The coronavirus outbreak has left many businesses teetering on the verge of insolvency. To seek to counteract this, the Government has introduced a raft of measures to prop up the economy for the immediate future, such as the Job Retention Scheme (‘JRS’) and the introduction of Government backed loans.
Despite the Governments’ generous and widespread financial assistance, for some businesses, unfortunately this is not enough to avoid financial difficulty. Instead, some businesses are left in a difficult position where they must continue to trade, but cannot maintain staff costs, due to a significant reduction in income. Where this has happened, many businesses are asking key members of staff, who they require to continue to work, to reduce or waive their earnings for the immediate future, until the business recovers.
However, the tax rules on earnings contain potential traps for businesses, which could still result in employees, employers and directors still being subject to tax on the gross unreduced income, despite employees and directors waiving all or part of their earnings.
Employees and Employers
An employees’ earnings include salary, contractual bonus (where applicable) and other additional benefits connected to the employment (section 62, ITEPA 2003). For tax purposes, earnings are taxable on the earliest of (section 18, ITEPA 2003):
- The point that the payment is made; or,
- The point that the employee becomes entitled to the payment.
Therefore, on this basis, employees must ensure that an agreement to waive or reduce their earnings must be effective before the point that the employee becomes legally entitled to the payment (i.e. when the payment is legally due).
Where the agreement is not effective by the point that the employee becomes legally entitled to the payment, PAYE and National Insurance Contributions (‘NIC’) must be accounted for on the gross unreduced income, despite employees waiving all or part of their earnings and having agreed to receive a reduced amount.
Additional rules also apply to directors, in relation to their earnings. Notably, despite a director effectively agreeing to waive or reduce their income prior to the point that the director becomes entitled to the payment, a tax liability could have already crystallised by that point. Specifically, the rules provide that a director will be taxable on their earnings where those earnings have already been credited to the company accounts; or, where the amounts have been determined by the end of a period, it will be taxable at the end of that period (section 18 ITEPA 2003). Notably, such tax liabilities could be ‘the straw that broke the camel’s back’ and tip the business into insolvency.
There may be an argument that technical breaches of the rules where there is a clear intention to waive or reduce earnings could result lead HMRC to take a pragmatic approach and not enforce these rules strictly. However, there is certainly no guarantee that HMRC would take such an approach and there remains a chance that HMRC could seek to enforce the rules as intended. Therefore, anyone contemplating or in the process of agreeing pay waivers or reductions should seek specialist advice at the earliest opportunity, so as to ensure there are no unforeseen tax consequences.
At ETC Tax we have an experienced and specialist team who have a wealth of experience in advising businesses and business owners.
If you or your client would like any assistance in relation to any of the issues raised above, then please get in touch.