What is a PAYE Settlement Agreement?
PAYE Settlement Agreements, often simply referred to as PSAs were introduced by HM Revenue and Customs (HMRC) in the 1990s as a form of administrative easement for employers and HMRC under a formal arrangement. Unfortunately, the previous system was an informal arrangement and had no legal binding and therefore had to be replaced.
The PSA allows employers to settle the income tax liability on behalf of their employees for certain minor, irregular or impracticable benefits in kind and expenses. Once the PSA is agreed by HMRC, there is no requirement for the employer to report it on an employee’s P11D or for the employee to include it in their tax return.
OTS Recommendations
In 2014, the Office of Tax Simplification (OTS) carried out a review of employee benefits and expenses and highlighted several issues with the PSA process. In response, the Government conducted a consultation in 2016 on the proposals to simplify the process of arranging a PSA and to clarify the use of PSAs. As a result of the consultation and in line with the OTS’s recommendations changes were made to the PSA process.
Deadlines
Ideally an employer should put in place a PSA before the start of the tax year but in fact an agreement can be reached with HMRC at any time during the year up to 5 July following tax year end. The deadline of 5 July is set because if the PSA item is rejected by HMRC, then the employer must report it on the employee’s P11D by 6 July unless of course they are payrolling the benefits or expenses. By including the items in a PSA there is no Class 1A liability as Class 1B NICs are paid instead.
There are several benefits and expenses that can be included in a PSA but one item that does not qualify is if you are paying your employees an amount in cash. For example, if an employer pays an employee a bonus but wants to meet the tax and NIC liability they cannot include it in a PSA. The employer’s only option would be to gross up the amount of the bonus and pay it via the payroll so that the employee receives a set amount in their net pay. Other items that are excluded from a PSA are round sum allowances and beneficial loans.
Another item that cannot usually be included in a PSA is a major benefit in kind such as the provision of a company car although there may be some scope to include a shared car. It is also possible to include (subject to HMRC approval) the cost of a hire car for a couple of weeks for an employee.
Examples of what can be included are set out in the guidance on Gov.uk and are as follows:
- Long term service awards (these are items or gift vouchers that exceed the tax-free limit but not cash)
- Telephone bills
- Small gifts and vouchers (but not exchangeable for cash)
- Staff entertainment such as a ticket to an event
- Non business expenses while travelling overnight on business where they exceed the daily limit of incidental expenses (£5 per night within the UK and £10 per night if travelling abroad)
Where the items you want to include are classed as irregular, because they are not paid at regular intervals and the employee does not have a contractual right to them you can include:
- Relocation expenses which exceed the tax-free allowance of up to £8,000.
- Use of a company holiday flat.
- Expenses to cover the cost of a spouse accompanying an employee abroad on business.
Where the expense or benefit in kind is classed as impracticable this would be because it is difficult to place a value on it or to divide it up between several employees. This would include items such as:
- Staff entertainment that is not exempt from tax and NIC. A good example of this would be attending a Christmas party or annual function(s) where the total cost exceeds £150 per head.
- Personal care expenses such as hairdressing.
Avoiding Common Mistakes
Although employers are at liberty to apply for a PSA at any time during the tax year up to 5 July following tax year end, it is advisable to obtain approval prior to providing the benefit or expense particularly if it is for non-cash vouchers. Non-cash vouchers, (excluding childcare voucher and luncheon vouchers) that are provided to employees such as gift vouchers at Christmas, for example, are not only taxable but attract Class 1 National Insurance. If a PSA is not in place for the gift voucher when it is provided to the employee, then the employer is obliged to calculate and deduct Class 1 NIC at that point. The value of the voucher for NIC purposes is the cost to the employer rather than the face value of the voucher. Further information can be found in the CWG2 and here is the link to the specific section 2.6.2:
Application
If you have not previously applied for a PSA you must write to HMRC Business Tax and Customs describing the expenses and benefits you want to include in the PAYE Settlement Agreement. Once HMRC has agreed the items to include they will send you 2 draft copies of form P626. Both forms must be signed by the employer and returned to HMRC, they will then formally authorise your application and send back a form which is your PSA. The PSA can continue for subsequent tax years unless the circumstances change or the arrangement is cancelled.
Payment is due on the grossed up tax and Class 1B NIC by 19 October (or 22nd October if paying electronically) following tax year end. Class 1B NIC is an employer only liability and is currently charged at 13.8%.
You can use form PSA1 to calculate the overall amount you will need to pay HMRC. There are three versions of the form as there are three sets of tax thresholds depending on where the employee is based for tax purposes:
- England and Northern Ireland
- Wales
- Scotland
All three versions of the form can be completed online and then printed and posted to HMRC. They can be found at www.gov.uk/government/publications/paye-paye-settlement-agreement-psa1 but please ensure you use the correct form(s).
