Compensation for Loss of Earnings

What are the tax and NICs implications when an employee repays sick pay from a compensation award?

When an employee is absent from work as a result of an accident, the employer may pay to the employee either

SSP and, in some cases, occupational sick pay, or

an advance of an amount equivalent to sick pay.

The employee's contract may require the employee to make a claim for damages and, when a compensation award for loss of earnings is eventually paid out, reimburse the employer an amount from the award that covers some or all of the sick pay or advance.

This situation has both PAYE tax and NICs implications. In all cases, it is advisable for the employer to discuss the appropriate procedure with the employer's tax inspector.

PAYE implications

The payments that are made to the employer, whether they are sick pay or an advance, must be added to gross pay and taxed accordingly.

When damages are received and the employee has paid the appropriate amount to the employer, a repayment of tax may be due to the employee and/or the employer. How this is done depends on whether the employee refunds

the gross amount paid by the employer, i.e. before the deduction of tax, or

the net amount paid by the employer, i.e. after the deduction of tax.

Gross advance refunded: If the refund is made in the same tax year as the advance, the employer should adjust the employee's payroll record by reducing the "total pay to date" (i.e. column 3 of form P11) by the amount that has been refunded to the employer and on which the employee has already paid tax. The tax refund generated should be paid to the employee on the next payday.

If the refund is made in a later tax year, the employee must complete a self-assessment return or R40 Tax Repayment Form (see further information, below) and claim a refund of tax, taking figures from the employee's P60 for the tax year(s) in which the tax was deducted and entering

the total pay for the year, less the amount of the refund, and

the total tax deducted for the year, without any adjustment.

Net advance refunded: In this situation, the employer's tax inspector should always be consulted and will ask for the following information:

the dates on which the sickness absence started and ended

from the payroll records, the total amount of the advances and the total tax deducted in respect of the sickness absence, separated into tax years if necessary

the gross amount of compensation paid to the employee

the amount paid from the compensation by the employee to the employer, and the date of the payment

if the compensation paid to the employee was not the full amount claimed, the percentage that the amount paid is to the amount claimed.

If the refund is made in the same tax year as the advance, the employer should

recover the tax deducted from the advance from the next payment made to the employer's Accounts Office, and

adjust the employee's payroll record by

reducing the employee's "total pay to date" (i.e. column 3 of form P11) by the gross amount of the advance on which the employee has paid tax
reducing the "total tax due to date" (i.e. column 6 of form P11) by the tax deducted from the advance.

If the refund is made in a later tax year, the tax inspector will arrange for the tax deducted from the advance to be repaid to the employer by the Accounts Office. If the employee only receives a percentage of the damages claimed and refunds the same percentage of the advance to the employer, the amount of tax repaid to the employer will also be reduced to that percentage.

In addition, the employee must complete a self-assessment return or R40 Tax Repayment Form (see further information, below) and claim a refund of tax, taking figures from the employee's P60 for the tax year(s) in which the tax was deducted, and entering

the total pay for the year, less the gross amount of the advance (giving the net refund plus tax)

the total tax deducted for the year, less the tax repaid by the Accounts Office to the employer.

Note that, if the contractual arrangements are such that the employee keeps all of the sick pay paid during the absence and simply hands over the compensation to the employer, i.e. the compensation is not offset against the sick pay, none of the procedures above apply. The sick pay has been correctly taxed and no repayment of tax is due to either the employee or the employer.

NICs implications

If an employee is not required to repay the employer, all payments made to the employee, whether they consist of sick pay or an advance, must be added to gross pay for Class 1 NICs.

If, however, the employee is required to repay the employer, even if the claim for damages is not successful and no compensation is ultimately paid, the payments are not added to gross pay for NICs purposes. If, at a later date, the employer decides to write-off the payments so that the employee no longer has to repay them, the amount written-off must be added to any other earnings received by the employee in the earnings period in which the employer makes the decision to write-off the payments and Class 1 NICs assessed accordingly.

...UK Payroll News - Latest

Further Information:
R40 Tax Repayment Form
R40 Guidance Notes

Payroll News

Payroll & HR Press

Payroll & HR Directory

Payroll & HR Software

Payroll & HR Reading

About