Administration and effectiveness of HM Revenue and Customs - Treasury Contents

4  The Future of PAYE

74. As noted in the previous chapter, HMRC attribute many of the difficulties facing the Department to the problems with PAYE during 2010. This chapter examines those issues and looks ahead to the future of PAYE.

The National Insurance and PAYE Service

75. PAYE is the system used to collect Income Tax and National Insurance contributions from those individuals who are employed and/or receive an occupational or private pension. PAYE cannot be applied to the State pension. Taxpayers in the PAYE system are given a tax code for each of their employments or pension sources at the beginning of each year. Where the PAYE system rather than self assessment is being used to collect tax on other sources of income, the tax code will require an estimate of those amounts. The code will also reflect the individual's personal circumstances, such as the higher personal allowance given to older people. The taxpayer pays tax during the year on the basis of the code. At the end of the year there is a reconciliation whereby the tax paid is compared to the tax due (information will have been provided by employers, financial institutions that pay interest etc.), adjustments are made and tax overpayments or underpayments are made as necessary. Adjustments are most likely where there has been a change of individual circumstances or where an individual has multiple sources of income (for example, an income and a pension). Before 2009, these reconciliations had to be done manually because HMRC held its taxpayer employee details spread across 12 separate regional databases. This required considerable manpower.

76. In June 2009 HMRC introduced a new computer system, the new National Insurance and PAYE System (NPS). This is able to bring information about each taxpayer together into a single record. The NPS is able to perform the annual reconciliation process automatically for most taxpayer cases, so that considerably less manual intervention will be needed in the future. Unfortunately, the introduction of the NPS was hampered by the quality of data used to populate it and a series of incorrect coding notices was issued in early 2010.

77. Eventually, the introduction of the NPS was delayed by a year to ensure proper testing, so that the results of the first large-scale PAYE reconciliation exercise did not become apparent until autumn 2010. Because of the delay launching the NPS, HMRC had not reconciled taxpayer records for 2008-09 in the summer of 2009. Consequently, they had to use NPS to reconcile both 2008-09 and 2009-10 in 2010 when it finally began to function on live cases. In autumn 2010 it became public knowledge that some 6 million taxpayers were likely to receive repayments or face overpayments as a result of the reconciliation process, resulting in considerable public concern and media criticism. There had been no prior warning of this to the public.

78. It has since become apparent that there were also unreconciled 'open cases' from earlier years and much of the unpaid tax due has had to be written off.

79. We held a hearing on HMRC's handling of this issue in September 2010 and their performance was the subject of sustained criticism of in the Committee of Public Accounts (PAC) report on HMRC's 2009-10 Annual Report.[79] The Government accepted most of the PAC's criticisms and HMRC is committed to clear the backlog of open cases, which stood at 17.9 million in late 2010, by 2012. The National Audit Office, in its report on HMRC's 2010-11 Accounts, notes that the Department is ahead of its target to clear the backlog of open cases, but also that substantial work will still be needed to stabilise the PAYE system.[80]

80. The episode's impact on the reputation of HMRC cannot be overstated. The problems with PAYE spring immediately to mind when reading Tax Help for Older People's damning verdict on HMRC's public profile:

Ten years ago the Inland Revenue had the reputation of being one of the best run Departments in Whitehall. Today HMRC's reputation is in tatters as one disaster has followed another.[81]

81. Paul Aplin of the ICAEW was concerned about the damage done by the incorrect coding notices to the public perception of the tax system:

[My parents] are taxed through PAYE. They would not have a clue if the coding was right or wrong but what they do have, because it is a generational thing, is an absolute trust that a Government department is going to get it right. [...] If that fundamental trust breaks down because people start having reason to think that PAYE is not working for them, or that perhaps they can't telephone someone who can help them and answer their question convincingly, I think there is a knock-on effect.[82]

82. The fact that six million taxpayers will have received letters telling them they have previously paid the wrong tax following the autumn 2010 reconciliations can only have reinforced this perception. Media reports that erroneously portrayed a process of reconciling data as correcting 'HMRC mistakes' or 'computer errors' will have done more damage. The PCS union told us that the Department had considerably underestimated the impact of NPS on HMRC's contact centres meaning people will have struggled to obtain the advice they needed.[83] The Department itself has conceded that the reconciliations are likely to have a continuing negative impact on its customer service performance and that the negative publicity will have impacted on staff engagement.[84]

83. The National Insurance and PAYE Service should ultimately make PAYE work more effectively and ensure efficiencies across the Department. However, the problems resulting from its flawed implementation have done significant damage to the public perception of HMRC and the tax system more generally. It is crucially important for the credibility of the management team that the 2012 target for clearing open cases is met and that improvements in overall performance follow soon afterwards.

Reforming PAYE: Real-time Information

84. HMRC was already consulting on a possible change to the collection of PAYE data at the time of the autumn 2010 announcements.[85] The initial consultation contained two options: Real-time Information and Centralised Deductions. Real-time Information would allow tax codes to be updated when employees are paid, by transmitting information to HMRC via the Banks Automated Clearing System (BACS), rather than reconciled at the end of the year through the submission of forms by employers. Centralised Deductions would have been a longer-term option, building on Real-time Information to move responsibility for calculating and deducting Income Tax, National Insurance and student loans away from employers to HMRC.

85. The Government decided in autumn 2010 to press ahead with a second consultation on implementing Real-time Information.[86] Centralised Deductions have not been ruled out in the longer term, but the proposal in the first consultation was controversial and no further plans have been advanced.

86. In HMRC's remit letter, David Gauke, the Exchequer Secretary and Minister for HMRC, stated that Real-time Information is "crucial to the delivery of the Government's welfare reform agenda." HMRC's Business Plan says Real-time Information will be introduced by 2013 and a further consultation on the detailed changes was published in December 2010. The Government's consultation proposed that employers would provide information on gross pay, tax and National Insurance contributions deducted in respect of every employee to HMRC, the information would be attached to the payment and transferred via BACS to HMRC.

87. The second consultation envisaged a test system up and running by April 2012 with a small number of volunteers. A further test group would be introduced in October 2012. HMRC expects to begin mandating large employers to use RTI from January 2013, with medium and small employers following later in the year.

88. Speaking in the House on the 8 September 2010 the Exchequer Secretary described the PAYE system as "outdated, inefficient and burdensome to the Exchequer and taxpayer alike."[87] Vocalink, who operate the BACS, told us that the current PAYE system is largely a "computerised version of the original 1940s paper-based system." They told us that many of the problems with PAYE come from the quality of information provided to HMRC and the time-lag between that information being submitted and being acted upon.[88] Stephen Banyard, the acting Director General for Personal Tax at HMRC, admitted that for Real-time Information to work well, data quality would have to be considerably improved. He set out a programme of data matching with employers to attempt to 'cleanse' the data held by HMRC. Data quality has been a key weakness in the PAYE system to date. The success of both the National Insurance and PAYE Service and Real-time Information will depend to a large extent on how effectively HMRC can 'cleanse' the data it receives and holds.

89. Our witnesses were generally supportive of Real-time Information in principle. However, few believed that the case for reform was as urgent as the Government initially portrayed. The Institute of Payroll Professionals rejected the suggestion that the PAYE system was "broken" and the Institute for Chartered Accountants Scotland observed that "The UK PAYE system still works remarkably well".[89] A common theme in the evidence from professional bodies was the need to introduce the reform slowly, following proper testing and only once the NPS had stabilised.[90] There was also scepticism as to whether the project would be delivered within the £100 million budget set by the Government.[91]

90. When we heard from HMRC in September 2010 Dame Lesley Strathie described Real-time Information as "high cost, high risk and [not] without difficulty."[92] Eight months later we asked how certain she was it would be delivered on time. She said "I would be a fool to say 100% but that is how I feel. I believe that we can do this."[93] We pressed Stephen Banyard, acting Director General of Personal Tax, about whether the concerns discussed earlier about potential problems not reaching senior managers might lead to issues arising later in the project. He told us managers had spoken to frontline staff and management and were confident the project would be delivered on time. He also stressed that the reform would be introduced more gradually than the NPS.[94]

91. We welcome the move to introduce Real-time Information. We agree with the professional bodies that the system must be tested thoroughly before full implementation, with full consultation with users and close co-operation with the Department for Work and Pensions at all stages. We note that large employers will be required to use the new system in January 2013, which is before the system has been tested through one complete tax year.

92. A particularly important point was the reminder by the ICAEW that Real-time Information is a means of transmitting information, not a means of processing that information.[95] Crucial to the success of the project will be HMRC's ability to process the information in a timely and accurate way. The transfer of information to HMRC via BACS is only part of the Real-time Information project. HMRC must also be able to process the information in a timely way, deal with the increase in customer contact that will occur with the introduction of a new system and have in place satisfactory arrangements for those who do not pay their employees through BACS.

93. HMRC has committed to an ambitious timescale to deliver Real-time Information, driven in part by the importance of the project in delivering the Universal Credit. The history of large IT projects subject to policy-driven timescales has been littered with failure. The timetable is made more ambitious by the fact HMRC will still be resolving the legacy of open cases and stabilising the National Insurance and PAYE Service during the project's early stages. Introducing Real-time Information before HMRC and the Government can be sure it will work correctly would run unacceptable risks for the reputation of the Department and the tax system. We recommend that HMRC and DWP have contingency plans in place in case a delay becomes necessary. Given the importance of the project we further recommend that the preparations for Real-time Information in both HMRC and DWP are subject to external audit as implementation proceeds, for example through the National Audit Office, to ensure that they are as robust as possible. We expect arrangements to be put in place for the National Audit Office to report quarterly to Ministers, this Committee, the Public Accounts Committee and other relevant Committees to ensure Ministers in both Departments can be held properly accountable for the progress of the project.

79   Committee on Public Accounts, Eighteenth Report of 2010-12 Session, Her Majesty's Revenue and Customs' 2009-10 Accounts, HC 502 Back

80   HMRC Annual Report and Accounts 2010-11, p. R38 Back

81   Ev w24 Back

82   Q 111 Back

83   Ev 83 Back

84   Ev 97; Q 136  Back

85   HMRC, Improving the Operation of Pay As You Earn, July 2010 Back

86   HMRC, Improving the Operation of Pay As You Earn: Real-time Information, December 2010 Back

87   HC Deb, 8 September 2010, col. 325 Back

88   Ev w25-w26 Back

89   Ev w2-w3; Ev w13 Back

90   See for example Ev 79; Ev w20-21 Back

91   Ev w29; Ev 86  Back

92   Oral Evidence taken before the Treasury Committee, HMRC's Operation of the PAYE System, 15 September 2010, Q 114  Back

93   Q 321 Back

94   Q 324 Back

95   Ev 77 Back

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Prepared 30 July 2011