When the HMRC inspector comes to call, how ready are you for a compliance visit? Deborah Parks-Green identifies two areas that expose employers open to tax repayments and fines
In an attempt to make the government’s books balance, pressure is on HM Revenue and Customs’ employer compliance officers to ensure that employers are fully compliant with their obligations in accounting for PAYE and NIC where appropriate. The correct tax and NIC treatment of payments made to workers depends upon the contractual arrangements, so communication between the finance and HR departments of a business is absolutely crucial.
Problem areas of compliance
Two common problematic areas that have been identified by HM Revenue and Customs (HMRC) are:
- identifying the status of the worker
- treatment of termination payments
Failure to identify employees and account for the correct amounts of tax and NIC under PAYE can be very costly for a business. HMRC will recover any unpaid tax and NIC from the employer – and not the employee. In addition, an interest charge will be made for the period that the tax/NIC was outstanding and a penalty may be charged of up to 100% of the outstanding liability. A settlement may be sought going back six years, so care should be taken to get things right at the outset.
Employed or self-employed?
When you engage an individual to work in your business, it is important that you establish from the outset the nature of the relationship between the business and that person. The correct tax and national insurance treatment of payments depends upon this relationship. Where the work undertaken is integral to the business, for instance, as cooking is to a restaurant or bricklaying is to a builder, HMRC will look very closely at their relationship.
Employment status is certainly not a matter of choice but is based upon the terms and conditions of the working relationship. The legislation helps us very little in the definition of an employee and we must turn to case law for guidance on what is a grey and problematic area.
There is no single test governing whether an individual is employed or self-employed. There is a status indicator tool found on HMRC’s website which can be helpful but sometimes ambiguous. Many different factors should be considered to see whether they point towards employment or self-employment and it is the overall picture that determines the status.
The key factors are summarised in figure 1.
Figure 1: summary of self employment vs employment indicators
| Pointer towards self employment |
Pointer towards employment |
| The worker can provide and pay a substitue or helper of their own choice. |
The worker must provide the services personally. |
| The worker provides own materials and main items of equipment. |
The worker is provided with all that is needed to perform their duties. |
| The worker is unsupervised, working when, where and how they choose. |
Thw worker is under direction and control with regard to the manner in which they work. |
| The worker agrees a fixed price for the job so they can make a loss or a profit. |
The worker is paid by the hour, week or month. |
| The worker is not entitled to benefits of sick leave, annual leave or pension. |
The worker receives benefits such as annual leave. |
| They work regularly for a number of different clients. |
They solely work for your business. |
| The worker is engaged for a specific task. |
The worker can be moves from one task to another. |
Termination payments
In the present economic climate, many employers are finding themselves looking at the tax treatment of termination payments. It is a common misconception that by calling a termination payment an ex-gratia payment, this automatically makes the first £30,000 of the payment tax-free .
Termination payments fall into one of the following two categories, and the treatment of that payment for the purposes of tax and NIC depends on which category the payment falls into:
- it arises from the employment as a contractual payment making it chargeable to tax and NICs as earnings; or
- it represents compensation to the employee for loss of rights in respect of the employment. The tax rules for charging payments that fall into this category are different from the NIC rules. The full amount would exempt from NICs but only the first £30,000 would be exempt from tax.
In reality, a termination payment is usually made up of different parts, and an employer must break this payment into its constituent parts to consider in which category each part falls. For instance, where part of the payment is for outstanding holiday that the employee was entitled to under the terms of their employment contract, this would be chargeable as earnings. On the other hand, a statutory redundancy payment will be seen as compensation for loss of office and also HMRC do not normally challenge payment of enhanced redundancy where it is calculated by reference to the statutory formula.
Payment in lieu of notice (PILON)
The most difficult type of termination payment to assess correctly is the payment in lieu of notice (PILON), which depends upon the terms of the contract. If the contract contains a clause that reserves the right for the employer to make a PILON instead of allowing the employee to work their notice, in nearly all cases, this PILON should be put through the payroll to account for tax and NICs, as it will be seen as a contractual payment.
Even where there is no PILON clause in the contract, if the employer has historically made PILONS, HMRC can try and argue that the payment is chargeable to tax and NICs. For this reason, many employers find it appropriate to seek advice before making PILONS to ensure that they are not left with a settlement with HMRC in the future.
Only where there is no written PILON clause in the contract and no established practice of making a PILON can an employer safely make the PILON NIC free and within the £30,000 tax free exemption.
Note
In this article we have looked at two areas of employment tax that are open to scrutiny by HMRC. If you have any doubts over the status of any of your workers, or the correct treatment of termination payments, you would be well advised to seek specialist help.
www.bakertilly.co.uk
www.hmrc.gov.uk/calcs/esi.htm
See also Daryl Cowan’s article on Compromise Agreements in the 16 July edition of the People Bulletin