An employer has given non-cash incentive awards to some employees during the past tax year but now realises that the awards must be reported on form P11D and, as a consequence, the employees will have to pay income tax on the value of the awards. Can the employer do anything so that the employees do not have to pay any tax?

Awards can lose their incentive value if the recipient later has to pay tax on the award. The solution to this problem is a PAYE Settlement Agreement (PSA), an arrangement between employer and tax office to meet any tax and NICs liabilities on non-cash awards instead of the employees. Tax inspectors will consider arranging a PSA to cover almost any taxable expenses payments and benefits, e.g. those that are

• minor in value when compared with the employee's earnings,
• irregular, i.e. one-off or infrequent, or
• impracticable to operate under PAYE or to apportion as a shared benefit.

However, cash incentives and such major benefits as company cars cannot be included in a PSA.

The employer should think carefully about entering into a PSA because they are very expensive. There are four possible components of a PSA. The employer has to pay

• tax on the reportable value of the benefit, at its grossed-up value - i.e. 28.2% if the employee pays basic rate tax, 66.7% if the employee pays higher rate tax, plus
  
  
• Class 1B NICs on the total amount of tax paid under the PSA, plus
  
  
• Class 1B NICs on the taxable value of the benefit if it would otherwise have been reported on form P11D and incurred a Class 1A liability, plus
  
  
• Class 1B NICs on the expenses payment or voucher if it would otherwise have incurred a Class 1 liability through the payroll at the time the payment was made or the voucher was given to the employee.

Class 1B NICs are paid only by the employer, at the same rate as the standard Class 1 NICs rate, i.e. 12.8% for 2004/05.

An employer should expect the cost of a PSA

• covering basic rate employees to be 44.6%
• covering higher rate employees to be 88.0%

of the reportable value of the benefits and/or payments. The amount due under a PSA must be paid to the Collector of Taxes by 19 October following the end of the tax year.

Example 1: An employer provides a digital camera as an incentive award. The market value of the benefit at the time of provision was £;200. The employer's options are

1. to report the £;200 on form P11D, in which case the employee will pay tax on £;200 and the employer will pay Class 1A NICs on £;200, or
   
   
2. to settle the employee's liabilities under a PSA.

The tax due under a PSA is £;56.41, i.e. ((£;200 ÷ 0.78) - £;200). The Class 1A NICs due are £;32.82 , i.e. 12.8% of £;56.41, plus 12.8% of £;200. The total payment by the employer is £;89.23.

Example 2: An employer provides non-cash vouchers with a face value of £;200 as an incentive award to an employer paying higher rate tax. The cost to the employer of the provision was £;200. The employer's options are

1. to report the £;200 on form P11D, in which case the employee will pay tax on £;200 and both the employer and the employee will pay Class 1 NICs on £;200 at the time of provision,, or
   
   
2. to settle the employee's liabilities under a PSA.

The tax due under a PSA is £;133.33, i.e. ((£;200 ÷ 0.60) - £;200). The Class 1A NICs due are £;42.67, i.e. 12.8% of £;133.33, plus 12.8% of £;200. The total payment by the employer is £;176. Tax inspectors may be willing to arrange a PSA right up to the 6 July deadline for submitting forms P11D. However, PSAs covering expenses payments and vouchers, where Class 1 NICs are otherwise due, should be agreed with the tax office in advance of the time at which liability to Class 1 NICs is first incurred.

For basic information about PSAs, see Revenue booklet IR155, available at www.inlandrevenue.gov.uk/pdfs/ir155.pdf .

Detailed information is available at www.inlandrevenue.gov.uk/....htm .

Discuss this news item in the PayPerShop Forum

...back to 17 September 2004