Ministers have clarified the tax situation for low income workers who claim a Test and Trace Support Payment of £500.

Labour MP Maria Eagle put forward a written question for the Treasury asking whether people in receipt of the Test and Trace Support Payment will have a change applied to their PAYE code as a result of that payment having been made.

Conservative MP Jesse Norman, financial secretary to the Treasury, answered the question and said that test and trace payments are linked to employment, and the legislative default is that these payments are liable to income tax.

This is in line with the tax treatment of other Covid-19 support payments.

Norman said: “HM Revenue and Customs will use existing powers to gather data from local authorities on the payments made through this scheme. This information will be used to adjust the tax codes through the employer’s PAYE scheme for employees receiving Test and Trace Support Payments.”

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Support payments are normally liable to national insurance contributions (NICs), but the UK government has granted a NICs exemption in England to reduce the administrative burden on the local authorities making the Test and Trace Support Payments and employers.

The government is also working with the devolved administrations to extend this NICs exemption to the equivalent schemes in Wales, Scotland and Northern Ireland.

The Low Incomes Tax Reform Group (LITRG) wants the government to make the £500 support payments free from income tax. It says this will make them simple for people to understand and less expensive to administer.

Victoria Todd, head of LITRG, said: “We suggest the government reviews its decision to tax its payments. If they are paid gross by the local authority, recipients’ tax affairs could be vastly complicated. It is not clear how claimants of the payment will be informed about the potential tax liability.

“If a taxpayer is employed, HMRC will most likely try and collect the tax due by adjusting their PAYE code. Collecting tax in this way can lead to confusion if the person does not understand why the tax taken from the other source of income is higher than expected.

“The PAYE coding facility does not always work well. Codes can be fiendishly complicated to understand and check – and because tax is collected on an estimated basis, you may not have paid the right tax overall by the end of the tax year.

“If insufficient tax is paid, for example because someone loses their job, we believe that HMRC will try to identify and tax the payment in the end of year reconciliation process. This could leave individuals with an unexpected tax debt.”

Jane Gilbert, head of the payroll division at accountancy firm Nordens, said: “Having your tax code changed can mean a number of things – if your tax code increases you pay less tax, and if your tax code decreases you pay more tax.

“The current tax code for this tax year is 1250L, which means your personal tax allowance is £12,500. It’s neither a good or bad thing if it’s been changed by HMRC. A decrease in your tax code means you have either underpaid tax in the past, you have a second job or additional income. Should there be an increase in your tax code, it means if you’ve overpaid tax previously.”

Test and Trace Support Payments were introduced on 28 September. To get the payment people need to meet the following criteria:

• Told by NHS Test and Trace that they are required to self-isolate
• Employed or self-employed
• Unable to work from home and will lose income as a result
• Currently receiving Universal Credit, Working Tax Credit, Income-Based Employment and Support Allowance, Income-Based Jobseeker’s Allowance, Income Support, Housing Benefit and/or Pension Credit.