Read our quick guide to payroll for new employees covering tax codes, the new starter checklist and student loans.

Payroll – how to deal with new starters

From a payroll perspective, there are various tasks that an employer has to perform when they take on a new starter.

For 2019/20 an employer needs to operate PAYE where the employee earns more than £118 per week (the lower earnings limit for National Insurance purposes). However, if any employees earn more than £118 per week, the employer must comply with RTI and report all payments to employees to HMRC (even those below £118 per week).

Work out what tax code to use

The tax code is fundamental to the operation of PAYE and it is important that the correct tax code is used. To ensure that a new employee is taxed correctly, the employer will need to know the correct tax code to use.

If the employee has a P45 and left their last job in the current tax year, the employer can simply use the code shown on the P45. If the employee left their last job in the 2018/19 tax year, the code on the P45 can be updated by adding 65 to codes ending in L, 59 for codes ending in N and 71 for codes ending in M.

If the employee does not have a P45, the employer will need to ask the employee to complete a new starter checklist.

New starter checklist

The new starter checklist enables the employer to gather information on the new employee. Even if the employee has a P45, it is still useful for the new starter to complete the checklist as it contains information which cannot be gleaned from the P45 (such as the type of loan where the new starter has a student loan which has not been repaid).

As far as establishing which tax code to use, the employee will need to select one of three statements:

  • A: ‘This is my first job since 6 April and I have not been receiving taxable Jobseeker’s Allowance, Employment and Support Allowance, taxable Incapacity Benefit, State or Occupational Pension’.
  • B: ‘This is now my only job but since 6 April I have has another job or received taxable Jobseeker’s Allowance, Employment and Support Allowance or taxable Incapacity Benefit. I do not receive a State or Occupational Pension.
  • C: ‘As well as my new job, I have another job or receive a State or Occupational Pension’.

The following table indicates what code should be used for 2019/20 depending on what statement the employee has ticked.

Statement ticked Tax code to use
A 1250L on a cumulative basis
B 1250L on a Week 1/Month 1 basis
C BR

Does the employee have a student loan?

The employer will also need to establish whether the employee is making student loan repayments. If the employee has a P45 and is making loan repayments, the student loan box will be ticked. However, the P45 will not provide details of the type of loan. Student loan information can be provided on the new starter checklist, enabling the employer to ascertain whether the employee has a student loan, and if so what type, and also whether the employee has a post-graduate loan.

Tell HMRC about the new employee

The employer will need to add the new employee to the payroll and also tell HMRC that the employee is now working for the employer. This is done by including the new starter details on the Full Payment Submission (FPS) the first time that the employee is paid.

Partner note: The Income Tax (Pay As You Earn) Regulations 2003 (SI 2003/2682), reg. 67B and Sch. A1, para. 35—44.

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IR35 -

Have you been affected by IR35?

Getting ready for off-payroll working changes

From 6 April 2020 the off-payroll working rules that have applied since 6 April 2017 where the end client is a public sector body are to be extended to large and medium private sector organisations who engage workers providing their services through an intermediary, such as a personal service company.

There are tax and National Insurance advantages to working ‘off-payroll’ for both the engager and the worker. The typical off-payroll scenario is the worker providing his or her services through an intermediary, such as a personal service company. Providing services via an intermediary is only a problem where the worker would be an employee of the end client if the services were provided directly to that end client. In this situation, the IR35 off-payroll anti-avoidance rules apply and the intermediary (typically a personal service company) should work out the deemed payment arising under the IR35 rules and pay the associated tax and National Insurance over to HMRC.

New rules

Compliance with IR35 has always been a problem and it is difficult for HMRC to police. In an attempt to address this, responsibility for deciding whether the rules apply was moved up to the end client where this is a public sector body with effect from 6 April 2017. Where the relationship is such that the worker would be an employee if the services were supplied direct to the public sector body, the fee payer (either the public sector end client or a third party, such as an agency) must deduct tax and National Insurance from payments made to the intermediary.

These rules are to be extended from 6 April 2020 to apply where the end client is a large or medium-sized private sector organisation. This will apply if at least two of the following apply:

  • turnover of more than 10.2 million;
  • balance sheet total of more than £5.1 million;
  • more than 50 employees.

Where the end client is ‘small’, the IR35 rules apply as now, with the intermediary remaining responsible for determining whether they apply and working out the deemed payment if they do.

Getting ready for the changes

To prepare for the changes, HMRC recommend that medium and large private sector companies should:

  • look at their current workforce (including those engaged through agencies and intermediaries) to identify those individuals who are supplying their services through personal service companies;
  • determine whether the off-payroll rules will apply for any contracts that extend beyond 6 April 2020 (HMRC’s Check Employment Status for Tax (CEST) tool can be used to determine a worker’s status);
  • start talking to contractors about whether the off-payroll rules apply to their role; and
  • put processes in place to determine if the off-payroll working rules will apply to future engagements. These may include assigning responsibility for making a determination and determining how payments will be made to contractors who fall within the off-payroll working rules.

Workers affected by the changes should also consider whether it is worth remaining ‘off-payroll’; providing their services as an employee may be less hassle all round.

Partner note: ITEPA 2003, Pt. 2, Ch.10.

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Employment allowance – upcoming changes

The employment allowance (EA) was introduced from April 2014, potentially cutting every employer’s NIC payments by allowing businesses and charities to offset up to a pre-set annual threshold (£3,000 from April 2016, previously £2,000) against their employer PAYE NIC liabilities.

Employers may generally claim the EA if they are a business (including a Community Amateur Sports Club) that pays employer Class 1 NICs on employees’ or directors’ earnings and is not funded by central government or a charity.

To keep the process as simple as possible for employers, the EA is delivered through standard payroll software and HMRC’s real time information (RTI) system. However, it isn’t given automatically and must be claimed.

How to claim

Claiming is very straight forward – the employer simply signifies their intention to claim by completing the ‘yes/no’ indicator just once. Although, ideally, the claim should be made at the start of the tax year, it can be made at any time in the year.

The employer will then offset the allowance against each monthly Class 1 secondary NICs payment that is due to be made to HMRC until the allowance is fully claimed or the tax year ends.

For example, if employer Class 1 NICs are £1,200 each month, in April the employment allowance used will be £1,200, in May it will be £2,400, and in June £800, as the maximum is capped at £3,000. The following tax year, the allowance will be available as an offset against a Class 1 secondary NICs liability as it arises during the tax year.

The EA applies per employer, regardless of how many PAYE schemes that employer chooses to operate, so each employer can only claim for one allowance. It is up to the employer which PAYE scheme to claim it against.

Recent changes

The EA was restricted from April 2016, so that a company no longer qualifies where all the payments of earnings it pays in a tax year, in relation to which it is the secondary contributor, are paid to or for the benefit of one employed earner only who is, at the time the payments are made, also a director of the company.

This sounds complicated, but the purpose of the change was to prevent perceived misuse of the allowance by personal service companies and help focus it on businesses creating employment. The government estimated that this change affected around 150,000 limited companies with a single director.

Future changes

The Autumn Budget 2018 announced details of a further restriction, expected to take effect in 2020/21, which aims to target the allowance on businesses that need it most.

From 6 April 2020, access to the EA will be limited to businesses and charities with an employer National Insurance contributions (NICs) bill below £100,000.

Currently some 1.1million employers claim the EA and the government estimates that around 93% of these will continue to be eligible once the restriction takes effect, with many paying no employer NICs at all.

It is worthwhile checking that the EA has been utilised where possible. If a claim is made too late in a tax year to set the whole allowance against the employers’ NIC liability, the employer may apply to HMRC for a refund.

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Salary v dividend for 2019/20

A popular profits extraction strategy for personal and family companies is to extract a small salary, taking further profits as dividends. Where this strategy is pursued for 2019/20, what level should be the salary be set at to ensure the strategy remain tax efficient?
Salary
As well as being tax effective, taking a small salary is also advantageous in that it allows the individual to secure a qualifying year for State Pension and contributory benefits purposes.
Assuming the personal allowance has not been used elsewhere and is available to set against the salary, the optimal salary level for 2019/20 depends on whether the employment allowance is available and whether the employee is under the age of 21. The employment allowance is set at £3,000 for 2019/20 but is not available to companies where the sole employee is also a director (meaning that personal companies do not generally benefit).
In the absence of the employment allowance and where the individual is aged 21 or over, the optimal salary for 2019/20 is equal to the primary threshold, i.e. £8,632 a year (equivalent to £719 per month). At this level, no employee’s or employer’s National Insurance or tax is due. The salary is also deductible for corporation tax purposes. A bonus is that a salary at this level means that the year is a qualifying year for state pension and contributory benefits purposes – for zero contribution cost. Beyond this level, it is better to take dividends than pay a higher salary as the combined National Insurance hit (25.8%) is higher than the corporation tax deduction for salary payments.
Where the employment allowance is available, or the employee is under 21, it is tax-efficient to pay a higher salary equal to the personal allowance of £12,500. As long as the personal allowance is available, the salary will be tax free. It will also be free of employer’s National Insurance, either because the liability is offset by the employment allowance or, if the individual is under 21, because earnings are below the upper secondary threshold for under 21s (set at £50,000 for 2019/20). The salary paid in excess of the primary threshold (£3,868) will attract primary contributions of £464.16, but this is outweighed by the corporation tax saving on the additional salary of £734.92 – a net saving of £279.76. Once a salary equal to the personal allowance is reached, the benefit of the corporation tax deduction is lost as any further salary is taxable. It is tax efficient to extract further profits as dividends.
Dividends
Dividends can only be paid if the company has sufficient retained profits available. Unlike salary payments, dividends are not tax-deductible and are paid out of profits on which corporation tax (at 19%) has already been paid.
However, dividends benefit from their own allowance – set at £2,000 for 2019/20 and payable to all individuals regardless of the rate at which they pay tax – and once the allowance has been used, dividends are taxed at lower rates than salary payments (7.5%, 32.5% and 38.1% rather than 20%, 40% and 45%).
Once the optimal salary has been paid, dividends should be paid to use up the dividend allowance. If further profits are to be extracted, there will be tax to pay, but the combined tax and National Insurance hit for dividends is less than for salary payments, making them the preferred option.

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