Notional payments

25 August 2021

Mike Nicholas MCIPP, editor of CIPP’s Professional magazine, provides a reminder of the complex compliance issues


The term ‘notional payment’ applies to a range of payments made to employees that are not in the form of cash but which must be treated as cash for purposes of pay as you earn (PAYE) and National Insurance contributions (NICs).

Section 710 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) defines a range of payments that are to be treated as notional payments, including the following.

Cash vouchers – A ‘cash voucher’ is a voucher, stamp or similar document that can be exchanged for a sum of money that is greater than, equal to, or not substantially less than the expense incurred by the person at whose cost the voucher, stamp or similar document is provided. If an employer gives a cash voucher to an employee, the employer is treated as making a payment of income equal to the amount for which the voucher is capable of being exchanged. However, this provision does not apply if the cash voucher is used to meet business expenses or is exchanged for an amount that is used to meet business expenses. The payment is treated as being made at the time the employee receives the voucher. (ITEPA s.693, https://bit.ly/3fQFY8W)

Non-cash vouchers – A non-cash voucher is a voucher, stamp or similar document or token that is capable of being exchanged for money, goods or services, a transport voucher, or a cheque voucher, but does not include a cash voucher.

If an employer gives a non-cash voucher to an employee, and the voucher is either capable of being exchanged for anything that would fall to be regarded as a readily convertible asset (RCA), or itself would fall to be regarded as an RCA (see below), the employer is treated as making a payment of income equal to the cost of the expense incurred in or in connection with the provision of the voucher, and the money, goods or services for which it is capable of being exchanged by the person at whose cost they are provided. (ITEPA s.694, https://bit.ly/3xApCrc)

Credit tokens – A credit token is a credit card, debit card or other card, a token, a document or other object given to a person by another person who undertakes on the production of it, to supply money, goods or services on credit, or if a third party supplies money, goods or services on its production, to pay that third party for what is supplied. (ITEPA s. 695, https://bit.ly/3s6zw2y)

Readily convertible assets (RCAs) – If an employee receives income in the form of a RCA, the employer is treated as making a payment of income equal to the amount that, on the basis of the best estimate that can reasonably be made, is the amount of income that is likely to be the PAYE income for the asset. Examples of readily convertible assets are stocks and shares, gold bullion, commodities, loan securities and bonded goods. (ITEPA s.696, https://bit.ly/2VFscPd)

Enhancing the value of an asset – An employee is treated as having received a RCA if provided with anything that enhances the value of an asset in which the employee, or a member of the employee’s family or household, already has an interest, and the asset, with its value enhanced, would be treated as a RCA if it were provided at the time of the enhancement. (ITEPA s.697, https://bit.ly/3Autb42)

Charges on employment-related securities – A charge to tax arises in several different situations involving employment related securities. The value of the benefit counts as employment income for the employee. The benefit is treated, for both PAYE and NICs purposes, as a RCA. (ITEPA s.698, https://bit.ly/3jFWidF)

Gains from securities options – When an employee acquires securities from a securities option, the value of the benefit, counts as employment income for the employee. The benefit is treated, for both PAYE and NICs purposes, as a readily convertible asset. (ITEPA s.700, https://bit.ly/3s5TCd4)

In addition, the notional payment rules operate for payments made by an intermediary of the employer (ITEPA s.687); and payments made by a non-UK employer (ITEPA s.689).

 

Tax liabilities

The tax liabilities on notional payments are, initially, handled under PAYE. However, if the employer and the employee fail to follow the statutory procedures correctly, some or all of the value of the notional payment may have to be treated as a benefit in kind, resulting in both the employer and employee incurring additional costs. The procedures, which are punitive in terms of the additional tax that the employee must pay and the additional secondary class 1 NICs that the employer must pay, are intended to compel compliance.

Note that the term ‘employee’ includes office-holders, e.g. company directors and company secretaries, even if they do not have a contract of employment.

In the circumstances described, below, the amount of tax that the employee fails to repay to the employer within ninety days of receiving the notional payment is treated as a benefit to the employee and is reported in the P11D return. The same amount is also used to determine the class 1 NICs liabilities.

The value of the notional payment or, in the case of RCAs their estimated value, is notionally added to gross pay for PAYE purposes. The resulting tax liability is deducted from the employee’s earnings, to pay the tax charge.

In some cases, the employer may be unable to deduct the full amount of income tax because, for example, the amount due is more than the whole of the employee’s cash wage for the pay period. If this situation arises:

the employer must, nevertheless, pay the full amount of the tax and NICs due in respect of the employee’s gross pay to HMRC Accounts Office by the next normal payment date, and

the employee must repay the amount of tax that the employer has been unable to deduct to the employer within ninety days of receiving the notional payment.

The result of this procedure is that, until the employee makes reimbursement, the employer has to bear the cost of the tax that could not be deducted from the employee’s earnings.

Throughout this procedure, the liability for the income tax due on the notional payment remains with the employee. The payment is only treated as settling the employee’s tax liability at the end of the ninety-day period if the employee has failed to reimburse the undeducted tax by that time.

If the employee fails to reimburse some or all of the undeducted tax by the end of the ninety-day period, the amount unpaid at that time is treated as if the employer had met the pecuniary liability of the employee, i.e. the tax owed by the employee to HMRC. The amount unpaid is ‘money’s worth’ (ITEPA, s.62) in the hands of the employee and creates an additional tax reporting requirement and a further class 1 NICs liability.

Where, for practical reasons, it is not possible for the employee to make the reimbursement by means of a payment to the employer within ninety days, it would be acceptable for another reimbursement method to be used, such as the parties entering into a loan agreement, whereby the employer loans to the employee the amount necessary for the reimbursement, and the employee is contractually required to make regular loan repayments. Such an arrangement may have tax liabilities under the beneficial loan provisions.

Other arrangements that purport to meet the reimbursement requirement are payments into escrow accounts, or into a director’s loan account, or indemnity contracts. These arrangements, however, do not satisfy the reimbursement requirement as no payment has been made directly to the employer.

The amount of the tax unpaid at the end of the ninety-day period is treated as a settlement by the employer of the employee’s personal liability for the income tax due on the notional payment. It is reported in section B – Payments made on behalf of employee, on the line specifically designated ‘Tax on notional payments not borne by employee within 90 days of receipt of each notional payment’. If the employee repays the tax due after the end of the ninety-day period, that does not remove the reporting requirement or the resulting tax charge for the employee.

 

Class 1 NICs

The NICs liabilities on the various kinds of payments that are defined as ‘notional payments’ for tax purposes are to class 1 NICs. The amount on which tax is due under PAYE is the amount that is liable for class 1 NICs. The resulting primary NICs are deducted from the employee’s earnings in the earnings period in which the notional payment is made.

The amount of tax that is paid to the HMRC is also treated as earnings for class 1 NICs purposes. Consequently, if the employee fails to reimburse the undeducted tax within the ninety-day period, the employer has settled the employee’s pecuniary liability and the outstanding amount becomes liable for class 1 NICs in the earnings period in which the ninety-day period ends.

Even if the employee subsequently repays the tax, the NICs liability will stand and cannot be refunded. As the NICs liability and the tax reporting requirement occur at different times, employers must take care to meet both requirements. 


 

Featured in the September 2021 issue of Professional in Payroll, Pensions and Reward. Correct at time of publication.