New PAYE stealth tax spares employee share schemes
From 6th April 2011 new rules are being introduced in relation to payments made to leaving employees after the P45 has been issued. It comes as no surprise that these arrangements work to the advantage of HMRC; in particular they could affect the taxation of compromise agreements. However the good news is that they will not affect employee share schemes.
Presently, if a termination payment is made after the P45 has been issued, and the payment is taxable, employers must deduct tax at basic rate only. Under the BR tax code the employee would then need to declare the amount on their self assessment tax return and pay any further tax due after the end of the relevant tax year. This provides a cash-flow advantage to employees as any extra tax does not need to be paid for a number of months after.
Under the new regulations, from 6th April onwards, employers must apply the new 0T tax code and deduct tax up front on the post P45 payment, at the basic 20%, higher 40% and, if necessary, the additional 50% rate. The 0T tax code should be applied on a "non-cumulative" basis. For an employee paid on a monthly basis, this means that only 1/12th of the basic rate band (and, if relevant, 1/12th of the higher rate (40%) band) is available in the month of payment. This will mean that if the termination payment is more than the appropriate proportion of the 20% band, the excess will be taxed under PAYE at 40%, and if the payment is also more than the available 40% band, the excess will be taxed under PAYE at 50%.
The new tax code increases the risk that the amount of PAYE deducted may exceed the actual tax liability. In this case, the employee will need reclaim any excess after the end of the tax year via their self-assessment tax return.
Currently, post termination payments in excess of £30,000 are subject to tax at the basic rate of 20 per cent. Under the 0T tax code, tax must be deducted at source at basic, higher or the additional rate, with no personal allowance.
In practice, until now, employers have been able to offer a cash-flow advantage to employees when negotiating a compromise agreement. The change will remove this advantage and may encourage employers to consider splitting post termination payments to reduce the amount subject to deduction at 40% or 50%. There could be a cash-flow advantage from making several months' basic and higher rate bands available for PAYE purposes.
In relation to share based payments and share option taxable values, ifs ProShare, which is a not for profit organisation that promotes employee share ownership, submitted a paper to HMRC with its concerns on how the new 0T tax code could impose unfair levels of taxation on employees, an increase in administration on employers from having to apply multiple rates of tax and the possible need for employees to sell a greater number of shares to cover the tax bill. HMRC have now responded and confirmed that the change to the 0T code will not apply to share-based payments and employers should continue to deduct tax at basic rate using the BR code.
Employers are responsible for ensuring the correct amount of PAYE is deducted and paid over to HMRC, in order to not incur penalties. Payroll systems must be updated accordingly to incorporate the changes. Employers should inform employees who are leaving the amount of tax that will be deducted. Thought must also be made to wording used in compromise agreements to explain any tax implications.
If you would like further information on this issue please call us on 020 8949 5522 and ask to speak to one of our advisers.