The PAYE underpayment conundrum

Robin Williamson MBE CTA (Fellow)

January 14, 2020

The recent case of Goldsmith looked at how HMRC collects PAYE underpayments, with some interesting points on when they can validly issue a notice to file a tax return.

PAYE underpayments and how they are recovered

When a taxpayer’s liability is not collected in full through PAYE in the current year, HMRC’s usual method of collecting the balance is to issue a P800 showing an underpayment of tax and to ‘code out’ the underpayment; that is, to increase future PAYE deductions to collect it. In the rare cases where that cannot be done, HMRC invites the taxpayer to make ‘voluntary’ payments by way of settlement. If the taxpayer does not engage with HMRC, or defaults on the voluntary payments, HMRC can issue a notice to file a self-assessment return. Alternatively, from 2016/17, they can issue a ‘simple assessment’ – of which more below.

The PAYE system is supposed to yield a near-enough approximation to the correct amount of tax for a year, so how is it that such underpayments arise?

It could be because of a job change during the year, or a change in other circumstances that affects the taxpayer’s PAYE liability, with which the system has not fully caught up by the end of the year. Or it could be that the taxpayer does not have enough PAYE income (i.e. sources of income from which tax can be deducted through PAYE) to settle their full tax liability; for example, a pensioner whose State pension is taxable but paid to them gross and who has insufficient other income for the PAYE system to collect the tax due on the State pension.

In Goldsmith, it was because the taxpayer was in receipt of taxable Employment and Support Allowance as well as employment income, and a full personal allowance had been credited erroneously against both sources before tax was deducted.

The purpose for which a return may be required

Under s 8(1) of the Taxes Management Act (TMA) 1970, a person may be required to make a return ‘for the purpose of establishing the amounts in which [the] person is chargeable to income tax and capital gains tax for a year of assessment’.

In HMRC Commrs v Goldsmith [2019] UKUT 325 (TC), the taxpayer had defaulted on a time to pay agreement relating to a PAYE underpayment for which he was liable, so HMRC required him to submit self-assessment returns, which he failed to do on time. The taxpayer appealed against the ensuing late filing penalties.

The taxpayer was successful at the First-tier Tribunal (FTT), although he lost at the Upper Tribunal (UT).

The question before the FTT ([2018] UKFTT 5 (TC)) was whether the self-assessment system could be used as a mechanism for collecting amounts of tax which were already known to HMRC, when the legislation clearly stated that the power applied ‘for the purpose of establishing’ the amount. The FTT (Judge Thomas) decided that the wording of the legislation precluded HMRC from requiring a return for the purpose of establishing an amount which they already knew, in order to create an enforceable tax debt, and vacated the penalties on those grounds.

The jurisdiction of the FTT

HMRC appealed. It argued that the FTT did not have jurisdiction to review HMRC’s exercise of its discretion to issue a notice to file, as that was a public law issue which could only be challenged by way of judicial review.

The UT rejected its argument on this point. After reviewing recent cases where a taxpayer unsuccessfully sought to challenge the validity of a notice by appealing against the penalty charged for non-compliance, the UT held that in giving the FTT jurisdiction to decide whether a penalty is payable as well as against the amount of the penalty, the statutory scheme (FA 2009, Sch 55) clearly intended that the FTT should be able to examine the validity of the notice to file that gave rise to the penalty. If the notice to file was itself invalid, no penalty was payable for non-compliance with it. The UT judges said:

‘We accept that HMRC have a discretion conferred by section 8(1)(a) TMA whether to issue a notice to file. That statutory power, however, must be exercised for the stated statutory purposes. Whether the power has been exercised for the statutory purposes raises questions of fact and statutory interpretation, not general public law questions of reasonableness or legitimate expectation. Moreover, those questions, given the context, will be suitable for consideration by a specialist tribunal.’

Meaning of ‘establishing’

Nevertheless, the UT allowed HMRC’s appeal against the decision of the FTT that the notice to file issued to Mr Goldsmith was invalid. The FTT’s basis for this was that the notice was not issued for the purpose of ‘establishing’ the amount of his liability to income tax. It all turned on the meaning of the word ‘establishing’.

The point also came up at the FTT in Crawford v HMRC [2018] UKFTT 392 (TC). Judge Barbara Mosedale considered the meaning of ‘establishing’ in that context to be not only ‘calculating’ the liability, but ‘assessing’ it, which is closer to the dictionary definition of ‘establish’: to ‘make secure’ or ‘settle’ or ‘make permanent’. On that basis Judge Mosedale declined to follow Judge Thomas’s reasoning in Goldsmith (which had been heard previously at the FTT).

The UT agreed with Judge Mosedale’s analysis and concluded that even though HMRC knew the taxpayer’s liability from his PAYE record and the P800, it had served a valid notice to file for the purpose set out in the legislation.

The future, and simple assessment

HMRC will no doubt be relieved that its preferred method of collecting tax that the PAYE system cannot collect survived challenge by the FTT. There are other collection methods it could have used, and while the one it chose was not invalid, we shall probably see less of it in future. My guess is that HMRC will, in time, make greater use of the simple assessment scheme, which applies from 2016/17 and so was not available in Goldsmith, where the liabilities were for 2011/12 and 2012/13.

Simple assessment is specifically designed for cases where HMRC knows the amount the taxpayer must pay but cannot collect it all through PAYE. Simple assessment has the advantage, for the taxpayer, of obviating the bureaucracy of self-assessment; however, any assessment does need to be checked promptly and carefully, as only 60 days are allowed to notify HMRC of any inaccuracies, and only 30 days after HMRC’s response to that for making an appeal.


Robin Williamson MBE CTA (Fellow) is an author and commentator on tax and welfare issues. He was formerly a senior policy adviser at the Office of Tax Simplification and technical director of the Low Incomes Tax Reform Group of the Chartered Institute of Taxation.