PAYE Procedures for Students - HMRC consults on changes to P38(S) procedures for student employees

View the previous news item for P38(S)

13 March 2008

Form P38(S) and its related procedures are intended to allow students to be employed during their holiday periods if they do not expect their earnings to exceed the personal allowance for the year.

Student work patterns have changed significantly over the last twenty years. In 1984, 18% of 18 to 24 year olds in full time or part time education were working at a given point in the year. By 2006, this had increased to over 42%. Around 67% of students in full time education were in employment for at least one period during 2005.

Starting 3 March, HMRC launched a Student Tax Advice Campaign, aimed at ensuring that students understand their responsibilities for tax and national insurance. Findings of the Student Tax Advice research include:

• a total of 76% of students are in paid employment: 58% of students work part-time, while 39% do 'odd jobs' now and again
  
  
• more male (66%) than female students work part-time (55%)
  
  
• the retail sector is the biggest employer for UK students, at 32%; followed by office work (26%), and bar work, (18%).
  
  
• students are aware of the importance of knowing their National Insurance Number, with 93% claiming to know their number, or to have it safely to hand.

At the same time, HMRC published a new consultation document, entitled Modernising PAYE Processes for Students. It addresses concerns that, as a result of changing student work patterns, the P38(S) procedures may no longer address the needs of most working students. In particular,

• although many students now work during term time as well as the holidays and, as a result, the P38(S) cannot be used, only about 20% of students earn enough in the tax year to pay tax
  
  
• many students have low incomes, may have several different jobs during a tax year and have gaps in their employment
  
  
• many employers do not use the P38(S) procedures because they are administratively burdensome, preferring instead to apply normal PAYE procedures through their computerised payroll systems.

As a result of these trends, a growing number of students are over-paying tax on their employment income and having to claim repayments during the tax year or at the year-end, requiring additional HMRC resources.

The consultation document puts forward three options for discussion, all of which involve scrapping the P38(S). None of the proposals involve changes to the calculation of NICs. For the second and third, the procedure would only be available to a "student", defined simply as a person who

• is age 16 or over
  
  
• is attending or studying with a school, college or university full-time
  
  
• has an NI number or has evidence of applying for one, and
  
  
• does not expect to earn more than the personal allowance in the tax year.

This is a broader definition than that used for the P38(S) procedures as it would apply to students in their first or last years at college or university, and would also apply to sixth-form students. There is also no distinction drawn between work performed in term-time and during holiday periods.

The first option is to treat all students as other employees and apply the normal PAYE procedures. If the student has two or more different jobs during the tax year, there may be little tax deducted in the first job, where P46 procedures indicate that the emergency tax code on a cumulative basis may be used. In subsequent jobs, however, tax may be deducted on a non-cumulative basis or, if two jobs are held at the same time, at the basic rate, likely resulting in an over-deduction of tax for the year. The employers would have to file P14s for each employment and the student would have to reclaim the overpaid tax or wait for HMRC to repay it once the in-year and end-of-year details have been merged.

The second option is a new student tax code that would be applied by the student's employer if the student meets the student definition (see above). A code of ED (short for "Education") is suggested in the consultation document and its use would enable a student to earn the personal allowance in a tax year before tax starts to be deducted. The option to apply this code if the student conditions are met would be added to form P46. The conditions would also be added to form P45, so that the student code used by the previous employer could continue to be used by the new employer. It would be used across all employments held by the student during the year, as long as the student is able to re-confirm eligibility at the start of each employment and the aggregated income from all employments is not expected to exceed the personal allowance. If the conditions cannot be met in any employment, the student will be taxed under normal PAYE rules. A full payroll record would be maintained by each employer and a P14 filed at the year end for each employment. It is expected that 80% of all students would not pay any tax under this arrangement.

The consultation document is not particularly clear on how this ED code would work. It suggests that new tax tables would be required so tax would be deducted automatically by the payroll when earnings exceed the personal allowance, likely using tax code BR on a non-cumulative basis. But, if students regularly change jobs and do not pass on a P45 to the new employer, the personal allowance may not be exceeded in any particular job but may be exceeded over a number of jobs without any tax having been deducted. The examples in the consultation document do not address this situation.

The third option, as described in the consultation document, is difficult to distinguish from the second option. It involves a new student tax code, ET is suggested (short for "Education Tax" code), which would operate in the same way as the existing NT code but would require a P45 to be issued on termination. The student would have to confirm at the start of any new employment that the student conditions are met and it seems that, although a P45 would be issued, this would not be applied by the new employer unless entitlement is first re-confirmed. A P14 would be filed by each employer at the year end.

The key difference between options two and three appears to be that tax would start to be deducted automatically under option two when the personal allowance is exceeded, but that would not happen under option three. If, under option three, a student's earnings exceed the personal allowance, the underpaid tax would be collected by means of an adjustment to a normal tax code in a later year when the student conditions are no longer met. Both of these options are open to abuse or could operate so that the student owes tax at the year end. HMRC would introduce compliance checks to ensure their correct use.

Options two and three would also require HMRC to be informed when an employee ceases to meet the student conditions. A new tax code, taking into account any unused personal allowance, would be issued so that normal PAYE procedures can be applied. This situation and the operation of the option two tax code when the personal allowance is exceeded would result in the student's earnings being reduced considerably by the resulting tax deduction.

Employers are invited to send their comments on the following questions, quoted directly from the consultation document, to HMRC:

1. Which is your preferred option and why?
   
   
2. What other benefits do you think it would bring?
   
   
3. Will there be any impact because of having to [maintain a payroll record] and [complete] P14s for all students you employ or do you already do this anyway?
   
   
4. Do you see any downsides to your preferred option or situations where it might not work as effectively?
   
   
5. Do you have a view on whether the criteria listed accurately reflect the definition of a student and are a workable definition for employers to use?
   
   
6. Options two and three would require the inclusion of the student definition on a new P45 and P46 - what are your views on this?
   
   
7. Option two envisages that students would be able to use the Student Tax code across all employments in a tax year - what are your views on this?
   
   
8. Option three envisages creating a new tax code which works in a similar, but not identical way to the current NT code. For example, currently employers are not required to issue P45s where a code NT is in use, but the new student code would require employers to issue P45s. What are your views on this?
   
   
9. In the case of option two, in circumstances where the pay in one particular employment exceeds the Personal Allowance for the year, it is proposed that the employer puts the student on to emergency code non cumulative. [The consultation document actually proposes BR non-cumulative] Do you have any views on this?
   
   
10. Where aggregated pay exceeds the Personal Allowance during the year, but not in any one job, HMRC will not become aware of this until after the year end reconciliation. HMRC will then adjust the student's tax code in the following year to collect this underpaid tax. There is currently no formal assessing machinery for PAYE cases outside the Self Assessment process, so this would mean that these students would go onto standard PAYE to allow the underpayment to be coded out. Do you have any views on this?
    
    
11. If a student drops out of education part way through a tax year and has previously worked in the tax year, they will be put on to the emergency code non cumulative week 1 basis [P46 procedure] in their next employment until HMRC can confirm the correct code to be used. If however they stay in the same job they ought to inform HMRC of this change in circumstance and HMRC should send the employer a new code. Do you have any views about this?
    
    
12. When a student completes their education it will not usually tie in with the end of the tax year, so we think the same logic should follow as in 11 above - i.e. to be put on the emergency code non cumulative week 1 basis in their employment until HMRC can confirm the correct code to be used. Do you have any views on this?
    
    
13. In order to reduce the compliance risk some thought has been given to the idea of time limiting these tax codes for individuals. This could be say three, five or seven years. Do you have any views on how this might work?
    
    
14. Do you have any data or comments on the impact that complying with a change to the current P38(S) process may have? We are specifically interested in the time or cost for both business and individuals.
    
    
15. Do you foresee any particular issues around implementation and transition?
    
    
16. What sort of support and guidance might be required from HMRC?

The deadline for submissions is 16 May 2008 and details of how responses should be sent are given in the consultation document. It is anticipated that any changes resulting from this consultation could not be implemented until April 2010 at the earliest.

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Further information:
HMRC launches campaign to help students learn about tax
Student Tax Advice
Modernising PAYE Processes for Students

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