PAYE/PIID pitfalls

November 2009 Supplement

When the tax inspector comes to call, charities can be in for a nasty surprise. How prepared are you for an HMRC employer compliance review? asks Deborah-Parks Green

In an attempt to make the government’s books balance, pressure is on HM Revenue and Customs’ (HMRC) employer compliance Officers to ensure that employers are fully compliant with their accounting obligations for tax and national insurance contributions (NIC). Where mistakes are made, HMRC will recover any unpaid taxes and NIC from the employer along with interest and a penalty of up to 100 per cent of the outstanding liability. Furthermore, a settlement may be sought going back six years.

Charities are no exception and it could be very damaging to be at the centre of a PAYE investigation. A review of the procedures in place is recommended to ensure that no nasty surprises are round the corner. This article looks at several areas of employment tax that are open to HMRC scrutiny. If you have doubts over any of these, you would be well-advised to seek specialist help before HMRC announces a visit.

Employed or self-employed?

When you engage someone to work in your charity, it is important that you establish from the outset the nature of the relationship between that person and the charity. The correct tax and national insurance treatment of payments depends upon this relationship. Where the work undertaken is integral to the charitable purpose, for instance, as a therapist is to a hospice, HMRC will look very closely at that relationship.

Employment status is not a matter of choice but is based on the terms and conditions of the working relationship. Legislation is of little help in the definition of an employee and we must turn to case law for guidance on what is a grey and difficult area.

There is no single test governing whether an individual is employed or self-employed. There is a status indicator tool found on HMRC’s website [1] which can be helpful but sometimes ambiguous. Many different factors must be considered to determine whether they point towards employment or self-employment and it is the overall picture that determines the status. See figure 1 below for a summary.

HMRC is willing to review contracts and comment on status where requested.

Termination payments

In the present economic climate, termination payments are topical for some charities. It is a common misconception that the first £30,000 of a termination payment is always exempt from income tax in the hands of the employee.

A termination payment may fall into one of two categories, which determine the tax and NIC treatment:

it arises from the employment as a contractual payment making it chargeable to tax and NICs as earnings;

it represents compensation to the employee for loss of rights in respect of the employment. The tax rules for charging payments that fall into this category are different from the NIC rules. The full amount would be exempt from NICs but only the first £30,000 would be exempt from tax.

In practice, a termination payment is usually made up of different parts, and an employer must break this payment into its constituent parts to consider in which category each part falls. For instance, where part of the payment is for outstanding holiday that the employee was entitled to under the terms of their employment contract; this would be chargeable as earnings. On the other hand, a statutory redundancy payment will be seen as compensation for loss of office.

The most difficult type of termination payment to assess correctly is payment in lieu of notice (PILON), which depends upon the terms of the contract. If the contract contains a clause that reserves the right for the employer to make a PILON instead of allowing the employee to work their notice, in nearly all cases this PILON should be put through the payroll to account for tax and NICs, as it will be a contractual payment.

Even where there is no PILON clause in the contract, if the employer has historically made PILONS, HMRC will generally contend that the payment is chargeable to tax and NICs. For this reason, many employers seek advice before making PILONS to ensure that they are not left with a settlement with HMRC in the future.

Employee expenses payments

It is not always understood by employers that in the absence of a PAYE dispensation, all expenses payments to employees must be reported on form P11D.

It is not difficult to obtain a dispensation, but before it is granted HMRC needs to be satisfied that the employer carries out an independent check of expense claims and ensures that receipts are submitted to support the claim wherever possible. Ideally, an employer will have an expense policy demonstrating that they are serious about monitoring claims.

Applying for a dispensation is straightforward. Where an expense policy has been implemented, this can be submitted to HMRC, along with a sample expense claim form. The smaller charity may prefer to simply use form P11DX, making appropriate declarations about the expense procedures in place. Once a dispensation has been granted, it can be backdated to 6 April in the tax year the application was made, so it is not too late to get a dispensation in place for the current tax year.

Volunteer expenses

Many charities are fortunate enough to have volunteer helpers. Where individuals work for no financial reward, it is often seen as fair and appropriate to reimburse any reasonable expenses they incur whilst carrying out these duties. HMRC takes the view that, as a volunteer has no formal contract of employment with the charity, the expenses claimed whilst carrying out their voluntary work should not be subject to tax or NIC.

The reimbursement of extra costs that put the volunteer in a position to do the work can also be exempt. So whereas an employee generally cannot claim travel costs for their home to work travel as a business expense, a volunteer can have a reimbursement of these extra costs incurred to enable them to carry out their volunteer work. Similarly, actual costs of providing care for dependents while carrying out volunteer duties may be paid without giving rise to a tax or NIC charge.

Provided the expense payment does no more than reimburse the actual cost incurred, and the costs are reasonable, HMRC would allow the following expenses to be reimbursed:

travel costs to and from the voluntary work place;
travel costs in the course of carrying out voluntary work;
work-related itemised telephone calls, postage or photocopying charges;
care of dependents while carrying out voluntary work; and
purchase of protective clothing for use in voluntary work.

Where a volunteer worker uses their own car for charity business, the rate of mileage payment that can be made tax- and NIC-free is the same as for an employee, which is 40p per mile for the first 10,000 miles and 25p per mile thereafter.

If, however, the expense payment exceeds what is reasonably regarded as a reimbursement of what has been spent, HMRC may well consider the worker to be receiving a salary for their services, chargeable to tax.

If a volunteer wishes to forgo their expenses to further support the charity, gift aid cannot be claimed unless the charity actually pays the expenses to the volunteer and they are
donated back.

The following procedures are seen as good practice for the payment of volunteer expenses:

use an expense claim form;
collect receipts wherever possible;
reimburse actual costs incurred; and
review to ensure they are reasonable.

Homeworker expenses

Charities may well encourage employees to work from home. If the charity is to reimburse employee costs of travelling from their home to the charity offices, they need to be clear as
to whether this represents travel in the performance of duties, and therefore exempt, or whether it is seen as ordinary commuting and chargeable to tax and NIC. Two key factors are relevant.First, the employee should be working under a homeworker's agreement with contractual terms specifying that working from home is a condition of the employment.

Next consider whether:
(1) the office is seen as a temporary workplace, so that home to office travel would be exempt as travel in the performance of duties;
OR
(2) the office is a second permanent workplace, in which case, the home to office travel would be seen as ordinary commuting and therefore taxable.

Employers commonly fall into problems in this area and it can be complex, but broadly, the following circumstances point to the journey being ordinary commuting:

people expect to find the employee at the charity’s office;
they have a desk reserved there;
they spend or are likely to spend 40 per cent or more of their working time at that office over a period of 24 months; and
they are required to attend the office regularly on a set day each week.

The charity may also wish to reimburse household expenses incurred in carrying out employment at home. Where a formal homeworking arrangement is in place, the employer can make tax-exempt payments to the employee to reimburse the additional household expenses that they incur working from home. This might include for example, costs of heating and lighting and additional insurance costs. HMRC requires payments in excess of £3 per week to be supported by records of the extra expenses.

A common problem that occurs is where the employer covers the employee’s ‘broadband’ costs. The costs will be exempt from tax where:

the employer contracts to provide the service AND
the sole reason is for work, AND
private use is insignificant.

Many employees however contract themselves and claim the costs back from the employer. This reimbursement would only be exempt where the expense can be seen to represent
‘reasonable additional costs’.This expense would not be ‘additional’ where the employee was already subscribing for broadband.

Construction Industry Scheme (CIS)

It is commonly thought that under the new CIS scheme implemented in 2007 [2], charities are exempt from CIS. However this is not always the case.

Charities must be aware that, even if they have been exempted, they may be indirectly involved if they have a trading subsidiary undertaking CIS operations, as that subsidiary will have to operate CIS. For example, if a housing association registered as a charity has a trading property company subsidiary undertaking CIS operations, the subsidiary must operate CIS under the new rules.

If the subsidiary fails to operate CIS appropriately, as with PAYE and NIC, HMRC may recover from that company the deductions that it should have made, along with interest and penalties.

Specialist sectors

There are specialist sectors within charities where specific problems can arise. For example in schools, accommodation provision for teachers can be a difficult area, frequently giving rise to settlements where the costs have not been correctly reported on form P11D [3].

Furthermore, most teachers fall into a category of workers that must account for their NIC through the payroll as though they were employees, even where they genuinely work under a contract of self-employment.

[1] www.hmrc.gov.uk/calcs/esi.htm
[2] www.hmrc.gov.uk/cis/whatis-cis.htm
[3] www.hmrc.gov.uk/paye/exb/overview/forms.htm

Author: Deborah-Parks Green

Deborah Parks-Green is an employer consulting specialist at Baker Tilly Tax and Accounting Limited. She has extensive experience in tax and NIC compliance, with a particular focus on the status of workers.

www.bakertilly.co.uk

Click here for other articles written by Deborah-Parks Green

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