What to do if you receive a letter from the HMRC demanding underpaid tax back

MORE than a million tax payers are to be asked to repay an average £1,380 inunderpaid tax after six million wrong tax codes were spotted by a new HM Revenue & Customs computer.

Clawing back 2 billion in overdue tax will put family finances under enormous pressure, as many are struggling to stay afloat on reduced recession incomes.

Problems have come to light because a new Pay As You Earn (PAYE) computer tracks earnings using National Insurance numbers rather than marrying employer accounts. This has thrown up millions of errors in past tax codes.

Traditionally, PAYE deductions were carried out manually, and based on your previous year's earnings or the one before that.

Such a system is not flexible, and copes poorly when circumstances change regularly.

John Whiting, policy director at the Chartered Institute of Taxation, said: "The system was designed for a time when people largely stayed in the same job, and there was very little change to their circumstances. It copes very badly with today's work patterns where individuals may have two or three jobs and wage packets or pensions coming in."

For this reason, notices of coding which are sent to taxpayers in the new year, ahead of the start of the tax year each April, are routinely riddled with errors.

A common mistake is where those who have more than one job receive two or more personal allowances when they should only benefit from one. It has also emerged that top-earning professionals may not have been caught by the new 50 per cent tax bracket, again because their wages are spread between different employment.

Where tax is over or underpaid, in theory reconciliations are undertaken at the end of the tax year, and adjustments made via the next notice of coding.

In reality, this practice has withered on the vine, and certainly no reconciliation has been carried out for two years.

Whiting added: "It seems that the computer is picking up errors which may have been going on for some years.

"In many ways PAYE is a very good system, as it allows employees to leave all their tax affairs to their employer, who sorts it out. It costs them nothing. However, a core fact which everyone seems to overlook is that there is no guarantee that the deductions are accurate."

For this reason, more than a million taxpayers will be in for a nasty shock before Christmas. So if you receive a letter, do you have to pay and if so how and by when? Here Scotland on Sunday leads you through the tax house of horrors.

How do you know if you will be issued with a demand?

Only those who pay tax via the PAYE system will be hit, and only a minority of these. If you have correctly filled in self-assessment forms, then you should not be affected. Six million letters are going out before Christmas. Nearly five million customers are due a rebate because they have paid too much, while more than a million may be asked to pay more.

If you hear nothing, then do nothing. However, it will be worth checking your tax codings for the years involved, in case you have overpaid, and this has not been picked up. In this case you will want to write to HMRC for a rebate.

Which years are we talking about?

The tax years involved are 2008/9 and 2009/10.

What do I do if I get a demand?

Don't panic if you get a letter over the coming weeks, because these are not tax demands. These letters, called P800s, are estimates of your tax position. The first thing to do is to check their information, because there is no guarantee this latest statement is correct.

How can I check their figures?

It is difficult but the important thing is to check that the core information is correct. Have they got the right employer? Are the pensions or benefits correct?

Can I calculate my tax code?

Everyone should check their tax code, but again this is not easy. However, it is possible if you work slowly and methodically. Essentially you begin with your earnings. You should have this information on payslips or on your P60, which your employer should give you at the end of each tax year. It will also include any taxable benefits provided by your employer, or state benefits or tax credits. Then you need to deduct pension contributions and your personal allowance, currently 6,475. What is left is taxed at 20 per cent up to 37,400, and 40 per cent over that figure, for the tax year to 5 April, 2010.

There is more detailed information on the HMRC website to help you check your tax code, including other allowances and information about the new 50 per cent band.

If the Revenue asks for more money, do I have to pay?

Not necessarily. If the amount is below 300 then the government is writing it off, so you will not need to pay anything.

There is another extra statutory concession, known as A19, which may help with any new demand for the tax year 2008/9. Essentially, it applies to any tax demands for tax years ending more than 12 months ago. If you have given HMRC every piece of accurate information relating to your tax affairs in that year, and they have simply bungled the matter, then you can ask them to write off the bill.

However, the concession is not the get-out clause some have indicated. Whiting explains: "Yes, the concession does exist, but it is not a universal panacea. Some people will get their bill wiped out in this way, but my guess is that the number will be small.

"You have to be able to demonstrate that you went out of your way to supply HMRC with total detailed information about all your financial affairs, and having done so, couldn't have been expected to spot their error. In other words, it is absolutely the Revenue's fault and no-one else's. But this is not easy to prove."

Can I make my employer pay?

Possibly. If you can prove that your firm was given every bit of relevant information, and then miscalculated, you can ask HMRC to pursue the company.

Will I be charged interest?

Yes, controversially you will. The law states that interest, currently 3 per cent, is levied on all overdue tax. This is particularly galling where taxpayers are the innocent victims of others' errors.

What if I haven't got the money?

You don't need to do anything immediately, as these letters are HMRC's opening negotiating position. Once you have agreed what is owed, you should receive a formal demand in the new year. You can pay this if you have the money, and to avoid further interest. If the amount is below 2,000, then you can ask for the repayments to be taken from your pay packet over the next three years.

If it is more than 2,000, you will have to negotiate individually about handing over the money.

What if I have paid too much tax?

After checking HMRC's sums, bank the cheque.