Key points:
- Expenses - why are not all of them allowable for tax?
- Practicalities - without a dispensation, the director or employee must submit a tax relief claim to HMRC.
- Are dispensations a good idea?
- How to apply for a dispensation.
- Real time information – ‘Pseudo pay schemes’ allow for dispensations.
Under current tax law, an employer is required to notify HMRC of all expenses paid to an employee, even if the employee has incurred the expense on the employer’s behalf. It is then up to the employee to make a claim in order to prevent the reimbursement becoming taxable. However, it is by no means automatic that the expense claim will be allowed because there are three hurdles that must be overcome before an employee can obtain a deduction against earnings for any expense incurred (ITEPA 2003, s 336), namely that:
- the employee must be obliged to incur the expense;
- the expense must have been incurred ‘in the performance of the duties’ of the employment; and
- the expense must have been ‘wholly, exclusively and necessarily incurred’ - the important word here is ‘necessarily’ i.e. the expense had to be incurred - it was ‘necessary’ to do so, otherwise the employee would not have been able to do the work.
Practicalities
Even if the expenses were clearly incurred for business reasons,, the totals per employee must be declared on the same form P11D that is used for the annual declaration of any benefits in kind received by an employee if paid more than £8,500 per annum; expenses and benefits provided to employees earning at a rate of less than £8,500 per year are declared on form P9D.
The employee then needs to submit a counterclaim that the amounts declared were ‘wholly, exclusively and necessarily incurred’ for business purposes. This is done by the individual completing a form P87 (Tax relief for expenses of employment) or writing a letter to the tax office or if completing a self-assessment return there is a section to show the amounts. However, if it is clear that a particular type of expense will not give rise to any tax charge on the employee (as it is allowable), then the employer may be best advised to apply to HMRC for a ‘dispensation’. This saves all around, not least for the employer from having to report those expense payments that would otherwise be a matching tax relief claim by the employee.
What is a dispensation?
A dispensation is an agreement between HMRC and the employer which allows the employer to pay agreed, allowable expenses that would fulfil the ‘wholly, exclusively and necessarily’ criteria without the need to submit a report of those expenses. The idea is to cover recurrent expenses that are clearly of a business nature, so long as they have been properly authorised by the employer. The application is by the employer submitting a completed form P11DX - this can be done either by paper or online (www.hmrc.gov.uk/forms/p11dx.pdf).
Key point:
If the company pays or reimburses expenses, HMRC is permitted to charge tax on the amount unless the employee submits a claim or a dispensation exists.
Are dispensations a good idea?
Advantages:
- Dispensations reduce the work involved in completing year end returns.
- Dispensations are not just time saving tools - the reduction in the number of P11D forms to complete (possibly down to nil) also means that they can reduce the company’s risk of being charged a penalty of up to £3,000 where a P11D is submitted and subsequently found to be incorrect.
Disadvantages
- HMRC view dispensations as a temporary concession that can be withdrawn retrospectively if the stated conditions do not accord to facts.
- If a dispensation is agreed then it is important to ensure that it is kept up to date in the light of changing circumstances and legislation.
- The company should always ensure that the expenses are reviewed and authorised independently, and check the Expenses and Benefits Booklet 480 (revised each year) to see if the expense is covered by a different part of the legislation, in case a dispensation cannot be granted (e.g. accommodation) (www.hmrc.gov.uk/guidance/480.pdf ). If there is no reference to the expense in the guidance, it means that the item cannot be included in a dispensation.
- Applying for a dispensation may lead to a compliance review. HMRC have slightly relaxed some of the conditions for granting a dispensation recently, but they may review the dispensation in any business record checks. This is certainly not routinely the case but interest will be awakened if there is doubt in the Inspector's mind about the basic soundness of the PAYE record keeping system. On a visit, HMRC will look at the method of control used to identify expenses that might be taxable. This is to ensure, amongst other things, that if a dispensation were granted and a taxable payment is made within a category of expense covered by the dispensation, it will be picked up and reported on the relevant employee's P11D.
Key point:
Companies can maximise their use of dispensations by regular review of the expenses, subject to a current dispensation, to ascertain whether other expenses being incurred can be included and to ensure that procedures of claim are secure.
How to apply
Typically a dispensation will be available for such items as professional subscriptions and travel and subsistence payments associated with business travel, but it can apply to any item that would be the subject of a valid business expense claim by the employee.
The main expenses routinely covered are:
- Travel and subsistence costs;
- fuel for company cars;
- hire car costs;
- telephones;
- business entertainment expenses;
- credit cards used for business; and
- fees and subscriptions.
Relevant points
- There is a statutory tax exemption for mileage allowance payments made to employees. Mileage allowance payments in excess of the exempt amount are taxable and consequently cannot be included in a dispensation. Dispensations are also not given for ‘round sum’ expense allowances.
- If granted, the dispensation will be effective as from the date granted, but a request can be made to be back dated to the beginning of the year - so it is worthwhile applying at any point in the tax year.
- Even if a dispensation is granted be aware that it does not cover every expense. Furthermore, HMRC is supposed to review them regularly to ensure their validity (HMRC suggests every five years).
Real time information - pseudo’ schemes
Under the new ‘real time information’ process, when applying for a dispensation a ‘live’ PAYE reference is required. However, legally there is no requirement for a scheme to be created where, for example, there is no intention to make wage or salary payments to director/employees.
To get round this problem, HMRC have decided that on request a ‘pseudo’ employer’s record will be created so the dispensation can be applied for - this should help small companies that often apply for PAYE schemes purely to obtain the expenses dispensation. www.hmrc.gov.uk/manuals/pommanual/PAYE20070.htm www.hmrc.gov.uk/manuals/cogmanual/COG907080.htm%20
Practical Tip:
Directors who are the only employee of their private company should consider applying for a dispensation, saving the need to submit a P11D and entries on their self-assessment tax return.
