Are you an employer who operates a Net of Tax Credit Scheme? Have your employees received K codes from HMRC?

11 September 2017

If any of your employees have received tax codes that contain a K code and you operate a Net of Tax Credit (Appendix 5) Arrangement, then these may be incorrect.

The purpose of a Net of Tax Credit Scheme is to allow employers to pay any overseas tax due by their UK resident employees working overseas thereby providing relief from double taxation to the employee on a real time basis. UK PAYE is deducted as normal, however, a portion is sent to the overseas tax authority and only the balance is sent to HMRC. HMRC allow this arrangement, provided it is approved, as it saves them time having to deal with UK personal income tax returns from individuals who would not otherwise need to file a tax return. Employees like this arrangement as they do not have to suffer both UK PAYE and overseas tax on the same income in the payroll and it avoids the necessity to complete a UK tax return to claim double tax credit. Employers also like this arrangement as it saves them from the unpopular task of deducting both UK PAYE and overseas tax from their employee’s salaries, impacting their net pay.

What we have seen in the last couple of months is that when the UK PAYE paid over is reduced due to foreign tax, HMRC’s computerised system registers a shortfall of UK tax but is not able to take into account the foreign tax paid.  The limitation of their system means that an underpayment of UK tax is recorded on an individual’s record and a tax code change is automatically applied. Because of real time payroll submissions and a failure to recognise the foreign tax payments, the newly issued incorrect tax code will trigger an increased rate of UK tax deducted from the employee in an attempt to recover the perceived underpayments of UK tax.

A similar problem can arise at the end of the UK tax year. If a portion of the UK PAYE has been paid to an overseas tax authority the employer must, at the end of the UK tax year, summarise these amount annually per person on a schedule to HMRC. HMRC should then allocate the amount of foreign tax paid to each employee’s record so as his or her record does not show an underpayment of UK tax. However, HMRC regularly either lose the schedule completely or do not deal with the schedule correctly. If the information on the schedules is not dealt with properly by HMRC, incorrect tax codes will automatically be issued.

In any event, we would recommend that all individuals who work overseas who have a foreign tax credit should review all tax codes received from HMRC to ensure they are correct.

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