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KEY POINTS
- Payrolling benefits will be more of a burden than completing P11Ds
- Taking into account benefits is likely to make employees' pay differ each month
- Not all benefits and expenses are predictable.
- There is more potential for unintentional PAYE errors
I doubt that many readers of Taxation are also avid readers of HMRC consultation documents, particularly as HMRC seem to have adopted the habit of issuing the most important ones around Christmas, which is also the middle of the tax return season.
However I urge readers to look at the document called 'Payrolling benefits in kind and expense payments' that appeared on the HMRC website on 13 December, and to let HMRC have their views.
I think that payrolling benefits will be an unmitigated disaster for small businesses. The document suggests that HMRC are very much in favour of it so, unless there is a strong body of representations against it, it is likely to happen (although probably not in this year's Finance Bill as the consultation period does not close until 14 March 2008 which is now just after Budget day).
The document presents payrolling as a simplification, as it leads to the abolition of the form P11D, the completion of which, research has shown, employers regard as one of their most costly administration burdens.
So why am I so vehemently opposed to the proposal? Surely I am in favour of simplification?
The reasons I am against it are:
- I do not believe that it is a significant simplification for small businesses; and
- I do believe that the additional administrative burdens that it creates will far outweigh the minor savings achieved by abolishing the P11D.
Of course completing forms P11D is burdensome. It will become even more so if the Government accepts HMRC's proposal to abolish the £8,500 threshold, as a P11D will have to be prepared for every single employee, including part-time employees who may well currently be paid at a rate of less than £8,500 a year (except where a dispensation is obtained).
The P11D burden
Why is completing forms P11D so burdensome? The following are the main reasons:
- Identifying what expenditure gives rise to a benefit.
- Calculating the benefit — particularly where a single expense generates benefits for a number of employees.
- Identifying and reporting expenses even though those will not give rise to a benefit.
- Completing the forms.
- Sending the forms to HMRC.
- Giving a copy to employees — although only to those still employed at the end of the tax year.
Which of these burdens are the most onerous? Far and away the first three items. Which one will payrolling obviate? None of those!
It will obviate the final three items but, in return, forms P45 and P60 will become more complicated documents, so it seems questionable whether there will be any administrative saving at all.
The additional burdens
Where are the additional administrative burdens? Currently most small businesses do their payroll monthly (although some still pay weekly). They either handle this in-house, or use a payroll bureau, their accountant or another third party to calculate the tax.
Give or take a few pence, if the salary remains constant, as most do during the course of a year, so does the tax.
The employee receives a relatively regular figure of take-home pay and only questions how it has been calculated once a year. At the end of the year, the employer will either prepare the P11D forms in-house or, again, outsource them.
The P11D is a very difficult document to get right. Most small businesses do not have a standard menu of benefits available to employees like large companies.
They provide benefits on an ad hoc basis, either at the whim of the employer or to meet individual difficulties faced by an employee.
The completion of the form accordingly requires a thorough review of both the cash book and petty cash book to identify both expenses and items that could give rise to a benefit. Indeed, for directors in particular, an individual item can be an expense as well as containing an element of benefit.
Before the introduction of self assessment many, if not most, small businesses prepared their P11Ds on an accounts basis, which enabled the forms to be completed by the business's external accountant at the same time as he prepared the accounts.
This saved considerable time and costs as the cash book had to be reviewed in order to prepare the accounts in any event, so the two jobs could be done together. The Government of the day decided to prohibit the use of the accounts basis.
Perhaps this was because it regarded saving costs for small businesses as irrelevant compared with the Government's wish to impose on employers part of the work of completing employees' tax returns timeously, by requiring a copy of the P11D to be given to the employee by 7 July after the end of the tax year.
This is necessary for employees who have to complete a tax return and wish HMRC to calculate their tax, so have to submit their tax returns by 31 October (previously 30 September).
As a result, P11D forms have to be prepared as a separate exercise between April and June each year. Many small businesses still sub-contract the work involved in spite of the extra cost.
Possible changes
What will happen under payrolling? The small employer will have to learn about benefits and expenses. The cost of subcontracting the work is likely to become prohibitive if it has to be done monthly. The employer will have to review all his expenditure during the month and decide for each item:
- whether it constitutes an expense attributable to one or more individual employees;
- whether only part of it constitutes such an expense;
- whether it gives rise to a benefit to one or more individual employees;
- if so, whether the benefit is liable to National Insurance under Class 1 or Class 1A; and
- if Class 1A National Insurance does apply, he will need to introduce a system to pick up the benefit at the end of the year.
Presumably he will have to do this on the payday itself as otherwise there would be a gap between the cut-off point and the payday, with the result that benefits in that gap period would fall into the wrong month, which might have penalty implications.
If the employer uses a payroll bureau, he has to transmit this information to the bureau for it to process the payroll. (In the real world the bureau will want the information at least a week in advance, so the cut-off will need to be at least that period prior to the payday).
Actually, the document suggests a different solution. The benefits and expenses for a month can be calculated on the basis of a 'best estimate' with an adjustment being made in a subsequent month when the amount is quantified.
Leaving aside the extraordinary concept of 'simplifying' something by doing it twice instead of once, it is unclear how an employer can, in practice, estimate with any degree of confidence what an employee is likely to do in the next fortnight that could generate a taxable benefit or expense.
NI contributions
The document makes clear that the Government has no intention of changing the current situation where some benefits are liable to Class 1 National Insurance, but most are liable under Class 1A.
Those taxable under Class 1 are already payrolled. Those taxable under Class 1A will, under the proposals, be payrolled for income tax but not for National Insurance.
They will continue to be liable to Class 1A National Insurance.
This means that when a person changes jobs, the new employer will need more than cumulative pay and tax, as the pay figure will include Class 1A benefits on which the old employer will remain liable to pay the National Insurance in due course.
The cumulative pay will probably need to differentiate between, on the one hand, actual pay plus Class 1 benefits and, on the other, Class 1A benefits.
Currently for Class 1 benefits, the tax itself gives rise to an additional benefit if it is not reimbursed to the employer within 30 days.
While that will continue for Class 1 benefits, it is proposed that the employer and employee agree between themselves how and when the employee reimburses the PAYE on other benefits to the employer.
It seems that all the Government cares about is getting the tax in the month following that in which the benefit is provided. If deducting the tax on benefits from pay leaves the employee unable to feed his family, that will not be the fault of the Government; it will be the fault of the employer for not agreeing to fund the employee's tax by spreading the reimbursement over several months — to the detriment of the employer's own cash flow.
In the less extreme case, the employee will move from a system where his take-home pay is relatively constant, i.e. as one twelfth of the tax on his benefits is collected each month because HMRC will have adjusted for estimated benefits in his notice of coding, to one where it will fluctuate violently if, as is normally the case, benefits fluctuate.
It is wholly unrealistic to expect most employees to understand their tax deduction in such circumstances, but in order to reassure them that the correct amount has been deducted, the employer may find he now has a new burden of explaining the tax deduction to employees on a monthly basis.
And there's more…
These are only the problems with the main features of the proposals. Space does not permit a consideration of the problems that arise on specific items.
Let's look at expenses. Most expenses do not give rise to a benefit but, for directors in particular, some sort of benefit element is often agreed with HMRC after the end of the year in relation to some items.
Presumably under the new system, the employer will need to determine himself whether there might be a benefit element. He has to do this in the knowledge that, under the current system, if he gets it wrong, the tax is his problem, not that of the employee.
So if he underdeducts not only does he lay himself open to interest and penalties to HMRC, but there is also the risk that the employee may have left his employment by the time HMRC challenge the split between business and personal benefit.
Another obvious issue is interest-free loans. The benefit is based on the average amount outstanding for the year. How can that be calculated on a monthly basis in the course of the year? Clearly it cannot.
What about the staff Christmas party? This is not taxable if the cost per head is under £150, but it will become taxable (as December pay) if later the business has a summer sports day, and the cost of the two combined exceeds £150 a head.
I could go on. But I hope that I have put across the message. We need to stop this crazy idea. If every reader responds to the consultation perhaps we can.
