Payroll insight
Arrears of pay
Justine Riccomini, head of taxation (Scottish Taxes, Employment and ICAS Tax Community), ICAS, explores the tax etc issues
A rrears of pay can accrue in many different circumstances – not just by a failure to meet national minimum wage (NMW) obligations. However, because of the proliferation of NMW-related cases which HM Revenue & Customs (HMRC) is pursuing, resulting in a quarterly naming and shaming list (http://bit.ly/2UlgCr9) and telephone number sized arrears bills in some cases, little wonder that when the term ‘arrears of pay’ is concerned, everyone thinks of NMW. However, pay arrears most frequently occur when: ● ● an employer or employee discovers that wages or salary paid in an earlier period were less than what they should have been paid under the employee’s contract ● ● backdated pay award is made ● ● the employer’s payroll or human resources systems make an error ● ● equal pay legislation applies, and the employer has to pay arrears. Liability to income tax Employment earnings are liable to pay as you earn (PAYE) under section 62 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA). It follows that any employment earnings paid in arrears such as NMW allowances, holiday pay etc are thus liable to income tax. Note that arrears of pay are not compensation awards even if ordered to be paid by
a tribunal and should never be treated as such – HMRC will not accept that argument. In terms of basic principles, the timing of the charge to PAYE on taxable earnings is the earlier of when: the payment was received by the employee or worker, or when entitlement arose to it (s. 686 ITEPA). In the case of arrears of pay, the employer will need to consider when entitlement arose.
should be subject to PAYE at the time they are actually paid. There are two settlement procedures, dependent on whether the employer is a ‘large employer’ or not. ● Large employers – Large employers (such as a local authority) wishing to settle income tax liabilities, and where large numbers of employees are involved, can settle directly with HMRC under regulation 141 of the Income Tax (Pay As You Earn) Regulations 2003 (‘the Regulations’). The tax rates used must correspond to the rates in force at the time the employee became ‘entitled’ to the payment. If no Scottish or Welsh rates were in force in the particular year in question, the rates used should be UK rates. If a large employer does not wish to use this settlement route, it must follow the same procedure as other employers, as follows. ● Other employers – An employer that is not a ‘large employer’ should allocate the payments to week 53 of the closed tax year to which the arrears correspond. If this is not possible or the employer does not wish to do this, the payment is taxed in full in the tax year in which received which could result in an employee being taken into a higher tax bracket for that tax year. The employer has a duty to tell the employee this,
...the employer will need to consider when entitlement arose...
To illustrate this, in a pay dispute, for example, the employees will receive a pay arrears award based on a contractual, or deemed contractual, entitlement to that pay, which entitles them to receive that money from a given point in past time. HMRC’s PAYE Manual sets out how to allocate a payment of arrears through payroll in closed tax years (http://bit. ly/2I2uwYp). The guidance explains, in line with the provisions at sections 18 and 686 ITEPA, that whilst legally the liability to tax arises in the tax year the money is earned, lump sum arrears
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Issue 50 | May 2019
| Professional in Payroll, Pensions and Reward |
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