made. This means that some incorrect payments to claimants
are not recognised promptly and that Department staff may not
have accurate information when dealing with queries. The Department
plans to introduce the fully automated system in the second half
of 2005-06
34. The Department has had difficulties in reconciling
its own record of payments with those cleared through the banks.
This is complicated by the need to account for some 400,000 payments
in respect of 2003-04 and 2004-05, which had not been allocated
to claimants' accounts at the end of 2004-05.
35. Some tax credits are paid directly by employers.
The Department gains assurance over these payments by reconciling
a sample of amounts reported as paid by employers to the Departmental
record of awards. The 2003-04 exercise resulted in a reconciliation
rate of 78.9%. This indicated that of the £2 billion paid
via employers, there was a likely net overpayment of £20
million. The Department believed these results to be reasonable
given that this was the first such reconciliation exercise and
that this was the first year employers had operated the new scheme.
Payment via employers is being withdrawn between November 2005
and April 2006 and replaced by direct payments to the claimants.
Tax credits targets
36. The Department checks how accurately it processes
information received from claimants. In 2004-05 the accuracy of
processing exceeded the 90% target, improving from 78.6% in 2003-04
to 96.5%. The significant improvement reflects continuing efforts
by the Department to identify reasons for inaccuracy and to introduce
new procedures to prevent error.
37. The Department's research indicated that the inaccuracy
was mainly due to:
— inputting of income from wrong financial
year;
— inputting of incorrect income; and/or
— omission of a partner's income, when the
claimant notified a change in their own income.
Complaints
38. The Department's Tax Credit Office has received around
51,000 complaints in 2004-05 and has had difficulties managing
this workload. Consequently, this required an increase in staff
numbers from around 200 in April 2004 to a peak of around 400
in April 2005.
39. The Department paid compensation to complainants
in accordance with its published Code of Practice 1, Putting
things right, for the costs they incurred as a direct result
of the Department's mistakes or delays and for the worry and distress
caused. Payments for worry and distress are not intended to put
a value on the upset caused but acknowledge that the Department
was responsible. In 2004-05 it made 20,000 compensation payments,
totalling £1.24 million.
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