Income Tax - Notional Payments

Notional payments

When an employee is given "notional payments", e.g. company shares other than under an approved scheme, the value of those shares is added to the employee's gross pay for tax and NICs. The result can be that there is not enough pay to cover the employee's resulting tax liability. Nevertheless, the employer must pay all of the tax and primary and secondary NICs due on the notional payment to the Accounts Office by the next payment deadline. This leaves the employee owing a sum of money to the employer.

Prior to 9 April 2003, the employee had to repay this money to the employer within 30 days of receiving the benefit. On that date, the repayment period was extended to 90 days, in order to help employers who had difficulty in obtaining the necessary valuations to process the payment at the time of the next payroll run. If the employee fails to repay the outstanding tax within 90 days, the employer must report the benefit in Section B of form P11D and must add the outstanding tax to the employee's gross pay for Class 1 NICs purposes.

We raised a number of queries with the Inland Revenue on this matter. Our questions and the Revenue's responses are as follows:

(1) Section B of form P11D for 2003/04 continues to show the repayment period as "30 days". May we take it that this is an oversight? The P11D Guide correctly refers to 90 days.

Yes, this is an oversight: reference should be to 90 days.

(2) What should the employer do if the employee repays the outstanding tax but does so after the 90-day deadline and after Class 1 NICs have been charged? Can the employee simply claim a deduction against the amount that the employer must report on the P11D and, if so, do the Class 1 NICs charges still stand? What position would the Revenue take if the employer were simply to fail to report the amount on the P11D and reverse the Class 1 NICs charges?

If the employee fails to make good the relevant amount to the employer within the time specified, then the employee is liable to a charge to income tax under section 222 ITEPA. The employer is required to report the charge to income tax on the P11D. The position is not changed by the employee making good the amount at a later date. If the employer does not report the charge then the employer will have submitted an incorrect return and may be liable to a penalty.

For NICs, Class 1 NICs remain due, the amount treated as earnings for income tax purposes under s.222 ITEPA is treated as paid on the 90th day for NICs purposes. If the employer does not charge NICs knowing that they are in fact due, the employer has knowingly omitted to report the earnings on form P11D and failed to include the earnings on deduction working sheets for NICs and forms P14 (end of year returns). In such circumstances the Revenue can consider charging penalties.

(3) Alternatively, would it be acceptable for the employer, at the end of the 90 days, to treat the outstanding amount as a loan to the employee and, instead of reporting the amount in Section B of form P11D and deducting Class 1 NICs, report it as a beneficial loan and pay Class 1A NICs?

"Making good" involves the transfer of value from the employee to the employer. How that is achieved is a matter between the employee and employer and not a matter for the Revenue. The most straightforward manner will be for the employee to make a monetary payment (cash/cheque/bank transfer etc). But the transfer of value may be achieved in other ways. One is entering into a loan agreement. If an employee enters into a loan agreement with the employer within the time allowed for making good, then there will be no charge to tax under section 222 ITEPA. If the beneficial loan legislation applies to that loan, then the amounts chargeable should be declared accordingly.

For NICs, the amount treated as earnings by virtue of section 222 ITEPA is treated as earnings for Class 1 NICs purposes. Therefore, Class 1 NICs are due on the section 222 amount irrespective of whether the employer provides a loan for the employee to meet the income tax liability originally not made good within the 90 day period. Class 1A NICs may also be due on the benefit derived from the loan. [Note that this paragraph refers to the situation where a loan is made after the end of the 90-day period.]

(Whether the payment described as a loan is in fact a loan will depend on the facts of the case. If the facts are such that the payment is simply a cash payment and not a loan, then a further payment of earnings has been made for the benefit of the earner and, as such, Class 1 NICs would also be due on that amount - Sections 3 and 6 of the Social Security Contributions and Benefits Act 1992 refer).

The following example illustrates the points made in the Revenue's response.

An employee, with a monthly salary of £;10,000, is given a bonus that consists of company shares with a current market value of £;40,000. The employer treats the employee's gross pay as £;50,000, creating a combined PAYE and NICs charge on the employee of, say, £;23,000, and an NICs liability on the employer of, say, £;6,350. The employee's £;10,000 salary is taken in full towards to £;23,000, leaving a debt of £;13,000.

The employer pays the full tax and NICs liabilities, i.e. £;29,950, to the Accounts Office when the next monthly payment is due.

Three situations are now possible:

(1) The employee raises the outstanding £;13,000 by selling a proportion of the shares and pays it to the employer within 90 days of receiving the shares. There are no further tax or NICs liabilities.

(2) The employee fails to pay the outstanding amount within the 90-day period. The employer must

• add £;13,000 to the employee's gross pay for NICs only in the earnings period in which the 90-day period ends. The further secondary charge on the employer that this creates is a strong incentive for the employer not to let this situation arise.
  
  
• report the £;13,000 in section B of the employee's P11D at the end of the tax year. The employee will pay further tax on this amount, similarly creating a strong incentive for the employee not to let this happen.

(3) Before the end of the 90-day period, the employer and employee enter into a formal loan agreement to cover the £;13,000. By doing so, the employee has repaid the £;13,000, so the liabilities described for situation (2) do not apply. The P11D reporting rules for beneficial loans must be applied as appropriate, with a liability for Class 1A NICs arising on any amount reported on form P11D for the employee.

However,

• if the loan is subsequently written off, the amount outstanding is immediately liable for Class 1 NICs. For tax purposes, the amount written off is reported on the employee's P11D at the year-end, using the non-Class 1A line in section N.
  
  
• if the loan agreement is entered into after the 90-day period has ended, the liabilities described for situation (2) still apply in full.
  
  
• if there is no contractual obligation for the employee to repay the "loan", the employee has, in effect, received a cash payment of £;13,000, liable to tax and NICs at the time it is provided by the employer to settle the employee's debt. In addition, all of the liabilities described for situation (2) still apply in full.

...back to 20 February 2004