Employment Tax

Payroll tax & income tax law

Employees and the directors of companies must pay income tax on their earnings.

Everyone has a “personal allowance” which they are allowed to earn each year without paying tax and in the tax year 2010-2011 this is £6475 although it will increase by £1000 for the tax year 2011-2012. In 2010 new rules were introduced for personal allowances granted to people who earned over £100,000. For every £2 which a person earns over this threshold, his personal allowance is reduced by £1 with the result that anyone who is earning more than £112,950 has no personal allowance and must pay tax on the whole of their income.

The basic rate of tax is 20% and is paid on all income between the personal allowance and £37,400. For any income between £37,401 and £150,000 the higher tax rate of 40% is applicable and any income over £150,000 is taxed at the top rate of 50%.

There are a number of issues which relate to the taxation of employment and there are a number of schemes which can be used to obtain an advantage and reduce the tax liability of the employee:

Salary sacrifice

Under a salary sacrifice scheme an employee will agree to take a reduction in his cash remuneration in exchange for additional benefits provided by the employer such as childcare vouchers. This can create a tax advantage for the employee if the benefit which is given is not taxable. Additionally, even if the benefit is taxable, because of the rules relating to the way in which tax on benefits is calculated, the tax which the employee pays on the benefit may be less than he would have paid on the cash sum which he has sacrificed.

Salary sacrifice can be complicated and specialist advice from a tax-planning advisor is recommended.

Pensions

Special rules apply to payments into pensions by both employers and employees and often these can result in a significant tax advantage. Tax relief on pension contributions needs to be specifically claimed and this is a complicated area of law which has been made more confusing recently by the governments attempts to reduce the tax advantages which employees on a high income can claim.

A specialist tax advisor can help you to structure your pension contributions in the way which is most tax efficient and can help you to understand the complicated rules about disclosure and tax avoidance which have recently been introduced.

Payment in lieu of notice

When an employment is terminated there is usually a notice period which the employee must be allowed to work out. However, the law allows the employer to opt to end the employment instantly and to then pay the employee an amount equivalent to the salary which he would have earned instead. When this happens the employer may be able to claim tax relief as under a recent court ruling payments in lieu of notice are considered to be compensation and are not taxable.

Penalties for late payment of employment taxes

Under current legislation Employers are required to deduct tax from the employee’s earnings at source and then to pay this over to HMRC but increasingly the tax authorities have experienced difficulties with employers who have failed to pay tax which is due promptly. In 2009 the government passed legislation which introduced penalties for the late payment of tax by employers and these penalties are governed by schedule 56 of the Finance Act 2009.

The penalties are calculated as a percentage of the amount which is paid late, and the size of the percentage varies depending on how many times the employer has paid tax late and how late the tax is. The penalty for up to 3 defaults is 1%, rising to 4% where there are 10 or more defaults. In addition, a penalty of 5% is applied to any payments which are more than 6 months late and this increases to 10% where a payment is more than 12 months late.

Under the legislation an employer may appeal any penalty charges and the penalty may be reduced or waived if the employer can show a “reasonable excuse” for the late payment.