Removal of NICs exemption for holiday pay schemes - NICs savings for employers and employees removed from 30 October 2007

For Holiday Pay FAQ's see FAQ (UK)

25 October 2007

In one of our newsletters in August 2006, we suggested that, following the declaration by the European Court of Justice that the use of "rolled-up holiday pay" schemes was in breach of the Working Time Directive, employers who had been using such arrangements might consider using instead the "holiday pay fund" schemes operated in the construction and related industries. These schemes take advantage of a statutory exemption that allows holiday pay from such schemes to be paid without any liability for Class 1 NICs - but only if the statutory conditions are met.

HMRC's CWG2 Employer Further Guide to PAYE and NICs describes holiday pay schemes in the construction industry where groups of employers contribute to a central, independently managed holiday pay fund. From that fund, the employees receive holiday pay when they go on holiday or when they leave the employment. The payment is usually made through the employer's payroll and is subject to PAYE tax but not to Class 1 NICs. Afterwards, the employer recovers the amount of the payment from the fund. The fund may, in some situations, make payments direct to employees, in which case there is also no NICs liability but special PAYE procedures apply.

The NICs exemption was originally introduced in the construction industry in 1979. The nature of the industry is that workers move regularly from one project to another and are not always with one employer long enough to take the holidays they have accrued. An arrangement whereby employers would buy holiday stamps and stick them on individual employee cards was introduced to resolve that problem. Employees could take their holiday cards with them from one employer to another and the next employer could redeem the stamps for which previous employers had paid. However, that created a problem for the employer redeeming the stamps because, on paying the holiday pay to the employee, the employer had to pay NICs on the value of all of the stamps redeemed, including those that had been purchased by previous employers. An extreme case would have been an employee starting a new construction job a week before the Christmas closure. The new employer could redeem the stamps that the previous employer had purchased for, say, two weeks' holiday pay, but became liable for Class 1 NICs on the whole payment. The NICs exemption was introduced to prevent this situation arising.

In recent years, holiday pay stamps have been replaced by holiday credits and the process is computerised. The practice of carrying forward stamps or credits from one employer to the next was discontinued from October 1998 when the requirement for employers to pay outstanding holiday entitlement on termination of employment was introduced by the Working Time Regulations 1998.

That does not mean, however, that construction employers benefit in full from the NICs savings. The construction industry Working Rule Agreement requires the employer to pay pension contributions for each employee (currently £3 per week) and to provide life and accident cover. For this reason, construction employers cannot simply buy holiday credits; they have to buy the whole package, including the pension and insurance benefits. The employees too are encouraged to contribute to the stakeholder pension and employers are required to match any amount that employees contribute between £3 and £10 per week.

For further information about holiday pay and other benefits in the construction industry see www.bandce.co.uk/corporate/about.asp and www.ucatt.info/content/blogcategory/23/34/.

The statutory exemption itself is to be found in the Social Security Contributions Regulations 2001, Schedule 3, Part X, Paragraph 12. This provides that payments in respect of a period of holiday entitlement can be disregarded for Class 1 NICs purposes where

the sum paid is derived directly or indirectly from a fund -

to which more than one secondary contributor contributes, and
the management and control of which are not vested in those secondary contributors; or

the person making the payment is entitled to be reimbursed from such a fund.

There is nothing in the wording of the exemption that limits its application to the construction industry. As a result, a number of enterprising providers of benefits schemes have, over the past couple of years, set up independent holiday pay funds and offered the statutory scheme to businesses outside of the construction industry. Many large companies have taken advantage of the scheme and they and their employees are enjoying significant NICs savings on payments of holiday pay - amounting in some cases to millions of pounds.

In August 2006, HMRC issued the following press statement about the use of the exemption by employers outside of the construction industry:

"We would not normally expect employees outside of �construction work' to be included in such schemes, because the legislation was introduced to cater for payments made to workers within that industry.

However, there is nothing in the legislation to prevent employers in other industries using these provisions. The first point of contact for such an enquiry would be the employer's HMRC office.

We naturally monitor the operation of the exemption to ensure that the legislation is meeting its objectives. We are reviewing the operation of the legislation by reference to its original policy intention, and changes since it was first introduced."

In our August 2006 newsletter, we made the following comments on the issues facing HMRC and those employers outside of the construction industry that had taken up the scheme:

While HMRC concedes in the reply that there is nothing in the legislation to prevent other employers taking advantage of the NICs savings by setting up their own schemes, there is clearly some concern about the future of the exemption. If the exemption was introduced originally to meet specific problems in the construction industry and was effectively conditional on the employers providing other benefits for employees, it is understandable that HMRC would be concerned about its use by other employers who are introducing their schemes solely to make NICs savings. There is nothing in the legislation that requires any employer to use the savings for other purposes.

Another factor that HMRC is likely to consider is that the key reason for introducing the NICs exemption, the need for an employee's holiday entitlement to be passed on from one employer to the next, ceased to be significant when the requirement to pay holiday pay on termination of employment was introduced by the Working Time Regulations 1998.

An HMRC decision to withdraw the NICs exemption would have significant cost implications for construction industry employers. An alternative approach would be for the legislation to be changed so that, in order to use the exemption, employers are required to provide a package of benefits similar to those provided to construction employees. The problem with that approach is that the Government, as proposed in the White Paper Security in retirement: towards a new pensions system, already intends to make employer contributions to pension schemes compulsory from 2012.

An HMRC decision to withdraw the exemption would also create significant problems for those employers outside of the construction industry that have introduced holiday pay fund schemes. As revealed by a number of postings on the PayPerShop Forum (www.paypershop.com/phpBB2/viewtopic.php?t=235), some employees are suspicious of their employer's motives in introducing the scheme, believing that the savings are greater for employers than they are for employees. Having promised their employees that they will make annual savings on their holiday pay, how will the employers back-track from that?

HMRC's written statement encourages employers to discuss the issues with their tax office before replacing their existing holiday pay arrangements and advertising the NICs savings to their employees. At the present time, employers should be very cautious and, if they decide to introduce a scheme with NICs savings, make sure that employees know that the savings will stop if the exemption is withdrawn.

The Government's decision on the continued use of the exemption was announced in the Chancellor's Pre-Budget Report documents. The exemption is withdrawn from 30 October 2007. However, it will continue to apply for five years, until 30 October 2012, in the construction industry if

the secondary contributor (i.e. the employer) is carrying on a business which includes construction operations; and

the employed earner (i.e. the employee) was personally engaged in such operations at the time that entitlement to that pay accrued.

In explanation of the exemption's retention in the construction industry, the Pre-Budget Report document states:

The exemption was aimed at addressing problems of high mobility and turnover of the labour force in the construction industry, but working time regulations now ensure holiday entitlement is preserved in all sectors and therefore an on-going exemption for construction is no longer appropriate. However, given the longstanding nature and wide range of benefits typically provided by schemes, the exemption will be maintained for the construction industry for 5 years to give it sufficient time to adjust.

The withdrawal of the exemption has had a mixed reception. The principal provider of the scheme to the construction industry, B&CE Benefit Schemes, has accepted the change without comment and welcomed the continuation of the exemption for a five year period. (www.bandce.co.uk/). In contrast, the Union of Construction, Allied Trades and Technicians (UCATT) has "reacted angrily" to this "major tax change" and believes that "the closing of the scheme is potentially disastrous, as many companies will use the changes to end direct employment of workers and instead opt for bogus self-employment" in order to avoid employer NICs. (www.ucatt.info/content/view/277/30/2007/10/)

Outside of the construction industry, one scheme, The Holiday Pay Fund, has immediately changed its website so as to offer its scheme solely to employers in the construction industry. Other employers are advised to contact their fund provider or a named contact in that business. (www.theholidaypayfund.co.uk/Q&A.htm).

...UK Payroll News - Latest

Further information:
The Social Security (Contributions) (Amendment No. 9) Regulations 2007
PBRN02 - Exploitation of National Insurance Contributions Exemption
Protecting tax revenues

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