PAYE & NI guide

• An Introduction to PAYE
• Payslips
• Employing Your Spouse
• Tax Free Gifts to Staff
• Don't Pay Too Much National Insurance
• Benefits In Kind and Expenses Payments
• Employed or Self-Employed

An Introduction to PAYE

Whether an individual is an employee or self-employed in a particular situation is a question of fact depending on the terms under which he or she works. When you engage someone to do work for you, you have to decide whether or not to apply the PAYE rules. It is up to you to get it right or suffer the consequences.

In certain areas, HM Revenue & Customs has placed emphasis on reclassifying individuals claiming to be self employed. They issued a leaflet, IR56, Employed or Self-employed? setting out the guidelines of employment status in the form of questions. These cover the following principal factors:

Please note: We strongly recommend that if you are in any doubt as to the status of an individual, ask HM Revenue & Customs to clarify the situation. Obtaining their approval will avoid the risk of you having to make a settlement of liabilities to tax or NI that you failed to deduct from the employee's remuneration.

Before establishing a PAYE system, it is necessary to notify the HM Revenue & Customs by telephoning the New Employers Helpline (0845 607 0143).

Upon registration, HM Revenue & Customs will send you guidelines on operating PAYE, national insurance, statutory sick pay, statutory maternity pay, statutory paternity pay and statutory adoption pay, including a number of forms with which to operate the PAYE and NI systems. (See checklist below).

To help you calculate the amount of tax and NI due, HM Revenue & Customs will supply you with sets of tax tables. By referring to these, and an employee's tax code, you will be able to calculate the amount of salary that is not subject to tax. The difference between this figure and the gross amount paid is the employee's taxable pay. The tax can then be calculated by reference to another set of tables. The employer's and employee's NI is calculated by reference to the employee's gross pay in conjunction with a third set of tables. Note, however, several 'benefits' are also subject to NI even where the tax is dealt with on a different basis.

The tax and NI should be paid to HM Revenue & Customs by 19th of the month following payment. Employers whose average monthly payments of PAYE and NI are less than £1,500 in total are allowed to pay quarterly rather than monthly (i.e. by 19th of July, October, January, and April). This should be requested using form P31. See also electronic payment of PAYE.

Payslips

Most employees receive payslips and take them for granted, but what are the legal requirements?

All employees, including those working part-time and temporarily, are entitled to receive a written payslip on or before their pay day. The Employment Rights Act (ERA) sets out the required contents of a payslip:

Employers paying Working Tax Credits should note that the Tax Credits Act requires the amount paid to be a clearly identifiable separate amount on the payslip.

Employers deducting premiums for stakeholder pensions must show the deduction clearly on the payslip.

In practice, most employers give much more information than the basic statutory requirements. For instance, it is obviously good practice to analyse gross pay to show:

It is also usual to show the period covered by the payment, and the date of payment.

You can significantly reduce queries from employees by giving basic details such as:

Employing your Spouse

When considering the overall tax position of your family, it is worth considering employing your spouse in your business.

This is a means of transferring income from you to your spouse. It is likely to show a tax saving if your spouse has unused personal allowances or pays tax at a lower rate than you do.

In order to justify a salary, the following points must be borne in mind:

As well as a salary, you may be able to pay premiums for a special pension arrangement for your spouse. These should not be taxable on your spouse and should save you tax as a business expense.

It may also be possible to provide your spouse with a 'company car', which should not give rise to any tax charge if the combined annual salary and notional benefit-in-kind is below £8,500, although again the need for commercial justification should be borne in mind.

All the above considerations apply equally to an unmarried partner or indeed to any other individual.

Administering a salary
If your spouse has no other employment, a Form P46 should be signed with the Statement B ("This is my only or main job") ticked. You may then pay up to the Primary Threshold for employees national insurance (£97 per week for 2006/07) without any further formality.

If you already have a PAYE scheme for other employees, or don't mind setting up a scheme for your spouse, you should consider the following points:

• a salary between £84 and £97 per week will protect an entitlement to basic state pension and other contributory benefits without incurring and actual National Insurance liability
• a salary between £97 and £645 per week is subject to employees' national insurance at 11% and employers' national insurance at 12.8%
• the income tax position depends on your spouse's personal circumstances
  the amount of salary exceeding £645 a week is subject to employees' national insurance at 1% and employers' national insurance at 12.8%, without upper limit

Tax-Free Gifts to Staff

In an environment where most employee 'perks' are subject to tax it may be helpful for you as an employer to be aware of the few concessions that have been made by HM Revenue & Customs.

Long service awards
Long service awards are allowed within strict limits. There will be no tax charge so long as the employee has been with you for at least 20 years and the article given has a value not exceeding £50 for each year of service.

Suggestion scheme awards
Such awards must be made under a properly constituted suggestion scheme, based on a set percentage of the expected financial benefit to your business. The maximum award allowed is £5,000. There is also a concession for 'encouragement awards' of £25 or less to reflect meritorious effort on the part of the employee concerned.

Staff parties
Staff annual functions (e.g. a dinner dance or Christmas party) are tax-free where the total cost per person attending is not more than £150 per year (including VAT).

Promotional gifts
Such items are normally purchased for advertising purposes and must display a 'conspicuous advertisement'. Staff may receive promotional gifts tax-free provided that the overall cost of the articles involved does not exceed £50 per person per year.

Gifts of food, drink, tobacco or vouchers are specifically excluded.
For further details of other non taxable benefits see "Benefits in Kind & Expenses Payments".

Don't Pay Too Much National Insurance

If you have income from more than one job, or if you have self employment income as well as being employed, you should take care to ensure that you do not pay more in national insurance contributions than you need to.

The prescribed annual maximum normal contribution for an individual is 53 weeks at the standard primary (employee) Class 1 contribution rate between the earnings threshold and the upper earnings limit. For 2006/07 this works out to be £3,194.84. There is also an additional 1% payable on earnings in excess of the upper earnings limit.

If you think there is a chance of your exceeding this limit, you can apply for deferment of contributions on the 'surplus' employments and/or self employment. The Deferment Group recommends that application should be made before the start of the tax year, but will accept applications up to 14 February during the tax year.

Class 1 contributions
The Deferment Group will tell you for which employments they have allowed deferment of contributions and will send to the relevant employer(s) a certificate telling them not to deduct primary Class 1 contributions from you during the tax year and asking them to refund any contributions they may already have deducted from your wages/salary during the year.

Class 2 contributions
If you expect your earnings from self employment to be less than the small earnings exception limit (£4,465 for 2006/07), you may apply for exception from paying Class 2 contributions.

However you may, if you wish, continue to pay Class 2 contributions voluntarily to keep up your entitlement to the benefits they provide (Incapacity Benefit, Retirement Pension, Widow's Benefit and Maternity Allowance).

Your Class 2 contributions may be deferred if you can show that you are otherwise likely to pay above the annual maximum normal contribution (£3,194.84 as set out above) in Class 1 and Class 2 contributions.

Class 4 contributions
Your Class 4 contributions may be deferred if your normal national insurance contributions (Classes 1, 2, and 4) are likely to exceed the maximum for Classes 2 and 4 normal contributions on their own (£2,391.70 for 2006/07).

After the year end
After the end of the tax year, the Deferment Group will work out your overall contribution position for the year and collect any balance of contributions that may remain payable.

Contribution refunds

If you do not apply for deferment in time, it is still possible to claim a refund of overpaid national insurance contributions. The time limit for claiming is broadly six years after the end of the tax year in which the payment was made.

Benefits in Kind & Expenses Payments

Benefits in kind are assessed on all directors and employees whose salary and benefits combined are £8,500 or more.

Remuneration by way of benefits is often attractive to employees, especially if they are paying the higher rate of income tax, because the benefit may either be tax free or subject to less tax.

A benefit that is not taxable is not automatically exempt from national insurance contributions (NICs).

An employer is required to complete form P11D in respect of each employee earning £8,500 or more (including benefits) and all directors. Form P9D is required to record benefits received by other employees. Benefits for NIC purposes must be included on the deductions working sheet column 1A 'earnings on which employee's contributions payable'. (This should not include Class 1A NIC benefits on company cars and car fuel). Comprehensive records should be kept in relation to all benefits and expenses payments.

Non-taxable benefits
There are several benefits that are not normally taxable, even when an employee is within the P11D category. These can be substantial. The most significant are:

• Contributions to registered pension schemes
• Car, motor cycle or bicycle parking facilities at or near the workplace
• Child care facilities
• Compensation/termination payments up to £30,000
• Redundancy counselling services
• Luncheon vouchers up to 15p per day
• Staff canteen and dining facilities (provided they are available to all directors and employees)
• Sports facilities (provided they are available to all directors and employees)
• Removal expenses, subject to HM Revenue & Customs limits
• Long-service awards (provided they are an established practice within the firm or are in the employees' contract) up to specified limits
• Awards under suggestion schemes (but there are restrictions)
• Use of a pool car
• Use of a mobile telephone
• The provision of representative accommodation (except for certain directors)
• Approved share incentive plans
• Use of computer equipment (if available to all directors and employees) up to specified limits
• Use of cycles and cyclist's safety equipment used mainly for journeys between home and work
• Certain bus services for journeys between home and work

You could also consider establishing a company pension scheme, which allows your employees to make additional provision for their retirement by paying regular amounts and additional voluntary contributions.

Small interest free loans
No tax is payable on 'cheap' or interest free loans to employees of up to £5,000.

Employee benefits
Tax efficient benefits can assist your company's profitability by ensuring that employees receive the maximum benefit from the money spent on their remuneration, thereby helping to retain key staff members.

Most, but not all, benefits are now caught by tax legislation. Most benefits are also caught for national insurance. Every employer operating PAYE schemes should obtain a copy of Employer's Further Guide to PAYE and £s (CWG2) - and should read it carefully.

Cars
When company cars are used for private motoring, the taxable benefit is normally calculated as a percentage of the list price. If an employee is also provided with fuel for private use in the car he or she is taxed on the same percentage applied to a standard value regardless of the value of the fuel used. NICs may be due on the fuel, depending on the method of purchase. Class 1A NICs must also be paid by the employer. National Insurance Planning - and don't forget that VAT is payable based on a special scale charge for fuel provided for private use.

Vans
If a company van is made available for private use (including travel between home and work) a standard taxable benefit applies. This benefit includes fuel for private use.

There is no charge for employees who have to take their van home and are not allowed other private use. There is also no charge for use of a commercial vehicle of more than 3.5 tonnes gross weight, so long as the employee's use is not wholly or mainly private.

Expenses payments
These also need to be disclosed on forms P11D. However, the employees then need to put in claims on their own tax returns or tax codes for expenses incurred in the performance of duties.

Where an employee is not required to complete a tax return, form P87 should be used instead.

How to save yourself work
Most employers can obtain a dispensation in respect of certain expenses payments, which could avoid the need to complete P11Ds in some cases. Application can be made at any time. Check with us for details.

Employed or Self Employed?

The question as to whether someone is employed or self employed is not as straightforward as it might at first appear. Many people assume they are free to choose, but HM Revenue & Customs emphasises that this is not the case.

How do you decide?
Although there is no clear-cut answer to this question, HM Revenue & Customs has published a leaflet (IR56 Employed or Self Employed?), which sets out a series of questions to test the particular circumstances of any working relationship. These cover areas such as:

• Ultimate control of the work
• Profit element, and risk of loss
• Provision of materials and equipment
• Integration with the employer's business
• The intention between the parties
• Usual conditions in the industry

Note, however, these are matters of general employment law, and not specific tax legislation.

What are the practical differences?
Employees are taxed under the PAYE system and are liable to Class 1 national insurance (NI) contributions. If the worker is an employee, the employer also has to pay Class 1 NI over a limit set each year, the employee's NI rate reduces to 1%, but for employers, NI continues at the full rate, with no upper limit. The employer also assumes responsibility for paying Statutory Sick Pay and Statutory Maternity Pay.

Employees have rights under health and safety and employment laws, such as the rights to redundancy payments and not to be unfairly dismissed. Moreover, the range of social security benefits is greater for employees than for the self employed.

Self employed workers are taxed under self assessment, and are allowed more scope in claiming expenses. They also pay Class 2 and Class 4 NI contributions, the combined burden of which is lower than Class 1 NI. Their 'employers' are not subject to NI.

It is not surprising, therefore, that many businesses show a marked preference for self employment status for their workers!

What if you are wrong?
It is the responsibility of the person making the payment to get it right. If you treat a worker as self employed and he or she is subsequently ruled to be an employee, you could find that all the payments you have made will be treated as net payments, and you will have to pay the corresponding tax and employees' NI, as well as the employer's NI. You have no right in law to recover such items from your employees after the event.

You may also have to pay interest and penalties for incorrect returns.

Can you create conditions to favour self employment?
If you want to substantiate a classification of a worker as self employed, we strongly recommend that you have drawn up and enforce a suitable contract defining the services provided. In line with the tests referred to above, you will need to give particular consideration to the following points:

Pricing
One of the main requirements is that self employed workers bear some element of risk in the arrangement, which means you will have to avoid the 'hourly rate', in favour of a 'price for the job'. The main principle is that the price, scope, and timing of the work should be agreed, and evidenced in writing, before the job commences.

Workmanship
Within reason, the more freedom the worker has in the detail of the way the work is carried out the better. You must also make it clear that the worker will have to put right any faulty work at his or her own expense.

One of the strongest tests of self employment is the right to substitute a worker who is equally capable of carrying out the work.

All self employed workers should hold public liability insurance.

Provision of equipment
Where practical, the worker should supply at least some of the important equipment or tools. Of course, the extent to which equipment is required depends upon the nature of the work.

What about the construction industry?
The construction industry is subject to exactly the same rules as any other type of industry. However, there are some special considerations.

Where the work entails use of heavy equipment or expensive plant, it is sometimes recommended that contractors hire the equipment to their subcontractors, who then include the cost within their 'price for the job'. Such arrangements may seem artificial, and there is the danger that with substantial hire costs being included in the pricing, the subcontractor's turnover may breach the VAT threshold and force him or her to register for VAT. However, this is not necessarily a bad thing because VAT registration is often cited as further evidence of self employment.

With regard to pricing work, a competitive tender is best, but in practice it should not really matter who makes the first suggestion of an appropriate price.

Although there is a special scheme for taxing construction industry workers, the possession of a Subcontractors Tax Certificate in itself does not necessarily prove self employment status.

What about personal service companies?

These guidelines apply equally to the so called 'IR35' rules to test whether a worker would be treated as an employee of the client, if it were not for the existence of an intermediate service company.