Reducing salaries or waiving bonuses – what are the tax issues?
Reducing salaries or waiving bonuses
This article reviews the tax implications of reducing employment income in response to the COVID-19 outbreak. Could PAYE arise on amounts that are not actually paid?
HMRC have published new guidance to ensure that individuals who choose to give up part of their income to support their business or employer during the COVID-19 outbreak are aware of the tax implications. This confirms that no income tax charges (or PAYE and NIC obligations) will arise on an amount given up where a reduction in salary or a bonus waiver is agreed before it is paid. However, for some individuals the position will be more complex. This article reviews the tax issues, and how salary reductions and bonus waivers should be structured to prevent unexpected PAYE obligations arising.
Why is this important?
HMRC report that many individuals are choosing to give up part of their income to support their business or employer during the COVID-19 outbreak. It is important that individuals and businesses understand the tax implications of making such decisions, and that correct timing and proper documentation are crucial in ensuring that income tax charges (and PAYE obligations) do not arise on amounts that employees do not receive.
What makes an effective waiver?
There are two basic requirements for an effective reduction of salary or bonus waiver:
- The employer and employee must validly agree that the relevant sum will be given up by the employee; and
- The employee must receive nothing in return (nor should the amount given up be redirected to another recipient, such as member of the employee’s family or a charity).
Additionally, to avoid income tax charges and PAYE obligations arising in relation to salary and bonus that the employee will not receive, the agreement to reduce or waive the remuneration must be made and appropriately documented before the tax point for the relevant payment arises.
What’s the ‘tax point’?
The ‘tax point’ is the point in time at which an income tax charge arises for the employee, and corresponding PAYE obligations are triggered for the employer.
For most employees, the tax point will be the earlier of the date on which they are actually paid the relevant salary or bonus; and the date on which they are entitled to receive payment (broadly, the date from which they would be entitled to sue for payment of the relevant salary or bonus).
This latter point can cause issues with salary reductions or bonus waivers where the employee and employer agree in principle that an amount is to be given up – and it is never actually paid – but they fail to remove the employee’s legal entitlement to receive the relevant sum before the tax point arises.
Other events can also trigger income tax charges, and PAYE obligations, in relation to directors – principally, when an amount is credited in the employer’s accounts or records in respect of earnings, regardless of any restriction on the director’s right to draw the relevant sum. Particular care should therefore be taken in cases involving directors.
What if the tax point has already passed?
If salary is reduced or a bonus waived after the relevant tax point has passed, the employee will still be subject to income tax even though the relevant sums are not received.
In these circumstances, the employer would be required to account to HMRC in respect of the relevant PAYE, but might potentially be able to agree a time to pay arrangement if it has been impacted by the coronavirus outbreak.
Different rules apply for NIC, which is generally only due when an actual payment is made.
What do employers need to do?
Employers should carefully review their arrangements and processes for reducing salary or waiving bonus payments to ensure these are robust.
Where employers have already agreed reductions or waivers of remuneration, these should be reviewed to confirm whether any unexpected PAYE obligations might have arisen and, if so, what remedial actions might be appropriate.
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