Last month, HMRC introduced ‘Dynamic Coding’ (also known as ‘PAYE Refresh’) which changes the way PAYE underpayments are dealt with. 

They will use third party information, from pension providers and personal tax accounts to update tax codes which collect the underpayment in year (now called an in year adjustment), rather than show it as a potential underpayment which, in the past, was collected the following year.

They will also minimise the use of Week 1/Month 1 codes to speed up refunds which were not previously repaid until after the tax year end.

HMRC will use estimated pay to calculate the under/over payment by annualising the pay to date figure from Real Time Information (RTI).  

What should employees watch out for?

Bonuses, particularly if paid early in the year, will cause problems as estimated pay will be considerably higher than actual pay, given that the calculation assumes pay will accrue evenly throughout the year. This could result in a lower restriction being applied to the code, leaving  the employee with tax underpaid at the year end.

It’s therefore important that employees check any changes to their tax code thoroughly to ensure they’re not under the impression that all tax is being collected during the remainder of the tax year only to find out this isn’t the case.

Furthermore, HMRC will code underpayments which arose in 16/17 in the current (17/18) tax year, meaning some employees will suffer a double tax ‘hit’ if they also had an underpayment for 15/16 included in their 17/18 code. Historically, the 16/17 underpayment would have been included in 18/19.

HMRC have confirmed tax codes will only have an in year adjustment when there is a trigger notifying a change of circumstances e.g. from the employee’s personal tax account or from an employer notifying of a new car etc.

Whilst HMRC encourages individuals to update their personal tax account, many will not, which again could lead to an underpayment not being coded out in year.