Report

by the Comptroller
and Auditor General

HM Revenue & Customs

Administration of Welsh Income Tax 2017-18

HC 1869 Session 2017–2019 24 January 2019

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The National Audit Office scrutinises public spending for Parliament and is independent of government. The Comptroller and Auditor General (C&AG), Sir Amyas Morse KCB, is an Officer of the House of Commons and leads the NAO. The C&AG certifies the accounts of all government departments and many other public sector bodies. He has statutory authority to examine and report to Parliament on whether departments and the bodies they fund, nationally and locally, have used their resources efficiently, effectively, and with economy. The C&AG does this through a range of outputs including value-for-money reports on matters of public interest; investigations to establish the underlying facts in circumstances where concerns have been raised by others or observed through our wider work; landscape reviews to aid transparency; and good-practice guides. Our work ensures that those responsible for the use of public money are held to account and helps government to improve public services, leading to audited savings of £741 million in 2017.

Report by the Comptroller and Auditor General

Ordered by the House of Commons
to be printed on 23 January 2019

This report has been prepared under Section 6 of the National Audit Act 1983 for presentation to the House of Commons in accordance with Section 9 of the Act

Presented to the National Assembly for Wales pursuant to Section 116K of the Government of Wales Act 2006, as amended by the Wales Act 2014

Sir Amyas Morse KCB
Comptroller and Auditor General
National Audit Office

21 January 2019

The Wales Act 2014 amended the Government of Wales Act 2006 to give the National Assembly for Wales the power to set Welsh rates of income tax that will apply to the non-savings non-dividend income of Welsh taxpayers from the 2019-20 tax year onwards.

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006698 01/19 NAO

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Simon Wakefield and Matthew Derrick, under the direction of John Thorpe.

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Summary

Introduction

1 The Wales Act 2014 amended the Government of Wales Act 2006 to give the National Assembly for Wales (the Assembly) the power to set Welsh rates of income tax that will apply to the non-savings non-dividend income of Welsh taxpayers from the 2019-20 tax year onwards.

2 From April 2019, the United Kindgom (UK) basic, higher and additional income tax rates will be reduced by 10 percentage points and the Assembly will use its powers to determine the Welsh rates that will replace them. The sum of the reduced UK rates and the new Welsh rates will determine the overall rate of tax paid by Welsh taxpayers. For 2019-20, the Welsh Government has proposed rates equal to the reduction in the UK rates: 10 percentage points (Figure 1).

3 HM Revenue & Customs (HMRC) is currently implementing the Welsh rates of income tax. This involves making changes to a range of IT systems that support tax assessment and collection, taxpayer communications and financial reporting functionality. It also needs to develop a Welsh taxpayer population from existing taxpayer records to ensure that the right amount of tax is collected from individuals and allocated to the appropriate government. HMRC planned to communicate with taxpayers before the beginning of the 2019-20 tax year to inform them of the changes.

4 Once implemented, HMRC will administer and collect income tax from Welsh taxpayers as part of the UK tax system. It will pay over revenues arising from the Welsh rates of income tax to HM Treasury in the same way that it does for all other tax receipts. HM Treasury is responsible for the payment of the Welsh income tax to the Welsh Government.

5 Each year, HMRC will report its estimate of revenue attributable to the Welsh rate provisions as part of its annual report and accounts, published following the end of the financial year. The first estimate of revenue for 2019-20 is expected to be published in July 2020, and the final outturn will be presented as part of the 2020-21 annual report and accounts expected to be published in July 2021.

6 The revenue must initially be estimated because the total income tax liabilities are not known until all Pay As You Earn (PAYE) taxpayer accounts are reconciled and income tax liability data are collected from Self Assessment taxpayers, which can take up to 10 months after the end of the tax year.

Remit of the Comptroller and Auditor General

7 The Government of Wales Act 2006, as amended by the Wales Act 2014, requires the Comptroller and Auditor General (C&AG) to prepare a report for each financial year on:

the adequacy of any of HMRC’s rules and procedures put in place, in consequence of the Welsh rate provisions, for the purpose of ensuring the proper assessment and collection of income tax charged at rates determined under those provisions;

whether these rules and procedures are being complied with;

the correctness of the sums brought to account by HMRC which relate to income tax which is attributable to a Welsh rates resolution; and

the accuracy and fairness of the amounts which are reimbursed to HMRC as administrative expenses.

8 This is the first report prepared under these responsibilities and covers the activities of HMRC before the introduction of the Welsh rates of income tax in April 2019. It provides:

an overview of HMRC’s approach to the administration of devolved taxes in the context of the UK tax system (Part One);

our findings from reviewing the Welsh rates of income tax implementation project, including key events and timings (Part Two); and

details of the cost of administering Welsh income tax, including whether the amounts are accurate and fair (Part Three).

9 This report does not consider the correctness of sums brought to account in relation to the Welsh rates of income tax, the adequacy of the rules and procedures put in place by HMRC or whether these rules and procedures have been complied with. These will be covered in later reports once the Welsh rates of income tax have been implemented. Appendix Three sets out our audit approach and methodology.

Key findings

10 HMRC has established a project governance structure within its wider devolution and change programme and it is engaging with Welsh Government representatives across the full range of project activities. The Welsh Government is represented throughout the project structure, including boards below the project board (paragraphs 2.5 and 2.6).

11 The project team has responded positively to the findings from project assessments. An internal health check review, completed in March 2018, rated the project ‘amber’ and raised a number of recommendations – all of which have since been actioned. The joint project assessment review, completed by independent Welsh Government and HMRC reviewers in October, has improved the project rating to ‘amber-green’, reporting that good progress has been made since the end of 2017-18 and successful delivery is likely if project risks are managed effectively (paragraphs 2.7 to 2.10).

12 HMRC completed a ‘lessons learned’ exercise from the implementation of Scottish income tax but it has not produced the proposed action plan to implement these lessons. HMRC has instead relied on both the inclusion of staff in the Welsh project team who have experience of Scottish implementation, and the continuity of wider stakeholder contacts inside and outside the department, to deliver improvements. We will examine whether HMRC has effectively implemented these lessons as part of our 2018-19 report (paragraphs 2.11 to 2.14).

13 HMRC has designed the IT systems changes and it is now developing and testing these changes before they go live in March 2019. The IT solution relies heavily on functionality introduced as part of the Scottish income tax project. This functionality was deliberately designed to be flexible to incorporate future devolution arrangements. As a result of using existing IT functionality, HMRC has reduced the risk of implementing the Welsh rates of income tax (paragraphs 1.10, 1.11, 2.15 and 2.16).

14 HMRC developed an appropriate approach to identifying Welsh taxpayers, which it planned to implement before the notification letter was issued in November. It is not possible to provide full assurance over the completeness of a tax base and there is no definitive list of Welsh taxpayers that HMRC can use to assure the Welsh taxpayer population. However, HMRC’s approach, which includes the cleansing of existing taxpayer records and the use of third-party data to corroborate these records – rather than just relying on the data it already holds – will provide greater assurance over the completeness and accuracy of the Welsh taxpayer population if it has been implemented as planned (paragraphs 2.21 to 2.24).

15 A communications strategy is in place that recognises the need for bilingual support. Following the approval of this strategy in March 2018, HMRC developed plans to communicate with a diverse range of external audiences including employers, pension providers and other businesses that deliver payroll-related services. The bilingual notification letter for individual taxpayers was developed with the Welsh Government. It explains the changes to Welsh income tax and provides links to further information. It was issued in November 2018 (paragraphs 2.26 to 2.28).

16 In 2017-18, HMRC incurred and recharged £0.34 million of costs for implementing the Welsh rates of income tax. Based on our procedures, we have concluded that the amount repaid by the Welsh government for the year ended 31 March 2018 is accurate and fair (paragraphs 3.2 to 3.3).

Part One

The administration of devolved taxes

1.1 Part One of this report includes an overview of the mechanics of the UK tax system, explaining where and how devolved taxpayers are identified and how HM Revenue & Customs (HMRC) administers and controls these processes.

1.2 This part of the report covers:

the key features of the income tax system in the UK (paragraphs 1.3 to 1.9); and

modifications that have been made to the income tax system to incorporate devolved taxes (paragraphs 1.10 and 1.11).

The income tax system

1.3 The income tax system is consistent across the UK. Depending on the type of income that an individual receives, income tax will be assessed and collected by employer’s deductions from earnings through Pay As You Earn (PAYE), the taxpayer submitting a Self Assessment return, or both.

1.4 The PAYE and Self Assessment processes have common principles, despite utilising different IT systems and data sources to assess and collect tax. Figure 2 identifies these principles and describes the main processes for each income tax stream.

1.5 Taxpayer information is submitted to HMRC through several channels. For PAYE, employers and pension providers complete monthly data submissions containing information about individuals’ earnings, pension payments and tax deductions. Self Assessment taxpayers complete an annual submission containing details of all the income they have received during the tax year.

1.6 The submissions processing systems complete data validation checks and then route the information to the appropriate tax processing system. A matching function identifies the relevant taxpayer record and stores the new data or updates the existing information in the relevant database.

1.7 The tax processing system consolidates all the available data to produce a total income figure for each taxpayer and calculates the associated income tax liability using the relevant business rules.1 The output from the income tax liability calculation is then stored on the appropriate taxpayer record.

1.8 The calculated tax liability is compared with the amounts deducted at source or collected from taxpayers directly through payments on account. The reconciliation determines whether the correct amount of tax has been collected. Where tax has been underpaid, this will be collected from the taxpayer and overpaid tax will be refunded.

1.9 Tax codes are recalculated based on the latest tax liability data and, if necessary, HMRC will update the tax code for the forthcoming tax year by issuing a coding notice to the taxpayer and the employer.

Devolved income tax

1.10 The administration of devolved taxes diverges from the UK processes only in the business rules that the system applies when completing the tax liability and tax code calculations. These rules are as follows:

The system checks the residency status of the individual and applies or removes a tax code prefix or flag if they are subject to devolved taxes.

The tax code prefix or flag determines which set of tax rates and bands are applied to the reported income to calculate the liability for the current tax year.

If an individual taxpayer is enrolled on a PAYE scheme, the system uses the tax code prefix to determine which income tax rates and thresholds are used to calculate a new tax code for the following year.

Figure 3 shows where these divergences occur within the income tax system.

1.11 The correct application of these business rules is dependent on the completeness and accuracy of address data that HMRC holds for each taxpayer, and the maintenance of a master list of UK addresses that confirms which country they are in.

1 Business rules contain data relevant to the calculation of tax liabilities and they are used by each tax processing system to calculate income tax liabilities based on income data. The rules include, but are not limited to, the application of tax codes and the rates and thresholds that apply to each type of income based on residency. Business rules are updated annually to reflect changes in tax policy.

Part Two

Implementing the Welsh rates of income tax

2.1 At the time of this report (January 2019), the implementation of the Welsh rates of income tax is ongoing and key elements of the project are being, or have yet to be, delivered. Although we are unable to comment on the effectiveness of HM Revenue & Customs’ (HMRC’) preparations until after implementation, we can comment on HMRC’s planned approach to the project and the progress it has made so far.

2.2 This part of the report covers:

an overview of the project timeline (paragraphs 2.3 and 2.4);

the governance arrangements for the project, including HMRC’s response to assurance reviews and its engagement with the Welsh Government (paragraphs 2.5 to 2.10);

the lessons HMRC has learned from implementing Scottish income tax (paragraphs 2.11 to 2.14);

an overview of the IT delivery needed to implement the Welsh rates of income tax (paragraphs 2.15 and 2.16);

how a Welsh taxpayer is defined and HMRC’s strategy for identifying Welsh taxpayers (paragraphs 2.17 to 2.24); and

HMRC’s communications strategy (paragraphs 2.25 to 2.28).

Project timeline

2.3 The project was initiated in April 2017 and activity in 2017-18 has focused on establishing the requirements of the project and developing workstream strategies for the successful implementation of the Welsh rates of income tax.

2.4 In 2018-19, HMRC has been implementing these plans. Development of the IT solution commenced in June 2018. At the same time, work began on the cleansing of taxpayer address records in preparation for the notification letter being issued to identified Welsh taxpayers in November. Figure 4 provides an overview of the project’s key events.

Governance and Welsh Government engagement

2.5 Figure 5 outlines the governance arrangements for the project. The Welsh Government has representation on the project board and each sub-board or group. The project documentation we have reviewed reflects a high level of involvement from Welsh Government representatives in discussing and challenging the plans put forward by HMRC and a positive, active response from HMRC to the matters raised.

2.6 It is also evident that discussions have occurred frequently outside formal meetings to provide background briefings and updates, reflecting a good ongoing relationship. This has been supported by HMRC establishing part of the project team in Cardiff to increase in-person communication.

2.7 To support the governance of the project, an independent HMRC team conducted a project health check in March 2018.2 The review resulted in a report that was issued on 14 March 2018 and the team’s responses to the recommendations were discussed at the May project board.

2.8 The review provided a delivery confidence assessment (DCA) of ‘amber’3 and raised thirteen recommendations for action by the project team. Five of these recommendations were rated ‘Critical’,4 covering compliance with expected best practice for project requirements and project planning. Since the end of 2017-18, all the recommendations have been acted on by the project team.

2.9 A more detailed project assessment review (PAR)5 was completed in 2018-19 by a joint HMRC and Welsh Government review team and provided an improved DCA of ‘amber-green’6 when it was issued in October. The report noted that “considerable progress has been made since the Health Check carried out in March 2018. The problems identified in that review have been largely addressed and the project is now in a much better place.”

2.10 We will return to the findings of the October PAR in our 2018-19 report because they largely relate to activities undertaken following 2017-18 – the year to which this report relates. Appendix One provides a summary of all the recommendations made as part of the health check and the PAR.

Learning from Scottish income tax

2.11 This is the second devolved income tax project that HMRC is implementing. In July 2017, the project team held a ‘lessons learned’ event with staff involved in the implementation of Scottish income tax.

2.12 This event identified a number of lessons around four themes that would be implemented and monitored in an action plan. The themes were:

project requirements;

project management;

communications; and

finance.

Appendix Two sets out the specific lessons HMRC identified for each theme.

2.13 The health check review performed in March 2018 identified that none of those lessons had been included in the required project documentation. Although the documentation has now been updated, HMRC has not been able to provide us with the action plan referred to in the project documentation to demonstrate active management and monitoring of those lessons by project management to support the delivery of the Welsh rates of income tax.

2.14 HMRC has instead relied on both the inclusion of staff in the Welsh project team who have experience of Scottish implementation, and the continuity of wider stakeholder contacts inside and outside the department, to deliver improvements.

IT delivery

2.15 In 2017-18 HMRC moved through the early phases of IT delivery: scoping the project and designing the high-level solution – including mapping system dependencies and impacts across the wider IT estate and the minor changes required to Department for Work & Pensions systems. Since then, HMRC has progressed into detailed solution design, development and testing. Figure 6 provides a summary of progress to date.

2.16 As we have highlighted in Part One of this report, HMRC has already modified existing IT systems to support the delivery of devolved income taxes. This reduces the complexity, cost and risk of implementing the Welsh rates of income tax.

Welsh taxpayers

2.17 A Welsh taxpayer is someone with a tax liability whose main place of residence in a given tax year is Wales, or who spends most of that tax year living in Wales.7 There are a number of specific cases whereby a taxpayer would always be deemed Welsh. HMRC is responsible for determining whether someone is a Welsh taxpayer. Figure 7 provides an overview of the rules used to determine residency.

2.18 Based on the latest Survey of Personal Incomes8 published in May 2018, HMRC estimates that there are 1.35 million Welsh taxpayers in 2017-18.9

Identifying Welsh taxpayers

2.19 Identifying the Welsh taxpayer population is the main challenge to HMRC in implementing the Welsh rates of income tax. To ensure that taxpayers are correctly notified of their Welsh status and that the right amount of tax is collected from individuals and allocated to the appropriate government, it is essential that address information is correct.

2.20 In 2017-18 the taxpayer identification sub-group developed a taxpayer identification strategy and this was discussed regularly by all parties during the first half of 2018, receiving agreement from the project board at their June meeting.

2.21 The strategy sets out three main steps to the initial identification of the Welsh taxpayer population:

Identify all Welsh addresses and compile a master record of the relevant postcodes of these addresses using Office for National Statistics (ONS) data and mapping information.

Cleanse the addresses contained in existing taxpayer records to ensure that they are in a consistent format to faciliate automated processing of residency.

Compare both the above data sets and update taxpayer records with the appropriate flag when a Welsh address is identified.

2.22 HMRC has also proposed a series of third-party data exercises that should provide greater assurance that the addresses HMRC holds for individual taxpayers are up to date. When third-party data suggest that an individual may be resident in Wales but HMRC holds an address outside Wales, HMRC will contact the individual to prompt confirmation of address.

2.23 It is not possible to provide full assurance over the completeness of a tax base and there is no definitive list of Welsh taxpayers that HMRC can use to check their Welsh taxpayer population. In this context, we are content that the strategy for taxpayer identification proposed by HMRC responds to the risk of not properly identifying Welsh taxpayers from the records it holds, either through:

incomplete or poorly formatted address data in HMRC systems; or

from holding incorrect addresses for individual taxpayers.

2.24 Taxpayer identification was due to be completed in advance of the notification letter being issued in November 2018. Our 2018-19 report will consider how HMRC has implemented this approach to taxpayer identification and any findings from our review of those processes. However, HMRC has confirmed that around 10,000 taxpayer records were not cleansed before the notification letter was issued. When these records have been cleansed, any Welsh taxpayers that are identified will receive a tax code letter as part of HMRC’s normal processes informing them of their status.

Communications

2.25 In 2017-18 the project team, led by the communications sub-group, developed a communications strategy to support successful completion of the project. The strategy incorporates high-level plans for audiences internal and external to HMRC and it was approved by the project board in March 2018.

2.26 Following the approval of the strategy, HMRC began developing their stakeholder mapping and external communications plans to engage with a wide range of audiences through a number of channels. Figure 8 provides a summary of some of the activities being undertaken for key external stakeholders.

2.27 The Welsh taxpayer notification letter has been developed in conjunction with the Welsh Government. It is bilingual and explains the changes being introduced. It also provides links to further information. Each letter also includes a flyer from the Welsh Government. The letter was posted to identified Welsh taxpayers in November 2018.

2.28 The PAR in October 2018 has resulted in two ‘Critical’ recommendations relating to external stakeholder engagement plans and the accountability and resourcing of those plans. The details are included in Appendix One.

2 The health check was completed by three members of HMRC’s change, assurance and investment team and covered the project’s governance, capacity, capability, risks, issues, and plans and progress to date. It also explored engagement with the Welsh Government and lessons learned from Scottish income tax implementation.

3 The report defines an ‘amber’ rating as: ‘Successful delivery appears feasible but significant issues already exist requiring management attention. These appear resolvable at this stage and if addressed promptly, should not present a cost or schedule overrun’.

4 Recommendations in the report are prioritised, from highest priority to lowest, as either ‘Critical’, ‘Essential’ or ‘Recommended’. ‘Critical’ recommendations require immediate action.

5 The PAR was completed by two members of the change, assurance and investment team in HMRC and a reviewer from the Welsh Government’s integrated assurance hub. The review has a wider and more detailed scope than the Health Check. The review team was led by an Infrastructure and Projects Authority-accredited reviewer to evaluate governance, project delivery, readiness for live service and value for money, and the scope included a wide range of project-specific questions, including a follow-up of health check recommendations.

6 The report defines an ‘amber-green’ rating as: ‘Successful delivery appears probable. However, constant attention will be needed to ensure risks do not materialise into major issues threatening delivery’.

7 This definition therefore excludes individuals who earn less that the personal allowance or those, for other reasons, who have income but no tax liability – for instance, because they have claimed a relief that reduces their potential liability to nil or had no taxable income during the year.

8 The Survey of Personal Incomes is based on a sample of information held by HMRC on individuals who could be liable to UK income tax. It is carried out annually by HMRC and covers income assessable to tax for each tax year. The data it gathers are used to construct an evidence base to inform policy analysis, national statistics, tax modelling and forecasting. Although it is reasonably accurate at a UK level, it is less robust for regional analysis because of the sampling methodology it employs.

9 Table 2.2, Number of income taxpayers by country, Income tax liabilities statistics: tax year 2015 to 2016 to tax year 2018 to 2019, HMRC, May 2018.

Part Three

Costs

3.1 This part considers the administrative costs of Welsh income tax, and whether these costs are reasonable.

Costs incurred in 2017-18

3.2 In 2017-18, HMRC incurred and recharged £0.34 million of costs on the implementation of Welsh income tax. HMRC recharges costs that can be validated as specifically related to the administration of devolved Welsh income tax and not the costs of administering the overall income tax system in Wales.

3.3 We examined HMRC’s method for estimating the costs of collecting and administering the Welsh rates of income tax for the year to ensure that this was reasonable in the context of the agreement with the Welsh government. Based on our procedures, we have concluded that the amount repaid by the Welsh government for the year ended 31 March 2018 is accurate and fair.

Appendix One

Summary of recommendations raised by project assurance reviews to date

Appendix Two

Lessons identified from the implementation of Scottish income tax

Appendix Three

Our audit approach

1 Section 116K of the Government of Wales Act 2006, as amended by the Wales Act 2014, requires the Comptroller and Auditor General (C&AG) to prepare a report for each financial year on:

the adequacy of any of HMRC’s rules and procedures put in place, in consequence of the Welsh rate provisions, for the purpose of ensuring the proper assessment and collection of income tax charged at rates determined under those provisions;

whether these rules and procedures are being complied with;

the correctness of the sums brought to account by HMRC which relate to income tax which is attributable to a Welsh rates resolution; and

the accuracy and fairness of the amounts which are reimbursed to HMRC as administrative expenses.

2 Due to the timing of this report, prior to the implementation of the Welsh rates of income tax, we have not reported or concluded on the first three of the statutory responsibilities because they are not yet applicable. This report only provides assurance over the accuracy and fairness of amounts reimbursed to HMRC.

3 In relation to administration costs, our conclusion on the accuracy and fairness of the costs charged to the Welsh Government is based on an evaluation of the costs against the details of the Memorandum of Understanding between the Welsh Government and HMRC. During the audit, we also obtained evidence that both parties regularly discuss and review the cost budgets and forecasts as well as agreeing the amounts to be invoiced and paid. These audit procedures have been planned, performed and reviewed in accordance with the National Audit Office’s internal quality control procedures for financial audit.

4 To inform the other findings of this report, we have reviewed published and unpublished HMRC documents about the Welsh rates of income tax, including project documentation, risk documentation and the results of key assurance work performed by the department.

5 This document review has been supplemented by discussions with HMRC staff. We also spoke to the Wales Audit Office to inform our risk assessment and planning work for this report.

6 We reached our findings following our analysis of evidence collected between June and November 2018.

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