Amendments to PAYE Regulations - New powers to recover tax liabilities from employee instead of employer

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27 March 2008

The Income Tax (Pay As You Earn) (Amendment) Regulations 2008 were made on 20 March 2008 and come into force on 6 April 2008. They include three specific provisions, two of which make the necessary changes to PAYE Regulations resulting from measures that have already been announced, namely:

1. the abolition of the 10% starting rate of tax from the start of the 2008/09 tax year, and
   
   
2. new powers from HMRC to assess an employer for non-payment or underpayment to the Accounts Office of PAYE tax, Class 1 NICs, student loan deductions and Construction Industry tax on account by specifying a combined amount rather than having to separately identify each particular liability.

The second of these subjects has been discussed in the last two newsletters and reference to it here is simply to confirm that the relevant changes have now been made to the PAYE legislation.

The third provision included in the Amendment Regulations relates to the decision of the Special Commissioner in the case Demibourne v HMRC. This decision highlighted a number of tax issues for employers and their employees that can arise as a consequence of an employer's failure to operate PAYE, in particular where an employer fails to deduct tax from PAYE income but it is paid instead by the employee under self-assessment.

The case confirmed that, where an employment relationship exists, the employer is responsible for deducting PAYE tax from payments made to the employee. Under the law as it stands, HMRC does not have the discretion to choose whether to collect tax from the employer or the employee. For example, in a situation where an employer gets the employment status of a worker wrong and makes payments on invoice, without deductions, instead of deducting tax and NICs through the payroll, HMRC is obliged to seek recovery of tax from the employer, even though tax on the earnings is paid by the employee under self-assessment.

The Regulations are intended to prevent that situation from arising by creating a new series of situations in which HMRC may make a direction to transfer an employer's PAYE liability to the employee who received the payments from which PAYE tax should have been deducted.

The Regulations allow HMRC to consider making a direction in circumstances where the following conditions are satisfied:

• an employment relationship exists and the employee has received relevant payments (including notional payments) in respect of which the employer has failed to deduct or account for PAYE tax,
  
  
• the amount of tax that the employer should have deducted exceeds the amount of tax actually deducted or accounted for,
  
  
• HMRC considers that the employee concerned has been assessed on the income under self-assessment, or the tax due has been paid as a self-assessment payment on account or as a Construction Industry sub-contractor deduction, and
  
  
• one of the following trigger events has occurred on or after 6 April 2008 (and none of them has occurred before that date):
  
  
  • HMRC assesses an employer for tax that includes tax on the payment in question,
    
    
  • HMRC receives a self-assessment return from the employee which includes an adjustment for a PAYE credit in relation to the payment in question,
    
    
  • the employee submits an amended self-assessment return, or an error or mistake claim, which includes an adjustment for a PAYE credit in relation to the payment in question, or
    
    
  • HMRC receives a letter offering to make a settlement of the employer's liability to pay an amount of tax, including tax on the payment in question.

The ability of HMRC to make such directions will apply to tax years before 6 April 2008 but only if none of the four trigger events has occurred before that date. HMRC will issue directions both to the employer and to the employee (or employees) concerned.

In practice, where a person, who should have been treated as an employee and had tax deducted under PAYE, has paid tax on earnings from the employment under self-assessment, an HMRC direction will have the effect of leaving the self-assessment as it is. The employee will, however, be able to claim a PAYE credit in respect of any tax that exceeds the amount specified in the direction. Similarly, the employer will be relieved of any PAYE liability for the amount of tax specified but not on any PAYE tax in excess of the amount specified. A direction will not cover any penalties for which the employer may be liable in respect of the breach of PAYE Regulations, but no interest will be charged on the amount specified in the direction.

No corresponding amendments to NICs legislation is required as HMRC already has statutory authority to offset wrongly paid Class 2 and 4 contributions against Class 1 NICs.

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Further information:
The Income Tax (Pay As You Earn) Amendment) Regulations 2008
Explanatory Memorandum to The Income Tax (Pay As You Earn) Amendment) Regulations 2008
Amended regulations to deal with issues highlighted in the Demibourne case
FAQ: New legislation to transfer a PAYE liability from an employer to an employee

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