EIM07700 - Employment income: tax-free remuneration ("grossing up")

An employer cannot typically pay tax on an employee’s behalf without incurring a further tax liability (see EIM00580).

If an employer wishes to make a “free of tax” payment to an employee, they can “gross up” the employee’s pay.

This is a system by which the employer increases the gross amount of the remuneration, so that the net amount (after tax) equals the amount the employee was expecting to receive.

The employer must deduct tax from the increased gross amount.

HMRC officers are not primarily involved because the question is one of interpreting an agreement between employer and employee.

Example

An employer has agreed to reward an employee with a bonus worth £500 after deduction of income tax. The employee pays tax at the basic rate.

If the bonus is £500, the employee will only receive £400 net after deduction of tax:

£500 - £100 income tax (at 20%) = £400

The employer must “gross up” the bonus by increasing the gross amount to £625 so that the employee receives £500 net:

£625 - £125 income tax (at 20%) = £500

Note that this is an illustrative example, and in practice the employer would also be required to deduct National Insurance Contributions from this payment.