Policy paper

Statement of Practice 5 (1996)

Published 15 October 1996

Introduction

1. PAYE (Pay As You Earn) settlement agreements (PSAs) - formerly known as annual voluntary settlements (AVSs) - are arrangements under which employers can settle in a single payment the Income Tax liability on largely, minor benefits in kind and expenses payments given to their employees.

2. PSAs are potentially available to all employers. They are intended to provide flexibility for those employers who use them because items covered by a PSA do not have to be included on Forms P9D or P11D at the end of the year. Nor do employees have to include them on their tax return, if they receive one. But they are not intended to provide a general alternative to the obligation on an employer to operate PAYE under Income Tax (Earnings and Pensions) Act (ITEPA) 2003 s 684 or to make a return after the end of the year in relation to benefits in kind and expenses payments. This means that PSAs will not apply to:

• cash payments of wages, salaries or bonuses including those paid to casual employees
• major benefits provided regularly for the sole use of individual employees - for example, a company car, car fuel, provided accommodation, beneficial loans
• round sum allowances

3. However, the key intention of PSAs is flexibility. It is intended that inspectors will regard PSAs as a useful way of reducing burdens for employers and HM Revenue and Customs (HMRC) alike.

4. ITEPA 2003, Pt 2, Ch 5 and the Income Tax (PAYE) Regulations, Statutory Instrument 2003/2682 Part 6 contain rules governing PSAs.

PAYE settlement agreements

Scope of items which may be covered by a PSA

5. Regulation 106 describes the earnings which can be covered by a PSA. This provides for the inclusion of expenses payments and benefits which are ‘minor’ or, if not minor, are either payable on an ‘irregular’ basis or in circumstances where it is ‘impracticable’ to apply PAYE or apportion the value of particular benefits which have been shared by a number of employees.

6. These terms have deliberately not been defined. The regulations require the employer and the inspector to agree where payments are of an amount, or are paid in circumstances, which satisfy one or other of the terms. In discussion with the employer, the inspector will be expected to make a reasonable judgment - based on the natural meaning of the words and taking account of the overall objective of the arrangements - about what may be included in a PSA.

7. Some examples are given below of items which may be suitable for inclusion in a PSA. It is not an exhaustive list. And it will not always be appropriate for an item listed below to be included in a particular PSA. In addition, some items might satisfy more than one term. The following paragraphs indicate some of the factors which an inspector may take into account.

Interpretation of ‘minor’

8. An expenses payment or benefit in kind can be included in a PSA if it is ‘minor’ as regards the sums paid or the type of benefit provided - Regulation 106(3)(a). In agreeing with employers what may be included in a particular PSA, inspectors will take account of the natural meaning of the term ‘minor’. The key question is whether on any objective judgment the item in question is minor in value. The nature of the item and the circumstances in which it is paid will normally also need to be taken into account. For example, a gift paid as part of a scheme to reward long service which does not satisfy ITEPA 2003 s 323. In deciding what constitutes minor, inspectors will not be influenced by, for example, the comparable earnings of the particular employees concerned or the size of the employer.

9. Some examples of what may constitute a ‘minor’ item may help:

• long service awards outside ITEPA 2003 s 323
• incentive awards
• reimbursement of late night taxi fares home outside Extra Statutory Concession (ESC) A66
• personal incidental expenses in excess of the statutory daily limit
• present for an employee in hospital
• staff entertainment - for example, a ticket for Wimbledon
• use of a company van
• use of a pool car where the conditions for tax exemption are not satisfied
• subscriptions to gyms, sports clubs etc
• telephone bills
• gift vouchers and small gifts

10. If it is not possible to accept that an item is ‘minor’, it may still be appropriate for inclusion in a PSA because the inspector will then consider whether it is either paid on an irregular basis or whether it is impracticable to apply PAYE to it or identify the amount to be included on form P11D. The following paragraphs indicate some of the factors inspectors will take into account when deciding if the circumstances satisfy either test.

Interpretation of irregular

11. Regulation 106(3)(b) provides that an item may be included in a PSA if it is paid irregularly to an employee. Whether an item is paid on an ‘irregular’ basis will depend on the facts of each case. The inspector will take into account, for example, the nature of the item, the normal frequency of its payment and how often it was paid or given to the individual employee in question. The exclusion of an item given to some employees because it was received regularly by them, would not necessarily mean that the same items received, irregularly by other employees would be excluded from a PSA. In considering if an item is received irregularly, inspectors will primarily consider the frequency at which an item is provided during the year for which the PSA applies. But in appropriate cases, for example the use of the employer’s holiday accommodation, the period taken into account may be longer. Items provided to the same employee every year are unlikely to satisfy the irregular test.

12. Relocation expenses where the amounts concerned exceed the £8,000 tax exempt threshold (ITEPA 2003 s 271) are an important example of a range of benefits in kind or expenses which may fail the minor test, but will normally qualify for inclusion in a PSA on grounds of irregularity.

13. Other examples may include:

• occasional attendance at an overseas conference where not all the expenses qualify for relief under ITEPA 2003 Pt 5
• expenses of a spouse occasionally accompanying an employee abroad
• occasional use of a company holiday flat
• one-off gifts which are not minor

Interpretation of ‘impracticable’

14. The key question is whether it is ‘impracticable’ for the employer to operate PAYE on a payment or to identify precisely how much of a shared benefit should be attributable to each individual employee and included on the Form P9D or P11D. The employer will be expected to demonstrate that it would not be possible to do so without a disproportionate amount of effort or record keeping taking account of the value of the item concerned, the number of employees involved and the nature of the items involved.

15. Examples of what might be impracticable may include:

• free chiropody care
• hairdressing services
• shared use of the firm’s bus to work
• christmas parties and similar entertainment provided by the employer which do not already qualify for relief
• the cost of shared taxi fares home which do not satisfy ESC A66
• shared cars

16. The flow chart at Annex A summarizes the tests of eligibility for inclusion in a PSA.

Overlap with Taxed Award Schemes

17. Currently, employers operating formal incentive award schemes can pay the tax on behalf of their employees by entering into a Taxed Award Scheme (TAS) with HMRC. A general information pack on TAS is available from

HM Revenue and Customs Local Compliance
Specialist Employer Compliance
SO794
PO Box 3900
Glasgow
G70 6AA

Telephone: 03000 577340

Most awards under these schemes will be suitable for inclusion in a PSA if employers wish to use a PSA instead of TAS. A third party who provides awards to the employees of another and who wishes to pay the employees’ tax bill cannot use a PSA. A TAS should be used instead.

Calculation of tax payable

18. Regulation 108 provides the basis on which the tax payable by the employer may be computed. In practice, this provides for the tax to be grossed up in a similar way to that already adopted by inspectors for agreeing amounts due under the previous, informal arrangements for AVSs. In calculating the tax payable, the inspector and the employer will take into account:

• the amount of any expenses payments and the value of any benefits in kind provided which are to be included
• the number of employees concerned receiving the payments or benefits
• the rates of tax which should be used in ‘grossing up’ the tax due

19. The tax due should be grossed up taking into account the effective marginal rates of tax of the individual employees covered by agreement. So, for example, where an agreement relates to a group of employees some of whom are basic rate taxpayers and some are higher rate taxpayers, the tax due will need to be grossed up separately for the 2 groups of employees and the results aggregated to give the total tax due. In appropriate cases, the inspector and the employer may agree that the amount of tax payable under a PSA in relation to a large number of employees can be calculated by reference to a sample of the employees concerned. An example of how to calculate the tax payable under a PSA is attached at Annex B.

Record-keeping

20. Once a PSA is agreed the employer no longer has to:

• operate PAYE on agreed items or include the items on the P35 or P14
• include the expenses and benefits concerned on Forms P9D or P11D

21. The employer will still need to retain suitable records of what had been provided or paid. In general, it will be sufficient to retain records for 3 years. Where items are easily attributable to individual employees, the same records otherwise required for the purposes of completing Forms P9D and P11D should be retained. Details of cash payments to individual employees should also be retained. But where it is impracticable to allocate a benefit or payment between employees, a record of the individuals concerned will not be needed. Instead the employer should keep sufficient information about:

• the overall cost of providing the benefits concerned (for example the total cost of providing a party which a number of employees attended)
• the number of employees concerned
• an indication of their marginal tax rates

What employers should consider telling their employees

22. Employees should not include items covered by a PSA in their tax return, if they receive one.

23. Employees who receive tax returns may ask the employer to clarify the position in relation to benefits in kind or expenses payments they have received which are not included on the P11D information given to them by their employer. So employers may find it best to tell employees about them at the same time as they issue the P11D information to their employees. And if the PSA is a regular arrangement, employers might find it best to tell employees when they first take up their employment or when employees first receive an item included in the PSA. This may reduce the number of possible queries from employees who are completing their own tax returns.

24. However, there is no statutory requirement for employers to tell their employees about a PSA and HMRC will not be liable to disclose details of agreements they have made with employers to their employees. Nor will it be possible for HMRC to check that an employee who has completed a tax return may have included such items in error.

Adjustments to the scope of a PSA

25. The inspector will not normally need to adjust a PSA during the year. But employers may ask the inspector to widen the scope of a PSA which applies for a particular year by:

• during the year, adding items on which PAYE would otherwise be due - but only ceasing to apply PAYE once the inspector has agreed the extension to the PSA
• during the year, adding items which would otherwise be included on Form P9D or P11D
• after the end of the year, but before 6 July following the end of the year, finalising the PSA by adding items which would otherwise need to be included on Form P9D or P11D

26. Many employers will want to carry forward their PSA to the following year. Inspectors will invite employers before the beginning of the year to renew their PSA. The PSA will only need to be altered if the employer wishes to make an adjustment to what had previously been agreed or it was justified because there had been a change in the circumstances on which the original PSA had been based.

Payment of tax

27. Regulation 109 provides for the payment of tax under a PSA. The employer - not the employee - will always be accountable for tax payable in respect of items included in a PSA (ITEPA 2003 Pt 2 Ch 5 and Reg 105).

28. The precise amount of tax does not need to be agreed by 6 July when the scope of the PSA has to be finalised. Normally, the tax due will be agreed between the employer and the inspector after 6 July, but in time to ensure that payment is made by the due and payable date of 19 October following the end of the tax year to which the PSA applies. There is nothing to preclude the employer from paying the tax in full before the due date (where it can be established in advance) or making instalment payments during the year. Those who wish to do so should contact the inspector accordingly.

Withdrawal of PSA by the inspector

29. Where the inspector establishes that an employer has operated outside the agreed terms of a PSA he may cancel or adjust the agreement. Employers will then be expected to operate PAYE as appropriate on payments made after the date of cancellation or termination. Similarly, all benefits and expenses provided after that date will need to be returned on Form P9D or P11D at the end of the year.

30. Inspectors may cancel a PSA where there has been a serious or persistent failure to account for the tax under the agreement; or more generally where there has been a failure under PAYE or in relation to the completion of Forms P9D or P11D. An inspector would not normally cancel an agreement because, for example, the employer had made a minor error as to the calculation of the tax payable under a PSA, or in relation to the sums on which tax should be computed.

31. Following a withdrawal, the agreement of a PSA for future years will be at the discretion of the inspector. Each case will be looked at on its own merits. But there would be nothing in principle to prevent an inspector agreeing a PSA for the tax year following a cancellation where he was satisfied that the failure would not re-occur.

Rights of appeal

32. There is no statutory right of appeal against the refusal of the inspector to agree a PSA or the cancellation of a PSA. But if the employer believed that the inspector had acted unreasonably, after review under HMRC’s internal complaints procedures, the matter could be considered by the Adjudicator for HMRC. Details of the complaints procedures for taxpayers are available in HMRC leaflet COP 1 ‘Putting things right: how to complain’.

33. There is a statutory right of appeal against a determination under reg 110 of the amount of tax payable under a PSA. Under TMA 1970 Sch 3 (as amended by FA 1996 Sch 22 para 10) the employer can elect to have the appeal heard where the place of business is located. In practice, this could be where the company head office is located or where the trade is carried on.

Treatment of national insurance contributions under a PSA

From 6 April 1999 Class 1B National Insurance contributions are due when a PSA is entered into. Information about Class 1B National Insurance contributions can be found on the HMRC website.

Annex A

Flow chart for deciding which items can be included in a PSA.

Annex B

Calculating the tax payable under a PSA-example.

Regulations

Income Tax (Pay As You Earn) Regulations 2003, SI 2003/2682.

Note: this statement was revised in August 2005.

Concessions A22 and A66 have now been classified as obsolete.