Jeff Salway: Taxing times for HMRC and they may pay a heavy price

IN MAKING itself even more unpopular than it already was, the tax office has achieved the seemingly impossible. Its rapidly declining reputation could go even further downhill over the coming months, for evidence suggests that this weeks revelations are just the tip of the iceberg.

Tax experts familiar with the travails of HM Revenue & Customs (HMRC) in recent years say the expensive errors that have come to light in recent days were a matter of when, not if.

More worryingly, we can expect far more where this came from. To recap briefly, at least six million people have been paying the wrong amount of income tax through pay as you earn (PAYE) for the past two years. Of the those identified so far, some 1.4 million people have paid too little tax and face repaying an average of 1,380.

However around 4.3 million taxpayers are in line for refunds averaging 419 after paying too much through the PAYE system. Those refunds will be made through changes to their tax codes in the 2011-12 tax year.

The problems arose after HMRC introduced a new national insurance and PAYE system, which brought to light discrepancies in its records, resulting in incorrect coding notices being issued.

This has come as no surprise to the many tax specialists who have highlighted HMRC's growing incompetence over the last few years. Writing in Scotland on Sunday in January this year, Bruce Connelly, head of tax at law firm Anderson Strathern, predicted - with impressive accuracy in retrospect - that around 4.5 million people could expect to be paying too much tax under the codes issued by HMRC in February and March ahead of the new tax year, while another 1.5 million would be underpaying.

The Chartered Institute of Taxation said in January that of the 25 million tax coding notices being issued by HMRC in the early months of the year, "a significant proportion" would be wrong.

HMRC itself warned of potential problems with tax codes in April, when it was forced to advise employees to check their April pay details to ensure that they were paying the right amount of tax after revealing that many were not sent the same PAYE code as their employer.

The revenue's technical glitches have been accentuated by staffing problems, with HMRC staff numbers being cut, departments being reorganised and tax offices closing. The coalition government's spending cuts will only exacerbate the problems currently being experienced at HMRC which, after discovering the defects in the system that caused the errors reported this week, decided to undertake a full review of the 45 million employment records it holds. It has been forced to divert a significant number of employees to nearly 18 million backdated cases that have yet to be properly checked and some reports suggest that there may be errors in up to a fifth of the records held by HMRC.That explains why many people believe the issues that have emerged this week are merely the tip of the iceberg.

A leading Scottish tax expert - also an ex-HMRC employee - recently told me that the system for keeping PAYE tax codes up to date is no longer fit for purpose. Any change in taxpayer circumstances during the course of the tax year may not be picked up by HMRC until well after the event, by which time the tax deducted may be completely wrong, leading to widespread underpayments and overpayments.

Of course, the controversy currently surrounding HMRC isn't limited to individual tax. It has attracted nearly as many headlines for its tax avoidance approach, which in the last 18 months has featured amnesty initiatives aimed firstly at expats and then professionals including accountants and doctors. The results have been mixed and it seems HMRC is now softening its stance on tax avoidance, despite the pressure on it to generate extra revenue. This is partly because of a shortage of personnel and partly because of court case defeats in recent weeks that have caused significant embarrassment.

However, this time the focus is on the shortcomings of a PAYE system that has been in place for nearly 70 years, having been introduced at a time when people typically stayed in their jobs for the long-term, or for life, and when relatively few people worked on a self-employed basis. It has long been clear that PAYE, and HMRC itself, have to be reformed and it's clear now that such reform can no longer be delayed.