Employment Income

Employment or Self-Employment?

There is a fundamental difference between income received as an employee and as a self-employed person/independent contractor. Where income is paid as employment income, the employer must deduct income tax and National Insurance contributions under the PAYE system and remit it to HMRC. There are quite different rules in terms of allowable expenditure and deduction between employment income and the trading income of a self-employed person who provides his services as an independent contractor.

Difficult questions can arise as to whether an arrangement is really an employment or an independent contract.  Generally, an employee is somebody under the direction and control of the employer. This was a more traditional test. Because of how employment has changed, this has been refined to a test as to whether the person concerned is in business in his own account.

The basis of Tax Charge

Employment income is taxed in the year in which it is received or, if earlier, when it is entitled to be received. Accordingly, the actual tax year applies as the basis in the case of a director of a company, with income received or to be received in the earliest. It is credited to the Director in the accounts and in respect of income within a period of accounts. The end of the period is determined within the period or the date of determination, later or earlier than the general receipt or entitlement date.

Employment income encompasses almost all income and benefits received by an employee, whether on commencement, termination of employment, or during employment. Retirement pension, job seekers allowance, statutory sick pay, maternity pay, and paternity pay are taxed similarly via the PAYE system. They are taxable irrespective of from whom they are received, employer or otherwise, as long as they arise by reason of employment.

All employees and directors are assessed on earnings received in the tax year. Earnings include cash salary but also a bonus, commissions and other benefits provided by the employer. There are very limited deductions allowable against an employee’s income for the purpose of calculating the tax. Expenditure must be wholly exclusively and necessarily incurred in the performance of the employment duties. This is much narrower than the test in respect of business expenses.

Certain expenses are allowed as deductions against employment income.  These include contributions to pension scheme subject to certain limits,  certain expenditures on travel subject to stringent rules and certain expenses incurred for equipment and machinery necessarily provided by the employee.

Travel expenses may only be incurred where they are necessarily incurred in the performance of the duties. Therefore the cost of commuting to and from work is not allowed. Necessary commuting within the working day is allowable if visiting a client. No relief is given for travelling between two separate employments.

As in Ireland, there are approved mileage allowances for employees who use motor cars for business purposes. The allowances are equivalent to the civil service rate allowed. They specify the maximum rates which can be claimed.

Ant-Avoidance

Anti-avoidance legislation seeks to limit the extent to which personal service companies may be used. A person might avoid being classed as an employee if they perform a service to a limited company (a personal service company) and purport to provide services to a company in what would otherwise constitute an employment relationship.

Legislation applies to relevant engagements, which are those where services are provided by a worker to a client through an intermediary, usually a company. If it had not been for the intermediary’s presence, it would have been treated as an employment relationship. It applies only where the income received from the intermediary is not taxable as employment income, and the worker does not have any other rights to income or capital from that entity.

Where the intermediary receives income from so-called relevant engagements, and the income exceeds the worker’s employment income that year, the excess is deemed a salary payment made at year-end. Accordingly, it is subject to income tax and national insurance contributions for the employer/client, for which PAYE must be operated.

In the above calculation, allowable expenses include expenses allowed for employment income, employer’s pension, national insurance contributions made by the intermediary entity, plus a flat percent of 5% of income from engagements. When the provisions apply, and dividends are paid that are in substance salary otherwise taxed, the dividends are not taxed.

A variant that anti-avoidance legislation aims at is a managed service company. These are typically structured as packages, where a number of employees may become shareholders who offer services to clients in bulk. The legislation operates broadly the same as that set out above.

Termination Payments

A payment on termination is tax free if employment ceases because of the accidental death, injury or disability of the employee, or if the employee worked overseas most of the time. If the sum is paid other than on death or retirement, the first £30,000 (including statutory redundancy in this limit) is tax free.

Termination payments are fully exempt if they are due to injury or disability of the employee, payable on the death of the employee, or lump-sum payments under a registered pension scheme. Payments — ex-gratia payments to compensate for loss of employment, together with statutory redundancy pay up to £30,000 are exempt. Apart from the above, all termination payments are taxable.

A taxpayer who has adjusted net income over £50,000 and received child benefit is subject to a high-income child benefit charge equal to 1% of child benefit for each £100 of income between £50,000 and £60,000. At £60,000, this is 100% of the child benefit amount.

PAYE

A PAYE system obliges employers to deduct income tax and national insurance contributions from employees on the payment of salary. The amounts, together with employer contributions, must be paid within 14 days of the end of the month or 17 days if electronic. The tax month runs from the sixth of the month. Employers whose payments are less than an average of £1,500 per month may make quarterly payments.

PAYE applies to payments assessable as employment income, including salary but also payments in kind and commodities relatively easy to turn into cash. See the separate section on benefits in kind. These are usually taken into account by an adjustment in the tax allowances.

Tax codes are issued by HMRC for each employee. They set out the amount that may be earned before taxation. This takes into account personal allowances, reliefs, and allowable expenses available, with adjustments as may be necessary to collect taxes on benefits in kind.

Employers who use a manual payroll system are given tax tables to calculate income taxed to be deducted weekly or monthly. Cumulative payments at the start of the tax year are recorded. Deduction sheets allow easier calculation of accumulated figures.

Table A sets out pages for each week or month for every tax code. The amount of tax-free pay with allowances spread out annually, the taxable pay table sets out the income tax liability to-date, the tax due in respect of the previous month or week is the tax due to-date less the tax paid to that date.

Various key forms include P45 for when — a form with four parts, setting out tax deducted to-date and paid when an employee leaves employment.

P60 is the annual certificate of gross pay and tax deducted, which must be given to employees at year-end. P35, the list returning all employees and showing each’s gross pay, net tax paid, national insurance paid must be returned to HMRC shortly after tax year-end. PD11 or 11D is a return showing benefits in kind of an employee or director earning more than £8,500. It must be submitted to HMRC within three months of tax year-end, with copies given to employees.

Forms; online filing has become mandatory for most employees. The real-time PAYE system. All employees and employers are subject to it with mandatory online returns, removing the need for a P35. P14 is an end of year return showing gross pay, tax paid, and national insurance paid, which is to be sent by HMRC to the employer.