The First-tier Tribunal (Tax Chamber) has held that two directors were not directly liable for income tax and national insurance contributions (NICs) that their insolvent employer failed to pay to HMRC because the tax and NICs had been “deducted” for PAYE purposes.

The decision highlights an important distinction between a failure to deduct and a failure to pay. It also highlights the key differences between being paid on a gross basis (with the possibility of HMRC making direct recovery) and on a net basis, where there has been no actual payment of tax and NICs to HMRC. For the tribunal to accept that payments were made net of tax and NICs:

  • There must be a pre-existing entitlement to gross salary. (In the context of an insolvent employer, the entitlement must arise before the employer suffers financial difficulties.)
  • Instructions should be given to those operating the payroll to ensure that salary is paid through the payroll.
  • Payroll procedures must be applied, and payroll records produced, contemporaneously (so that, for example, monthly payslips record that salary is received net of tax and NICs).

PAYE and Social Security Regulations

The PAYE Regulations provide that tax not deducted by an employer can be recovered directly from an employee if HMRC is of the opinion that the employee received the payment knowing that the employer had willfully failed to deduct tax. The Social Security Regulations make similar provisions for NICs.

Real time information

The practice of adjusting a director’s loan account at the end of the tax year has become more difficult following the introduction of real time information (RTI) (and late paid in-year PAYE penalties). Under RTI, information on payments made to employees and office holders must be provided to HMRC in real time.

This means that the employer will normally be required to send to HMRC (electronically) details of every payment made to an employee or office holder “on or before” the date the payment is made. Accordingly, every time a director draws money from a company, the nature of the payment must be analysed to decide whether an RTI return must be filed.

To avoid costly PAYE errors, many owner-managed businesses arrange for their directors to borrow from the company during the course of the year (with the borrowings repaid within nine months of the end of the accounting period to avoid a corporation tax liability, and the borrowings to be repaid by voting a dividend or paying an annual salary or bonus.