Employee expenses
25 May 2019
This article was featured in the June 2019 issue of the magazine.
The types of expenses payments being paid, and the associated tax implications for employment tax purposes, have evolved over the years. Justine Riccomini, head of taxation (Scottish Taxes, Employment and ICAS Tax Community), ICAS, discusses
The trickier aspects of expenses and benefits in kind can catch out employers, but the key is to keep it simple. First, make an objective distinction between private and business, then decide which type of expense or benefit it is. From there it is possible to allocate the correct treatment, if indeed no exemptions or reliefs are due.
What could possibly go wrong?
Private or business?
Making the initial decision as to whether an item of expenditure is ‘business’ or ‘private’ is fundamental to ascertaining the correct income tax and National Insurance contributions (NICs) treatment of that item. Usually, the expenses policy of the business stipulates what can and cannot be paid, and how this translates into either a taxable or non-taxable receipt for the employee. Anyone looking for guidance on this should first consult HM Revenue & Customs’s (HMRC’s) booklet 480 (http://bit.ly/2H7HItt) which deals with expenses and benefits, and booklet 490 (http://bit.ly/2JoFHL8) which deals with the treatment of travelling and subsistence expenses.
...can be classified as ‘trivial’ if they cost less than £50 to provide...
Who is taxable or exempt?
The Income Tax (Earnings and Pensions) Act 2003 (ITEPA) charges employment income to income tax. ‘Employment income’ includes salary, wages, fees and other emoluments from an employment, including amounts which arise under what is known as ‘the benefits code’. The benefits code takes account of amounts which are not ‘earnings’ but nevertheless count as employment income, such as expenses and benefits provided to directors and employees.
Section 336 of ITEPA details the general rule: certain expenses are eligible for tax deduction, making them partially or wholly free from income tax. In some cases, where the employee is not charged to tax on an expense, the value of the expense is instead taxed on the employer. More information on this is set out below.
Very few employees are exempt from the benefits code, although certain categories, such as lower paid ministers of religion are, as detailed in chapter 8 of ITEPA.
Exempt items of expenditure
If any payment of expenses whatsoever is made to an employee by reason of their employment, this counts in the first instance towards their pay for employment tax purposes under section 70 of ITEPA, unless covered by an exemption or it has already been subject to tax elsewhere. There is a long list of exempt payments and the best place to find these is by reading the relevant section of HMRC’s booklet 480, which is updated annually. Note that items which are normally regarded as taxable benefits can be classified as ‘trivial’ if they cost less than £50 to provide, are not cash or cash vouchers, are not received under the employment contract and are not a reward or in recognition for particular services.
Where the employer is a close company and the benefit is provided to an individual who is a director or other office holder of the company (or to a member of their family or household) the exemption is capped at a total cost of £300 in the tax year.
If any of these conditions is not satisfied then the benefit is not regarded as being ‘trivial’ and must be taxed in the normal way, subject to any other available exemptions or deductions.
Agreements with HMRC
It has been a long-held view of many businesses that only benefits in kind are reportable in the P11D return and that business expenses such as travel, subsistence and entertaining do not need to be included. However, this is a misconception. Any items within the benefits code are reportable in the P11D return – the clue is in the return’s name: Expenses and benefits – unless the items have been agreed under an approval notice or, from 6 April 2019, are scale rate payments (http://bit.ly/2PQb7Ls) which are compliant with section 289A ITEPA.
...is taxed on the employer business by counting towards business profits...
Checking benchmark scale rates
From 6 April 2019, employers are no longer required to operate a system for checking an employee’s expenditure in order to make payments free of tax in relation to expenses paid or reimbursed using benchmark scale rates. Instead, employers are only required to ensure that employees are undertaking qualifying travel on occasions in respect of which a payment is made or reimbursed and that neither the employer nor any other person knows or suspects or could reasonably be expected to know or suspect that travel was not undertaken. See http://bit.ly/2H5MVAF for further guidance.
Employers that pay any non-allowable expenses or provide non-exempt benefits will still need to put those through the payroll and deduct tax and NICs or report them in the P11D return, in accordance with existing practice.
Expenses or benefits that are only partially exempted will need to be put through the payroll in full and employees will need to claim a deduction from HMRC on the part that is exempt.
Reimbursements, or meeting expenses directly
Neither paying cash reimbursements nor meeting the cost of the expenses directly are problematic as they both fall under the rules mentioned above and can be exempted or assessed to tax accordingly. However, care should be taken when the expense being reimbursed or paid directly is something which is in the employee’s own name – such as a telephone bill or credit card bill.
Meeting bills which are the employee’s legal liability to pay is known as meeting a ‘pecuniary liability’.
Different rules exist here because the tax relief available under section 336 of ITEPA is not available unless it can be demonstrated that the amounts are ‘wholly, exclusively and necessarily’ incurred in the proper performance of the employee’s duties. If something contains even a small private element, it is not within the above definition.
Deduction for business expenses payments
As mentioned above, sometimes, an expense payment is technically still taxable on an employee or director, but tax relief can be obtained on it under sections 336–338 of ITEPA. Travel, subsistence and entertaining expenses are often confusing for employees and employers alike to categorise. To illustrate this point, I have set out below a simple table which shows why the employee is not always taxed on the expense. Usually, if something is not taxable on the employee it is taxed on the employer business by counting towards business profits instead of being deducted from them.
The table can be helpful when constructing an expense claim form for employees to complete or when creating expenses protocols for checking that expenses are being taxed on the employees or included in the accounting process which feeds into the business tax return. Once again, a comprehensive list of expenses payments can be found in HMRC’s booklet 480, as can definitions of business travel, subsistence and entertaining expenses.
Cash and non-cash vouchers
A ‘cash voucher’ is something which is redeemable for cash to approximately the same value as the cost to the business of providing the voucher, whereas a non-cash voucher is only redeemable for goods and services. Cash vouchers should always be payrolled in the pay period in which they are given and subjected to pay as you earn (PAYE) and class 1 NICs. However, non-cash vouchers are still liable to class 1 NICs but should be declared in a P11D return unless the business has agreed to payroll benefits in kind with HMRC (http://bit.ly/2H5LAuV). Some vouchers, such as those qualifying as a trivial benefit, are exempt but must still be reported.
Company cars and vans
One of the most common and costly errors made by employers relates to the private use of company cars and vans by directors and employees. The term ‘company car’ or ‘company van’ relates to any vehicle provided by a business to its employee or a director. Errors can arise when vehicles available for private use are not identified, the wrong list price or CO2 multiplier is used, and where private fuel provided is not reported in the P11D returns or payrolled. It is also important for the business to be able to reclaim VAT on the fuel purchases – but to do this the employee must retain all receipts to avoid the VAT element being disallowed, which can have an adverse effect on the employer’s cash flow.
Bearing the cost of income tax
As long as items are classifiable as minor, irregular or not practicable to operate PAYE or value for P11D inclusion, they can be included in a PSA. Bear in mind though that due to the grossing up calculation and the class 1B employer’s NICs due, this method can be costly to the employer – especially where higher and additional rate taxpayers are concerned – but it is up to every business to decide whether this is a cost it wishes to bear.
PSAs cannot be retrospective. For existing PSAs, the requirement to renew annually has been removed from 6 April 2018 and been replaced by ‘enduring agreements’, which are only renewed where there is a change or annulment.
A brand-new PSA should ideally be in place by the start of the new tax year – so applying to HMRC in February is probably a good idea. This also allows items which may carry a class 1 NICs liability (and which should otherwise be processed through payroll for the pay period in question), such as vouchers, to be included in the settlement instead of being taxed on the employee. For further information see http://bit.ly/2WsyfSJ and for further guidance see http://bit.ly/2VqsSHu.
Payrolling
Has your business or client chosen to payroll benefits in kind? Currently there is a facility to payroll most benefits in kind but beneficial loans and living accommodation benefit cannot be payrolled.
Whilst payrolling benefits removes the need to make P11D returns, it does not remove the need to complete and submit a P11D(b) return to HMRC by 6 July following the tax year in which the benefits are provided and pay over the class 1A NICs due on the benefits by 19 July to avoid a penalty.
Further information can be found at http://bit.ly/2uL3egN and examples at http://bit.ly/2JoLnoq. Payrolling is generally a good idea, because it means that employees tend to be paying the tax on their benefits whilst enjoying them, rather than being assessed a year later.
|
Type of expense |
Employee |
Employer |
|
Business travel – potentially taxable on the employee but not on the employer |
Business travel is only eligible for tax relief where it is “wholly, exclusively and necessarily” incurred in the proper performance of the employee’s duties under s.336 ITEPA |
The employer business can claim a deduction from profits in its accounts for travel expenses incurred by employees travelling wholly and exclusively on business |
|
Subsistence – potentially taxable on the employee but not on the employer |
Subsistence is only eligible for tax relief where it is “wholly, exclusively and necessarily” incurred in the proper performance of the employee’s duties under s.336 ITEPA |
The employer business can claim a deduction in its accounts for any subsistence incurred by employees whilst travelling wholly and exclusively on business |
|
Entertaining – taxable on the employer and not on the employee |
The employee must demonstrate that entertaining was taking place to further the course of the business relationship |
Client entertaining is “added back” to the business profit figure of the employer business |
|
Staff entertaining – taxable on the staff unless the employer settles it under a PAYE settlement agreement (PSA) or it qualifies as an ‘annual function’ |
Staff entertaining which falls outside of the annual functions exemption (http://bit.ly/2H215D3) at s.264 ITEPA is treated as a benefit in kind and should be declared in P11D unless the employer settles the liability using a PSA |
Staff entertaining is an allowable deduction (http://bit.ly/2YcjAf6) from business profits under s.46 of the Income Tax (Trading and Other Income) Act 2005 as long as it is wholly and exclusively for the purposes of the trade |