Chapter 3 - Errors and adjustments to employment income information
- Current requirements
- Types of errors and adjustments in employment income information
- Reporting errors
- Payroll corrections
- Interpretation errors
- Errors and adjustments relating to a previous assessment period
- Employee compliance errors
- Reporting employer superannuation contribution tax (ESCT)
3.1 Employers have an obligation to provide information to Inland Revenue when they withhold tax and other deductions from PAYE income payments.
3.2 The current obligation is to provide the PAYE information monthly in an “employer monthly schedule”. The Bill refers to the information as “employment income information” and proposes it will be required on a payday basis. Under the proposals in the Bill, employers over the threshold for electronic filing and employers with smaller payrolls who are using payroll software will have two working days following payday to submit employment income information for that payday. Employers not required to file electronically, and who are not using payroll software, will have seven working days following payday to report.
3.3 Payday reporting should result in some errors being identified and corrected more quickly. Because of delayed reporting and slow processing it can currently take three months before an employer who has not made employer KiwiSaver contributions is identified and notified to begin contributions. Payday reporting should see this type of error identified and corrected much more quickly.
3.4 It is recognised, however, that payroll corrections are inevitable and that processes for correction must improve if payday reporting is to result in a reduction in compliance and administrative costs.
3.5 Inland Revenue’s current PAYE guidance states that PAYE errors must be corrected by phoning or by completing a form which amends the original return that was in error. This requires an amendment to be lodged for each return (monthly at present, payday in future) that was wrong.
3.6 However, in some circumstances, Inland Revenue allows employers to make adjustments in a subsequent return. This approach is not available if netting the corrections off against the subsequent return would result in any of the fields (for example, for gross income or PAYE, or KiwiSaver deductions) having a negative value. This constraint arises because of limitations in Inland Revenue’s FIRST computer system, which cannot use negative values. It also limits the size of errors that can be corrected in a subsequent return.
3.7 The suggested changes set out below relate to how errors may be corrected once employers are reporting on a payday basis. The Bill proposes that this will become optional from 1 April 2018 and mandatory from 1 April 2019.
3.8 Over 700,000 corrections were made to PAYE information in 2016, based on information from employers. The potential solutions distinguish between a number of different types of errors and reasons for adjustments:
- Reporting errors – when someone was paid and tax and other deductions were withheld correctly but there was a mistake in the reporting to Inland Revenue.
- Payroll corrections – including when someone was wrongly paid due to human error, systems error or receipt of information after the payroll has been run.
- Interpretation errors – for example, when the employer has made a mistake about whether an allowance is taxable.
3.9 Officials acknowledge that having to distinguish between different error types adds complexity. However, if one rule is applied to them all it may impose more onerous requirements on some types than is necessary. Submitters have the opportunity to comment on the level of complexity.
3.10 For completeness, these sources of error are included but they have their own rules, which this paper does not propose to change:
- Employer non-compliance – for example, deliberate non-withholding or misreporting or failure to take reasonable care. These forms of non-compliance cannot be remedied by “correcting” the resulting “errors” and non-compliant employers will remain subject to existing penalties.
- Employee compliance error – for example, use of an incorrect IRD number or provision of wrong tax code, whether deliberate or inadvertent. The employer’s ability to rely on the information provided by the employee, and to only change employee information following an instruction from the employee or from Inland Revenue, will remain. No requirement to correct previous returns is proposed.
3.11 Reporting errors arise when someone was paid and tax and other deductions were withheld correctly but the information was reported wrongly. There are many reasons why an employer might not accurately report what was paid and/or withheld, for example:
- An employee might have been paid out-of-cycle, and while they have been paid and withheld from correctly, the details have not been included in the return.
- The return might inadvertently have been submitted for the wrong payday.
- A transcription error might have been made in recording an amount or other employee details.
3.12 Reporting errors often give rise to a mismatch with the payment made to Inland Revenue, which will generate contact from Inland Revenue and rework. Resolving the error requires the employer to make the correction in the return in which the error occurred, so that it matches with the payment that includes that return.
3.13 In other circumstances, for example, where information about employee A’s income and deductions has been attributed to employee B and vice versa, the reporting error would not generate a mismatch with total payment. It could, however, have social policy consequences for the employee and may generate processing errors when, for example, a KiwiSaver deduction is reported against an employee who is not a member.
3.14 Employment income information is currently shared with the Ministry of Social Development and Accident Compensation Corporation who use it to help ensure that people get their correct entitlements.
3.15 Because of the need for reporting to match payment and the potential impacts of reporting errors on an individual’s entitlements and obligations, officials propose that all reporting errors should be corrected by amending the return that was in error.
- Do you agree that when reporting does not reflect what was paid and withheld, the error should be corrected by amending the return that was wrong? If you disagree, please explain why.
3.16 Employment income information can also be incorrect because of the need for payroll adjustments. In this situation tax and other deductions have been calculated correctly but may subsequently require adjustment because the pay needs to be updated. This situation can arise for a variety of reasons, including:
- advice of unpaid leave or other changes received after the payroll has run;
- an allowance or other entitlement did not cease when it should have; or
- paid leave was anticipated and the employer was unable to recover it all from the final pay.
3.17 While an underpayment is an error from some perspectives, it is a well-established tax principle that income from wages and salary is derived (taxed) on a cash basis, and is taxed at the rates applying when the cash is actually received. Calculating the tax and other deductions when the payment is finally made removes the need for a PAYE correction as the information is simply included in the return when the payment is made.
3.18 If an underpayment spans income years, and tax rates have increased since the income was earned, this can seem unfair to the employee as the underpayment will all be taxed in one year and at the higher tax rate. On the other hand, if tax rates have decreased and/or the employee is on a lower income when the underpayment is corrected, the employee may prefer that the tax is calculated on the rates applying when the payment is made.
3.19 Officials are not proposing any changes to the principle that, when an underpayment is made up, tax and other deductions are calculated at the employee’s rate on the payday when the payment is made. In these circumstances there is no requirement to correct earlier returns.
- Do you agree that tax and other deductions due on underpayments should be calculated at the employee’s current applicable tax rate when the payment is made?
- If the proposal is not how you calculate tax and other deductions on underpayments, please explain how you calculate the tax and what information you provide to Inland Revenue. If you think your approach is preferable, please explain why.
3.20 Because of the employment law obligations, employers are usually required to get employee agreement before correcting overpayments. Officials understand that once agreement to repay is obtained it is not uncommon for payroll systems to correct overpayments back in the pay period(s) in which the overpayment occurred, and recalculate the tax and other deductions in those periods. As illustrated below, these systems then deduct the correction(s) from the income and deductions payable in the current pay period. The difference between the net amount owed to the employee for the current pay period and the amount after the agreed overpayment has been deducted is regarded as a loan to the employee, which may be repaid in one amount or over time.
3.21 Despite their own systems recalculating the PAYE and other deductions in the pay period(s) in which the errors occurred, some employers have advised us they would prefer to simply provide Inland Revenue with figures for the current payday, less the overpayments. Because it subtracts the overpayment from the amounts payable in the current pay period, this approach eliminates the need to amend (reverse and replace) earlier returns.
Option A: Adjustment reported in subsequent payday return
Jai has a base salary of $900 gross a week but has been paid a $100 weekly allowance that should have ceased at the end of the previous month. It continued for four weeks before it was discovered. In one of the overpaid periods she was paid $200 overtime. Jai has a student loan but is not in KiwiSaver. If the employer corrected the error by reporting it in a subsequent return they would recalculate what was paid (standard text shows what was originally paid) in each of periods 1 to 4 (the figures in italics are the recalculation) and then net the changes off the amounts after tax and other deductions have been calculated for payday 5. The employer would report the bold figures for payday 5.
|Original||Payday 1||Payday 2||Payday 3||Payday 4||Payday 5 adjusted to net off agreed error|
|Gross income||$1,000 − $100 = $900||$1,200 – $100 = $1,100||$1,000 – $100 = $900||$1,000 – $100 = $900||Correct – adjustment: $900 − ($100 × 4) = $500|
|Correct –adjustment: $151 − (($29 × 3) + $31) = $33|
|Correct – adjustment: $64 − (4 × $12) = $16|
|Correct – adjustment: $685 − ((3 × $59) + $57) = $451|
Option B: Amending the earlier returns
If the employer amended the earlier returns, the record of Jai’s gross income and deductions for paydays 1 to 4 would be amended to show the figures below.
|Corrected||Payday 1||Payday 2||Payday 3||Payday 4||Payday 5|
3.22 Option A and Option B, illustrated above, would result in the same overpaid amounts being refunded or credited to the employer. They leave the employee in the same situation both in terms of social policy and tax. If the employer amended the original returns, Inland Revenue would, however, pay use-of-money interest on overpaid deductions, provided the amount overpaid was more than $100.
3.23 If the correction is made by netting the changes off against a subsequent return (Option A), Inland Revenue’s records for paydays 1 to 4 will not match the employer’s amended records for those paydays. Officials are aware that PAYE-related reconciliation issues cause some employers significant concern. Submitters are invited to comment on whether employers should only be allowed to report an adjustment in a subsequent return if the employer retains both the original and amended records.
3.24 Allowing the employer to net overpayment corrections off in a subsequent return may also make it hard for Inland Revenue to see that appropriate deductions have been made. It is possible that having an indicator, at the employee level, that this return includes an adjustment to previous returns might resolve most cases.
3.25 It is proposed that when agreement is reached with an employee to repay an overpaid amount, an employer who recalculates the amounts in the pay periods that were wrong could report the change to Inland Revenue either by:
- rolling the changes forward and netting them off the gross income and deductions reported in a subsequent return (Option A). For a discussion about the ability to report negative values please see the next section, “Reporting negative values in a return”; or
- making a correction by amending the returns that required correction (Option B).
3.26 In terms of employment law, and with their employee’s agreement, employers may be able to correct some overpayment errors in other ways – for example, by reducing gross income payable in a subsequent pay period and calculating the tax and other deductions on the reduced gross.
Option C: Reduced gross income
If the employer is legally able to correct an overpayment by reducing the gross payable in a subsequent period, and has their employee’s agreement, the information reported would be what is shown in bold below. This example assumes the same scenario as in Options A and B, a gross overpayment of $400.
|Reduced gross||Information reported||Amount|
|Gross income||Current pay minus overpayment ($900 − $400)||$500|
|PAYE||PAYE on reduced gross||$76|
|Student loan||Student loan on reduced gross||$16|
|Net pay||Net pay||$408|
3.27 In this case the situation parallels an underpayment error as the tax and other deductions are calculated on the gross amount in the subsequent pay period. In these circumstances no adjustment or amendment is required.
3.28 The above options (A, B and where possible under employment law, Option C) are intended to meet the design principles of facilitating automation and, as much as possible, allowing employers to make corrections or adjustments consistent with their existing payroll practice. The ability to report negative values and what is required when an error occurred in a previous tax year are considered in the following sections.
- Is the method described in Option A how you or your system calculates the details of an overpayment? If not, how do you do it?
- If you are involved with paying staff, which option (Option A or B) would you adopt to report an error correction to Inland Revenue and why? If your answer would vary depending on the circumstances, please explain why.
- Should employers who adopt Option A be required to keep a record of both the original and corrected pay to enable the records to be reconciled if problems arise?
- If you have concerns about the workability of the options, or would recommend a variation, please elaborate.
- Do you ever recover overpayments by reducing gross income as described in Option C? If you do, can you please describe the circumstances?
Reporting negative values in a return
3.29 For employers who pay staff more often than monthly, payday reporting will reduce the values in their returns of employment income information. For example, an employer who pays weekly will have values in their weekly returns that are approximately one-quarter the size of those reported in the employer monthly schedule. Unless the constraint on filing negative values is relaxed, payday reporting is likely to increase the requirement to correct errors by amending previous returns.
3.30 The current constraint on filing negative values arises largely because Inland Revenue’s FIRST computer system cannot accurately process negative values. Until Inland Revenue completes its transition to the new computer system, it will be managing PAYE and related social policy deductions across two computer systems: FIRST and START. The constraint on filing negative values will remain during this period, which is referred to as “co-existence”.
3.31 Once Inland Revenue manages all aspects of employment income information in its new computer system, it is proposed that employers will be able to file adjustments with negative values. It is not possible to definitively indicate when the system will be able to accept negative values but it will not be before early 2020. Officials are seeking to explore and understand any reconciliation or systems issues that might arise if this change is introduced.
- If you run a payroll and make adjustments by netting off the change against a subsequent return, approximately how many times a year does the constraint on filing negative values require you to amend earlier returns?
- Do you support the proposal to allow employers to file negative values in their returns of employment income information?
- If you have concerns about the proposal to allow employers to report negative values, or if there are issues that implementation must address, please explain them.
3.32 Another type of error occurs when an employer misinterprets the law – for example, wrongly treating a taxable allowance or provision as non-taxable. These errors are similar to other interpretation errors the employer might make in other aspects of their tax affairs, and it is proposed that similar principles should apply. When a taxpayer discovers an interpretation error, the general rule is that the error must be corrected by making a voluntary disclosure proposing a reassessment of the incorrect return. Interest and penalties may apply.
3.33 Some of those who responded to the discussion document, Making Tax Simpler – Better administration of PAYE and GST, supported the proposal that there should be an ability to correct genuine PAYE errors in a subsequent return, up to a threshold or cap. A provision exists in section 113A of the Tax Administration Act 1994 whereby taxpayers can correct genuine errors, occurring in certain other tax types in a subsequent return, up to a cap of $1,000 per return.
3.34 A limit or cap of $1,000 per payday return for a large employer with several payrolls could amount to a very significant total in a year and could obscure systematic problems in the employer’s tax treatment of payroll.
3.35 In addition, the possibility of shorter assessment periods for some social policy entitlements and obligations has been raised. If those proposals go ahead, a non-trivial tax treatment error could detrimentally affect an employee’s social policy entitlements and obligations if it was all reported in a subsequent payday return.
Since starting a new job in April, Phil and his family have lived in a house supplied by his employer at a rent $150 a week below the market rent. The employer has not included the $150 in his gross income. After six months the error is picked up by the tax agent, at which time $3,900 in gross income has gone unreported. At Phil’s salary the PAYE owing is $1,224.
If the assessment period for Working for Families tax credits and child support reduces from a year to a shorter period, reporting the whole amount in a single payday return could materially reduce Phil’s entitlements or obligations without his available income changing.
3.36 Entitlements and obligations would be similarly affected if instead of his employer having made an interpretation error the employer had underpaid Phil $150 gross over the six-month period. However, in that case, when the underpayment is corrected, Phil would receive a cash lump sum and it is appropriate that his obligations and entitlements should reflect that.
3.37 Ideally, a threshold for interpretation errors would allow small errors to be corrected in a subsequent return while requiring other errors to be corrected by amending previous returns.
3.38 Officials propose that an employer who makes an interpretation error can correct it in a subsequent return provided PAYE on the discrepancy is less than 10 percent of the employee’s total PAYE in that payday return.
3.39 In addition, to ensure that frequent or widespread interpretation errors have visibility, we suggest that employers can only correct interpretation errors in a subsequent return up to an annual threshold of $10,000 a year of PAYE discrepancy for that employer. No threshold is proposed for correcting other error types. The $10,000 is proposed as a limit on upward reassessments arising from interpretation errors, not as a net threshold that allows upward and downward reassessments to be netted off.
3.40 A number of issues relating to PAYE information concerning non-resident employees and non-resident contractors were raised in feedback on Making Tax Simpler – A Government green paper on tax administration, and in response to Making Tax Simpler – Better administration of PAYE and GST.
3.41 This issues paper does not put forward any special rules in relation to the correction of errors in employment income information relating to these taxpayers. To the extent that the suggested changes would allow more flexibility around error correction, the employers of non-resident employees and contractors should also benefit. A number of specific issues are, however, being worked through separately in an effort to address specific concerns that have been raised relating to non-resident employees and non-resident contractors.
3.42 As with other tax types, interest on interpretation errors corrected by amending previous returns, would continue to apply, as would exposure to late payment and, if warranted, shortfall penalties.
- In your experience what issues most often give rise to interpretation errors?
- How do you or your payroll system, currently correct interpretation errors?
- If you consider that thresholds for allowing interpretation errors in a subsequent return should be set at different values or on a different basis to that suggested here, please tell us your alternative and explain your reasons.
3.43 The majority of PAYE errors and adjustments are identified and rectified relatively quickly. However, some will inevitably cross tax years, raising the question of whether special rules are required for error correction when the error occurred in a previous tax year. In addition, as noted above, the prospect of shorter assessment periods for social policy also needs to be considered.
3.44 As set out earlier in this chapter, underpayments are reported and taxed when they are paid, regardless of the tax year in which the underpayment occurred.
3.45 If overpayments in a previous tax year are adjusted in an employment income information return relating to a subsequent year, the individual’s record of income with Inland Revenue will reflect the reduction in income in the later year and it will be taxed at that year’s rates. A case can be made that this is appropriate. The employee was taxed on the income they had in the previous year and it is in the current year when they repay the overpayment that they experience the reduction in income.
3.46 When tax rates, thresholds or the individual’s circumstances have changed in the time between when an overpayment occurred and when repayment was agreed, adjusting in a subsequent period can seem unfair.
3.47 Requiring errors which span tax years to be corrected by amending the original returns would, however, not solve the problem. If the assessment for a prior year has been finalised, an employer amending employment income information returns for that year does not automatically prompt a reassessment for the individual. It would be up to the individual to either make the adjustment in a subsequent IR3 or to contact Inland Revenue to discuss their options. This would include requesting the Commissioner to make amendment. Permitting the employer to report and adjust for a payroll error in a subsequent year would at least ensure that the change factors into an assessment.
3.48 If proposals for shorter assessment periods for some social policies are adopted, entitlements and obligations could be based on income in the prior assessment period. In this environment, reporting an overpayment when repayment is agreed will ensure that the change in income feeds through to social policy entitlements and obligations in the following period. This is appropriate as it is when the available (net) income is reduced by the requirement to make repayment(s).
3.49 If the employer chooses to correct an overpayment error by amending earlier returns, some of the reduction in income may fall outside the social policy assessment period. It is intended, however, that there will be a mechanism whereby material changes affecting prior assessment periods are checked to see if a consequent reassessment of social policy calculations is needed. It is also proposed that an employee adversely affected by error correction in an earlier assessment period could seek to have their social policy entitlement or obligation reconsidered.
3.50 Officials suggest that employers should be permitted to report payroll overpayment errors relating to a previous tax year in a subsequent return.
3.51 If employers are permitted to correct overpayment errors relating to a previous tax year in a subsequent return, there does not appear to be good reason why they should not be allowed to remedy interpretation errors up to the relevant thresholds, in the same way.
- Can you estimate how often you correct overpayments or interpretation errors relating to a prior tax year? How do you report them?
- Do you agree with the proposal that employers should be able to report overpayment and interpretation errors relating to a previous tax year in a current-year payday return?
- If you have issues or concerns with the above proposal for an employee or an employer please tell us about them.
3.52 The suggested changes in this issues paper will not change an employer’s obligations if an employee has made an error in the information they have provided to their employer. For example, under payday reporting, the Bill proposes that the employer will only be required to action tax code changes from the next time they run the payroll. There is no obligation on the employer to go back and “correct” earlier periods.
3.53 Under payday reporting, it is intended that a separate IR345 (“employer deduction form” or EDF) would no longer be required to accompany payment of PAYE. This change would not be introduced until the processing of PAYE and related social policy administration occurs completely within Inland Revenue’s new computer system, which will not be before early 2020. This change would require that information about total ESCT, which is currently reported on the EDF, is added to the employment income information that is reported each payday.
3.54 Officials are aware that the current aggregated reporting of ESCT creates problems. For example, when an employer is due a refund of PAYE, the associated ESCT needs to be separately calculated and notified to Inland Revenue. In addition, because Inland Revenue cannot see the amount of ESCT withheld for each employee, it can be difficult to monitor that the employer is making appropriate KiwiSaver contributions.
3.55 To alleviate these problems, officials suggest that employers should be required to report the amount of ESCT withheld for each employee in their payday returns of employment income information.
- Do you support the proposal that instead of reporting total ESCT in the EDF (IR345) the amount of ESCT withheld is reported in the payday reports of employment income information at the employee level?
3.56 Inland Revenue’s new computer system, and the redesign of PAYE processes, provide an opportunity to eliminate other reasons for contact from Inland Revenue. If employers could notify Inland Revenue, using a checkbox or drop-down menu when something unusual was happening, it should reduce unnecessary contacts. For example, for some employees the employer’s KiwiSaver contribution is subject to PAYE not ESCT and it would help if the employer could indicate this. Only one notification should be required per employee.
- Do you support the greater use of one-off notifications, such as the one discussed above relating to KiwiSaver being subject to PAYE, to reduce contact from Inland Revenue?
3.57 Error correction often involves a trade-off between accuracy and cost. The changes suggested in this chapter would allow different approaches for reporting errors, overpayment errors and interpretation errors. An employer concerned about the complexity of distinguishing between different error types could, however, choose to correct all of these errors by amending the previous returns.
- Would you find the proposed changes unduly complex? If so, how would you simplify them?
7 The Taxation (Annual Rates for 2017–18, Employment and Investment Income, and Remedial Matters) Bill, introduced to Parliament in April 2017.
11 The Wages Protection Act 1983 identifies limited circumstances in which employee agreement is not required, such as when there has been unauthorised absence or a strike and the process followed meets the legislative requirements.
13 For discussion of overpayments that cross tax years and the implications of the proposed reductions in assessment periods for some social policies see the section on “errors and adjustments relating to a previous assessment period”.
17 Making Tax Simpler – Better administration of social policy, Chapter 3.