Challenge the Chancellor 2010 - Level 2 Tasks - Teacher Guidance

The Institute of Taxation has kindly provided the following guidance for teachers supporting their teams entering the Level 2 version of Challenge the Chancellor 2010:

How long should it take?
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This has been designed as a single session exercise to introduce students to the Pay as You Earn system of collecting income tax which they will encounter when they start work.

How much should they write?

Part 1 - One or two short sentences per question

Part 2 - A maximum of 300 words. Shorter entries will not be penalised if the content is good.

Introducing the topic
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About 22 million people pay tax and National Insurance Contributions (NICs) through the PAYE system. This accounts for the vast majority of people who pay income tax.
Around 40% of all Government revenue is collected through the PAYE system.

The PAYE system is designed to make employers collect exactly the right amount of tax and NICs from each employee over the tax year so that in most cases the employee doesn’t need to have any direct dealings with HM Revenue and Customs (HMRC) at all. This is a huge administrative saving for the Government.

In outline, the system works by allocating each employee a Tax Code. Most codes consist of numeric characters which normally summarise how much tax free pay a person is entitled to and one or two alphabetic characters which give other types of information. Everyone gets a ‘personal allowance’ – an amount of income that they can receive before they pay tax. For the tax year 2009/10 that is £6,475 for most people. That is translated into a tax code of, usually, 647L, ie drop the last digit and replace with a letter.

The employer uses the tax code along with other information supplied by HMRC to work out how much tax to deduct from the employee’s gross pay. The employer then has to send the tax and NICs to HMRC and pay what is left (the net pay) to the employee.

In essence, for weekly paid employees, the system allocates 1/52 of the personal allowance (tax free pay) which the employee is due and 1/52 of the other tax ratebands each week. Thus each week, a person due the standard annual personal allowance of £6,475 would be due 1/52th of £6,475 tax free, i.e. £124.52.

However, unless the employer has been notified of the person’s tax code by HMRC the employer cannot assume that a person is due the standard personal allowance – for instance, a person might have other income, possibly from another job, such that his weekly income is already above £124.52, hence the need for the “emergency tax code” which is set so that their employer deducts tax at the basic rate of 20% from all income. This is what has happened to Mike – his employer is using the standard emergency code of ‘BR’ – ie ‘Basic Rate’. When the notification of the person’s actual tax code comes through from HMRC the employer can make the necessary correction to the amount of tax deducted using the emergency code. If too much tax has been deducted, the employer makes a refund, funding this from tax collected from other employees in that period.

NICs use a somewhat different system. They are calculated on a week-by-week basis, depending on the pay for the week. If pay is over the weekly threshold (set at £110 for 2009/10) then NICs (at 11% for employees and 12.8% for employers) apply to the excess. (There are differences when pay gets higher.) If pay is below the weekly threshold, there is no need to deduct NICs from the gross pay – which is what is happening to MIke.

Unfortunately, some employers using part time temporary workers tend not to try very hard to get hold of the correct tax code because they know that if the employee leaves their employment before the correct tax code comes through from HMRC that the former employee will have to sort things out directly with HMRC, thereby relieving the employer of the work involved in making the tax refund.

What the judges will be looking for:
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Part 1 – succinct and accurate answers

Part 2 – imaginative but realistic suggestions for simplifying the current system as it applies to school students. They should be aware that the vast majority of school students with part time jobs earn below the personal allowance. The suggestions must reflect a basic knowledge of the current PAYE system for tax and NICs.