In all cases for new income from a provider, the tax code will be used on a month one basis, even if the client has provided a P45 from the same tax year. The P45 will show their correct personal allowance, but the month one basis will still need to be used.
The month one basis means the income or lump sum can only utilise one 12th of the annual personal allowance, and one 12th of each tax band. The emergency tax code gives the individual a full personal allowance, even if it later turns out they are not entitled to one.
Take for example an individual with an emergency tax code and a taxable payment of £10,000 (see Table 1). It doesn’t matter what other income the client has for this first payment, or when in the year it is paid. The emergency tax code on a month one basis is the same.
Table 1: How emergency taxation works in practice
Calculation | £ |
Gross income payment | 10,000 |
Less 1/12 of full personal allowance | 987 |
Taxable income | 9,013 |
Tax | |
20% on £2,875 (1/12 of basic-rate band) | 575 |
40% on £6,138 (remainder in higher-rate band) | 2,455 |
Total tax payable | 3,030 |
Net income payment | 6,970 |
Source: HMRC. Copyright: Money Management
If the member was going to take £10,000 each month, had a full personal allowance, and this all started in April, then this tax would be correct. However, if the client has no other income, then this would be an overpayment of tax of £3,030, which would need to be claimed back. If the lump sum is bigger, it could fall into the 45 per cent tax bracket for some of the payment, which would mean even more tax would need to be reclaimed.
It should be noted that if the member is not entitled to any personal allowance, or is already a 45 per cent taxpayer, the tax paid would not be enough. In such cases, the member would either owe tax at the end of the year through their self-assessment, or have their tax code amended to collect the additional tax. They won’t just get away with it. The end result is the same for everyone: the correct tax will be paid.
Reclaiming overpaid tax
If the member doesn’t take regular income, then it may be worthwhile reclaiming the extra tax paid during the tax year. This is possible even if the funds within the scheme have not been exhausted.
Alternatively, if none of the forms are completed, HMRC will reconcile the tax paid at the end of the year, either during self-assessment if applicable or just under the usual PAYE process. It will then provide a refund or an amended tax code in the following tax year. This is the least hassle, but will mean a significant delay in the refund, or the tax rebate being spread throughout the next tax year.
Once the scheme has the correct tax code, the month one basis will cease, so following payments shouldn’t have the same issues and reclaims shouldn’t be required for income from the same scheme.
