Settling tax and NICs using a PAYE settlement agreement

Sarah Bradford explains how a PAYE settlement agreement can be used to settle tax and National Insurance contributions on benefits provided to employees.

Sometimes an employer may wish to meet the tax and National Insurance contributions (NICs) liability that arises on the provision of a benefit to an employee on the employee’s behalf. For example, this may be as a gesture of goodwill to preserve the beneficial nature of the benefit. A PAYE settlement agreement can be used for this purpose.

A PAYE settlement agreement (PSA) is an agreement with HMRC, which allows the employer to meet the tax instead of the employee on the benefits and expenses included within the agreement. As the payment of tax on behalf of an employee is itself a benefit, the tax is payable on the grossed-up value of the benefit. This means that the total tax bill will be higher than if the employees paid the tax themselves.

The employer will also need to pay Class 1B NICs in place of the Class 1A or Class 1 NICs liability that would otherwise arise, and also on the tax payable under the PSA.

HMRC’s Statement of Practice 5/96 sets out what can and what cannot be included with a PSA and how to calculate the tax and NICs payable.

What can be included within a PSA?

A PSA is not for everything. A PSA can only be used for benefits that are minor, irregular or in respect of which it is impracticable to tax individual employees.

(1) Minor benefits

Since the introduction of the exemption for trivial benefits, the demand for a PSA to deal with minor benefits has been reduced. While many ‘minor’ benefits will fall within the trivial benefits exemption, not all will do so, and a PSA can be used to enable the employer to pick up the tab.

Examples of benefits that may be included within a PSA on the basis that they are minor where the trivial benefits exemption is not in point include incentive awards outside the tax exemption, telephone bills, small gifts and vouchers, staff entertainment (such as a ticket to an event) and non-business expenses when travelling overnight on business, which exceed the daily limit.

(2) Irregular benefits

A PSA can also be used to settle the tax and NICs on benefits that are provided on an irregular basis. Essentially, these are benefits that are not provided at regular intervals throughout the tax year and to which the employee has no contractual right.

Whether an item is provided on an irregular basis depends on the facts in each case. Consideration should be given to the nature of the item, the normal frequency of payment and how frequently it was paid to the employee in question. It should be noted that the provision of a benefit to one employee on a regular basis does not preclude a similar benefit from being included within a PSA where it is provided to another employee on an irregular basis.

Examples cited by HMRC of benefits that would fall into this category include qualifying relocation expenses in expenses and benefits in excess of the £8,000 tax-free limit, the cost of attending an overseas conference, the expenses of a spouse accompanying an employee on a business trip abroad or the use of a company holiday flat. One-off gifts that are not minor may also be included under this head.

(3) Impracticable benefits

Benefits can be included within a PSA if it is impracticable for the employer to operate PAYE on a payment or to identify how much of a shared benefit should be attributable to each individual employee. The employer should be able to show that it is not possible to do so without a disproportionate amount of effort or record keeping in relation to the value and nature of the item involved and the number of employees to whom it is provided.

HMRC provide the following examples in SP 5/96 of benefits that may be included on this basis: free chiropody care, hairdressing services, shared use of the firm’s bus to work (where the associated exemption does not apply), Christmas parties and similar entertainment that fall outside the exemption for annual parties, and shared taxis home which do not qualify for the late night taxi exemption.

What can’t be included?

A PSA cannot be used to meet the tax and NICs liability arising in respect of wages and salary payments, high-value benefits such as company cars, and cash payments such as bonuses, round sum allowances, and beneficial loans.

Effect of a PSA

Where a PSA is in place, the employer does not need to report the benefit on the employee’s P11D or payroll it. The employee pays no tax. Instead, tax and Class 1B NICs are payable under the PSA.

Agreeing a PSA

A new PSA can be set up by writing to HMRC setting out the benefits and/or expenses to be included.

Once HMRC have agreed the scope of the PSA, they will send the employer two draft copies of form P626, which need to be signed and returned. HMRC will send one back authorised. This forms the PSA.

A PSA needs to be agreed by 6 July after the first year for which it is to apply.

An enduring agreement

A PSA is now an enduring agreement and does not need to be agreed each year; once in place, it remains in place until cancelled or amended by either the employer or HMRC. However, it should be reviewed each year to ensure that it remains current.

Calculating the tax and NICs

The tax and NICs payable under a PSA can be calculated on form PSA1. This can be done online (see www.gov.uk/government/publications/paye-paye-settlement-agreement-psa1).

The tax is payable on the grossed-up value of the benefits, taking account of the employees’ marginal rates of tax. For Scottish and Welsh taxpayers, the appropriate Scottish and Welsh rates of tax should be used in the calculation.

A Class 1B NICs liability (at 13.8%) arises on the value of benefits that would otherwise be liable to Class 1 or Class 1A NICs, and also on the tax due under the PSA.

Example: One-off gift to employees

An employer provides 500 employees with a one-off gift costing £100 in celebration of the company’s tenth anniversary. The gift falls outside the trivial benefits exemption. The employer wishes to meet the tax liability arising and agrees a PSA with HMRC on the basis that the item is provided irregularly.

Of the 500 employees to whom the gift is provided, 370 pay tax at the basic rate, 125 pay tax at the higher rate and 5 pay tax at the additional rate.

The tax due is calculated as follows: £ £

Value of benefits provided to basic rate employees

(370 x £100) 37,000

Tax due @ 20% (£37,000 @ 20%) 7,400

Grossed up tax (£7,400 x 100/(100-20)) 9,250

Value of benefits provided to higher-rate employees

(125 x £100) 12,500

Tax due @ 40% (£12,500 x 40%) 5,000

Grossed up value of tax (£5,000 x 100/(100-40)) 8,333

Value of benefits provided to additional rate

employees (5 x £100) 500

Tax @ 45% (£500 @ 5%) 225

Grossed up value of tax 409

Tax due under the PSA 17,992

The Class 1B NICs due under the PSA is calculated

as follows: £ £

Value of items included in the PSA that would

otherwise attract a liability to Class 1A NICs

(500 x £100) 50,000

Tax due under PSA 17,992 67,992

Class 1B NICs @ 13.8% (£67,992 @ 13.8%) 9,393

The tax payable under the PSA is £17,992 and the Class 1B NICs payable is £9,393.

Paying tax

The tax and Class 1B NICs should be paid by 22 October after the end of the tax year to which the agreement relates where payment is made electronically, or by 19 October where payment is made by cheque.

Practical tip:

Consider the use of a PSA where you wish to pay the tax on behalf of employees in order to preserve the beneficial nature of the benefit.