Sarah Bradford outlines the exemption for paid and reimbursed expenses, and highlights some traps to avoid.
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Employees often need to incur expenses to do their work. The employer may meet the expense directly or the employee may incur the expense from the outset and reclaim the amount back from the employer.
From a tax perspective, all expenses are not equal, and it is important that both employers and employees understand when expenses can be paid or reimbursed tax-free.
Exemption for paid and reimbursed expenses
The tax legislation contains a dedicated exemption for paid and reimbursed expenses. It applies where an employer pays or reimburses an expense and the employee would, if they met the cost themselves, be allowed a deduction for an amount that is at least equal to the amount paid or reimbursed by the employer. However, the exemption only applies where the payment or reimbursement is not provided pursuant to a relevant salary sacrifice.
The key test here is whether the employee would be entitled to a deduction from their earnings if they met the cost. For this to be the case, the expense must either qualify for a deduction under the general rule, or be an expense of a type for which a specific deduction is permitted. If the expense would not be deductible if met by the employee, any reimbursement is taxable.
General rule for deduction of expenses
An employee can claim a deduction from their earnings for an expense if they are obliged to incur and pay it as the holder of the employment, and the expense is incurred wholly, exclusively and necessarily in the performance of the duties of the employment.
This is a notoriously difficult test to meet, and there are several points to note.
Firstly, the test is an objective one – a deduction is only permitted if each and every holder of the employment would need to incur the expenses. The test looks at the requirements of the job rather than those of the individual doing the job. The fact that the employee incurs the expense and it is work-related is not in itself enough.
For example, if an employee is provided with protective boots for work but finds them uncomfortable and buys another pair themselves, even though the boots are for work, the employee would not be entitled to a deduction – the individual has chosen to incur the expense; it is not one all jobholders would need to incur. An expense is only necessarily incurred if all jobholders would be required to incur it.
A distinction is also drawn between expenses incurred ‘in’ the performance of the duties of the employment and those incurred in putting the employee in a position to perform the duties of the employment. For example, an employee with young children may need to incur childcare costs to be able to do their job, but the expenses are incurred to put the employee in a position to carry out the duties of the employment rather than in performing them, so a deduction is not forthcoming.
A deduction is only given for expenses incurred wholly and exclusively in the performance of the duties of the employment. If an expense has a private and a business purpose, such as clothes worn to work, a deduction is denied. This is the case even if the employee only wears the clothes to work, as they still deliver the private benefit of providing warmth and decency. Where it is possible to split an expense between the private part and the business part, a deduction is allowed for the business element.
When reimbursing employee expenses, it is important to understand the general rule and to ensure that the tests have been met before making the reimbursement tax-free.
Travel expenses
Travel expenses are probably the most common item on employee expense claims. It is vital, therefore, that employers understand when these can be reimbursed tax-free. Again, the test is whether the employee would be eligible for a deduction if they met the expenses themselves.
Travel expenses have their own rules – the general rule does not apply. While the rules are quite complex, in broad terms a deduction is permitted for travel expenses incurred in the performance of the duties of the employment and for travel expenses that are attributable to the employee’s necessary attendance at any place in the performance of the duties of the employment.
For example, if the employee is required to attend a meeting at a customer’s premises, the cost of travel to the meeting would be deductible if incurred by the employee. Where this is the case, if the employer paid for the travel (say) by booking and paying for a taxi, there would be no tax to pay on the provision of the travel. Likewise, if the employee initially met the cost of (say) purchasing a train ticket for the journey, and later claimed this back from the employer, the reimbursement can be made free of tax as the conditions for exemption are met. As long as the deductibility test is satisfied, the exemption applies – there is no requirement for the employee to travel by the cheapest means.
However, (subject to very limited exceptions) the exemption does not apply if the employer meets the cost of the employee’s travel between home and work (known as ‘ordinary commuting’). Travel of this nature is not incurred in performing the duties of the employment; rather, it is travel to enable the employee to perform those duties and is private rather than business travel.
Fees and subscriptions
The tax legislation also allows employees to deduct certain fees and subscriptions. A deduction is available for the amount paid in respect of a professional fee where the duties of the employment involve the practice of the profession to which the fee is related and the registration, certification, licensing or other matter in respect of which the fee is payable is a condition, or one of alternative conditions, that must be met if the profession is to be practised by the employee in performing the duties of the employment. The professional fee in question must be one which is listed in the table in ITEPA 2003, s. 343(2). A deduction is also permitted for an annual subscription paid to a body on HMRC’s List 3.
If the employer pays a fee or subscription on an employee’s behalf which would qualify for a deduction if met by the employee, the resulting benefit is tax-free. Likewise, if the employee pays it initially and claims it back, the reimbursement is tax-free.
Scale rate expenses
The employer can use scale rate payments to reimburse expenses tax-free. However, certain conditions must be met.
The employer must have a system in place to check that the employee has actually incurred and paid expenses of a type that are being reimbursed, and there is no reason to suspect that the employee has not incurred the expense or would not be entitled to a deduction had they met the expense themselves. The employer can either use the benchmark rates set out in the Income Tax (Approved Expenses) Regulations 2015 (SI 2015/1948) or agree bespoke rates with HMRC.
Exempt benefits
It should be noted that the exemption only applies to expenses that would be deductible if met by the employee. This is very different to an employee meeting the cost of a benefit that would be exempt if provided by the employer. For example, an employer can provide employees with an annual medical check-up without triggering a tax charge. However, if the employee pays for a medical check-up and claims this back from the employer, the reimbursement would be taxed. This is because the employee is not entitled to a deduction for the cost of a medical check-up – the dedicated exemption only applies where the check-up is provided by the employer.
It is easy to fall into the trap of thinking that because a benefit is exempt if provided by the employer, if the employee incurs the cost and claims it back, any reimbursement will also be tax-free. This is not the case.
Practical tip
When paying or reimbursing employee expenses, check that the employee would be entitled to a deduction if they met the cost themselves. If this condition is not met, the payment or reimbursement will be taxable, unless another exemption is in point.
