If a company pays individuals gross for services (ie as self employed) and it transpires that they should have been paid as employees, who is liable for the PAYE and employees nic ?
I understood that the company would need to pay this over to HMRC (assuming the actual payment made was the gross) and then seek to recover this from the person to whom they made payment.
However, I have recently heard the view that HMRC would see to recover payment from the company on a grossing up basis.
Surely the latter cannot be correct unless the company agree to do so?
(I am aware that the company should have considered employment status before making payment and so are they, so that is a different issue)
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seeing as its the companies resp
To ensure they used correct treatment I would have thought company have to pay it and the amount paid to now deemed employee would be classed as the net so payment would need to be grossed up to calculate tax & NIC due & they shouldn't chase the employee for a penny after all it was the company's error not the employees.
If it was the employee's wish to be treated as self employed I would let sleeping dogs lie and get it right going forward.
Yes if HMRC take issue they will collect the tax and NI from the company on a grossed up basis. Yes of course it should be grossed up. What logic would there be in doing it any other way? Whether the company agrees doesn't come into it.
No the individual will not have to pay tax on a self-employed basis as well. So there is no double payment of tax on the same income.
The logic behind grossing up is that the employer no longer has the opportunity to deduct the PAYE and NI from the employee, which is the assumption on which the normal calculation is based. So if the company pays the tax and NI out of its own pocket, on top of paying the full gross amount to the employee without any deduction, the employee has received a further benefit, namely having his tax paid for him, which is itself taxable. Grossing up just avoids the need to go round in circles forever calculating tax on tax on tax etc.
Assumption
I disagree.
If the individual has already submitted their self assessment tax return they will have paid their liability via the SA system.
You don't disagree, you are making a different assumption. Yes if the individual can be shown to have already paid tax in his earnings by self assessment the company should not have to pay anything, on a grossed up basis or otherwiise.
But if he hasn't, and isn't going to - then obviously the grossing up approach is the only way to get the right answer.
HMRC Benefits?
I was thinking about the double taxation in that the self-employed individual may have honestly declared his received income and paid class 4 NI and tax on it.
If HMRC pursues the employer for having mistakenly taken the worker on as self-employed and demands PAYE and employee/employer's NI is it likely that HMRC will adjust the figures to take into account revenue already received from the same earnings?
technical answer...
The company would generally be required to pay the tax due on the payments made to [the self-employed who turned out to be employees] under s.223 ITEPA 2003 (as well as its NIC liability).
Alternatively, HMRC can seek to argue that the failure to deduct tax and NIC was ‘by agreement’, in which case, the amounts paid to the putative employees would be treated as net payments and grossed up to arrive at the tax and NIC due (which would be considerably higher), to which penalties and interest would also apply. If ‘grossing up’ was applied, you could nevertheless request assessment under s.223 instead, by arguing that there was no 'agreement' (ie that the company was misled as to the employees' status). The chances of success of that route depends on the precise facts and history which are not given.
Good start
I would say calculate the PAYE and ni due on the gross as would normally be the case when making payments to employees.
Well that's a good start. But how would you then deal with the tax liability arising on the company's payment of the amount you would just have calculated - assuming of course that the "employee" in question is nowhere to be found.
Shortfall
johngrogabjga, the company pays the PAYE and ni over to HMRC, with offset of any SA tax paid if available. It is then left to recover shortfall or bears the cost. That is my view, which may be one you disagree with.
And if it can't recover the shortfall (because e.g. the "employee" is nowhere to be found) what would you do next to ensure that the right amount of tax would be paid?
It's down to pure common sense as much as legislation Newbee.
HMRC can in some circumstances go after the employee not the employer in which case the payment maybe treated as gross.
Otherwise, if going after the employer then how can it not be grossed up? Means the employee has received more than he is entitled to.
I would suggest you read through again what people like John have said to you then think it through logically
PAYE Regs. 72 to 72G
The basic regulation for recovering from the employee PAYE tax not deducted by the employer is Reg.72 of the PAYE Regulations 2003, but this has been modified by the inclusion of Regs. 72A to 72H since then. Unfortunately, the online version at legislation.gov.uk has not been updated from the original version. The regulation dealing with recovery from the employee of tax which has been self-assessed is Reg.72F. Here is a HMRC statement concerning the changes to Reg.72F in April 2014, which gives some background.
Employee status
When I had the same situation recently, the client just submitted a few months of payroll late, calculating the tax which should have been due on the actual amount paid, paid this to HMRC and the employee reimbursed them, (no penalties were applied).
The status error was discovered before the employee had submitted a tax return or paid any tax themselves though.
It applies where the employee has previously paid tax on the income as self employed income under self assessment.
I read it as in effect splitting the liability.
HMRC will apply Reg 72f to the amount paid by the employee so that the employer only pays the excess.
So if the grossed up liability on the employer is £1k but the employee has paid under self assessment, as self employed, £500, the employer only pays £500.
Where the employer has a number of employees affected HMRC will be able to take a sample of excess liabilities and apply that to all employee's when assessing the employers liability.
Supposedly designed to reduce admin burdens on HMRC and employer and also double taxation.
I am taking the above from an explanatory note issued by HMRC on 21 Feb 2014.
Situation Reversed
Thought I'd throw this scenario into the pot.
An individual earns £1,000 from someone whilst claiming to be self-employed. He pays 9% class 4 on his earnings. In reality he should have earned the money as employed and paid no NI as under the NI employed thresholds. Would he be due a refund of the 9%?
Re situation reversed
Yes - he'd restate his SA Return I'd assume. In such a case he'd have to have a legitimate self-employed source from elsewhere to bring him over the Class 4 threshold, and would simply restate his accounts to remove the employed earnings.
No grossing up
It's not a matter of common sense. There is no grossing up unless you make up some numbers for a contract settlement with HMRC. There is no grossing up even if you don't know where the employee is and can't recover anything from him/her. HMRC is only entitled to tax what has been paid as far as cash wages are concerned.
If an employer under-deducts PAYE, its liability is for the PAYE that should have been deducted, not for the notional PAYE that hasn't been deducted from a larger sum.
If HMRC assesses that tax on the employer, it raises a Regulation 80 determination based on the PAYE regulations. They require tax to be based only on the earnings paid (see Reg 21 ff).
Reg 72 might come into play if the employer can show it took reasonable care and that the failure to deduct was due to an error made in good faith. HMRC might then collect from the worker instead, and would cancel the Reg 80 determination. But no grossing up is involved.
Reg 72F may be relevant. It was a response to the Demibourne case, where HMRC was worried that it might lose out. It's easiest to explain with an example. Employer pays 'wages' to X as if he is self-employed. No PAYE is paid, but X pays tax of £30 under ITSA. HMRC catches up with Employer and demands the PAYE, which would have been £40, applying the code (typically BR) to the earnings. However, it can see that X has paid £30 under ITSA, so it settles for £10 from Employer. Total tax collected is now correct. However, X could legitimately turn round and demand his £30 back, as it was never due - he was an employee subject to PAYE, which was the employer's obligation, and he was not subject to ITTOIA. HMRC would have to repay. It could then not go back to Employer for the £30 as it has already settled the matter by contract. Reg 72F deals with that problem so that the correct amount is collected, once. No grossing up.
ITEPA s223 only applies to company directors, past, present and future, so it is usually irrelevant to status cases, as few businesses nowadays really think that they have a self-employed director.
If the employer needs to recover the PAYE from a former employee, it can use the doctrine of restitution - see McCarthy v McCarthy & Stone plc - although the court costs might make this prohibitive for smaller sums.
That's it folks!
Read David Heaton's comment and go to bed knowing you've read all that needs to be said :)
So, £1,000 is paid to an
So, £1,000 is paid to an "employee".
You are saying that HMRC would ask for tax on £1,000 so at basic rate (and ignoring NIC) that is £200?
But the employee has still received £1,000 not £800!
Surely a loss to the exchequer so doesn't seem right to me
But is there not still a loss to the exchequer after deducting any tax paid under self assessment?
There is no loss to the echequor
@ JamesAnd
There is no loss to the echequor
In your example the wages/salary paid is £1,000 and the tax due is £200
As £200 has been paid under PAYE the correct amount of tax has been deducted
What has happende is that the "employer" has overpaid and as David Heaton points out (in what is a precise explanatioj of the relevant legislation and related law) thje "employer's" right of recovery is under the dopctrine of restitution (against the "employee" who has their extra £200).
You obviously would not bother with restitution for £200 but if the numbers were bigger (say) £200,000 you almost certainly would
Ok thanks fair enough.
Ok thanks fair enough.
And I suppose by treating as gross for employed means the same starting point as for self employed (before expenses obviously).
Yeah, but, No but...
Sorry, I'm late to this debate. On the technicalities, David Heaton (as ever) has correctly set out the answer. In a nutshell, where PAYE is operated retrospectively (whether by HMRC intervention or otherwise) there is no grossing up unless the recipient is a director, in which case, sec223 of ITEPA comes into play.
The original poster stated that he had heard that HMRC were trying to get the grossed up tax in (what I took to be) employment status cases. As can be observed from this thread, this is a matter which often causes confusion but it would be completely inexcusable if an employer compliance officer were to seek to do this.
However, perhaps one should no longer be surprised. I have recently had experience of (different) EC officers insisting that receipts are necessary for benchmark scale rates included in a dispensation (!); and that interest debited to a DLA does not prevent a beneficial loan from happening (even when the DLA goes into credit) because it has been capitalised. Reasoned legislative argument is like casting pearl before swine - I fear the lunatics have well and truly got hold of the asylum!!
Negotiate !?
I have had similar experience in the past with clients whose "subcontractors" were reclassified as employees.
I do not know if this is closing the stable door after the horse has bolted, but it is worth negotiating with HMRC:
1. On the basis that they are NOT employees, as there is insufficient control/supervision over them. Also, you do not state the position regarding their contracts FOR services, which may well be sufficiently strong to justify this contention. You do not say what business the company is in or what the Subcontractors do, so difficult to do other than generalise on this. If you have good contracts, this may be sufficient to stop HMRC going to the Tribunal.
2. If there can be no doubt that they are employees NOW, and it can be shown that they have all declared their income and paid tax and Class 4 NIC as appropriate, HMRC may be persuaded to waive the previous period, and start Employers PAYE etc from now (or a convenient date). I have achieved this, after providing HMRC with the individuals' UTRs etc.
3. If neither of the above contentions are open to you, you may be able to negotiate payment on the basis of the gross amounts actually paid, without grossing up, especially if tax/nic has been paid by them under Schedule D. In this case, there is a doubling up of tax etc, so the "employees" will be able to obtain a refund of tax, if appropriate, less Class 1 NIC, and the company may be able to negotiate with them to repay the company the relevant tax part and Class 1 NIC. I have also done this.
Worth a try unless it has gone too far !