Income tax paid on behalf of employee

By Tolley in association with Philip Rutherford
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The following Employment Tax guidance note by Tolley in association with Philip Rutherford provides comprehensive and up to date tax information covering:

  • Income tax paid on behalf of employee
  • Introduction
  • Tax-free payments to employees
  • Readily convertible assets
  • Failure to deduct PAYE
  • Special rules for directors
  • Trivial amounts

Introduction

Employers may wish to make payments to an employee / director without deducting tax or, in other words, net of tax. In these instances the employer must gross up the amount of the payment to take account of the tax and NIC. Also, there are instances where certain individuals, often professional sports persons and performers are engaged in a net of tax contract.

Tax-free payments to employees

An employer may knowingly choose to make a payment to an employee or director net of tax. In these instances the amount should be grossed up to take account of income tax and Class 1 NIC, as the employer in providing a benefit tax-free is effectively undertaking to meet the tax bill of that employee in relation to that benefit. HMRC guidance is at EIM07700.

For example, an accountancy firm wishes to reward an employee for passing some exams (and the payment does not fit within an exemption). The employer wishes to pay £1,000 to the employee. The employer wishes for the employee to receive the full £1,000, ie after tax and NIC have been deducted. The employee is a basic rate tax payer.

The £1,000 should be grossed up to take account of the 20% income tax and 12% Class 1 NIC rate. This represents the 32% of the gross amount that should have been deducted under PAYE.

£1,000 equals 68% of the gross payment. The gross payment is calculated as follows: £1,000 / 68% = £1,470.59.

To cross-check:

Income tax: £1,470.59 x 20% = £294.12

Class 1 NIC: £1,470.59 x 12% = £176.47

Total income tax and NIC equals £470.59 leaving £1,000 net payment to the employee.

This calculation is one that should be used for items appearing on a PAYE Settlement Agreement (PSA). Often employers will have a PSA in

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