Tax
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Understanding PAYE Settlement Agreements
Robert Salter unpacks how PSAs work and what traps could await the unwary
Illustration: Jackie Parsons
Q | What are PAYE Settlement Agreements?
As accountants and advisers are probably aware, PAYE Settlement Agreements (PSAs) enable companies to bear the costs of particular benefits (e.g. taxable removal costs or the staff Christmas party, where the £150 per head threshold cost is exceeded) on behalf of employees.
PSAs have several advantages. From an HR perspective, PSAs can help ensure that staff morale is maintained – after all, providing a Christmas party and then expecting the employees to actually pay tax on this perk is not going to do wonders for staff morale. Furthermore, by ensuring that the tax reporting obligations for these benefits are undertaken on an annualised basis at the end of the year, you are simplifying the payroll and its administrative reporting processes.
However, while the system of PSAs is well established and has a formal legal framework, there are still challenges that employers may not always be aware of.
Q | What is the process? What are the deadlines?
Firstly, it should be remembered that employers are not automatically entitled to a PSA; they have to be applied for and approved by HMRC (at least for the first year). The initial application for a PSA scheme needs to be submitted before 6 July following the relevant tax year-end (so before 6 July 2025 for the 2024/25 UK tax year). Once the PSA is approved by HMRC, it will automatically roll forward and remains in place for future UK tax years, though it can be cancelled by either HMRC or the employer.
In addition, employers need to understand that a PSA is not available for all benefits. While companies can agree with HMRC as to exactly which items will be reported on their specific PSA, the core regulations state that these items must be “minor, irregular, or impracticable” to report via the regular payroll.
HMRC typically requests that companies make their PSA submissions for a tax year by either 31 July or 31 August following the end of the relevant tax year. However, this deadline is not official and, as such, the core deadline for PSA submission and payment is 22 October. HMRC can impose interest on late submissions and can cancel a company’s PSA agreement in appropriate cases (e.g. where declarations are consistently late or wrong).
While the system of PSAs is well established and has a formal legal framework, there are still challenges that employers may not always be aware of.
Q | Are there any tax costs?
While PSAs are effective from an HR perspective and can help simplify the company’s overall payroll reporting position, it is important for employers to recognise that PSAs are quite expensive, as they involve grossing up the employee tax and paying employer NIC (class 1B) on the grossed-up value. The effective tax rates for the employer, once the grossed-up tax and class 1B NICs are included, are approximately:
20% taxpayer – effective tax cost 42%
40% taxpayer – effective tax cost 90%
45% taxpayer – effective tax cost 107%
This means, for example, that if you have a workforce where everyone is a 40% taxpayer and you spend £200 per head on the Christmas party, the actual, grossed-up cost to the employer, on a per head basis, would be approximately £380. As an adviser to businesses, it is therefore important that you help your clients correctly budget for these costs.
Moreover, when considering the costs included in a PSA, one should recognise that it is the VAT-inclusive cost of a service/benefit that needs to be captured for the PSA. This is regardless of whether the underlying business has recovered the VAT input costs.
Q | Is there any difference for employees in Scotland?
The grossed-up tax rates given above are relevant for taxpayers in England, Wales and Northern Ireland. Scottish income tax rates differ from those in the rest of the UK and those employers with employees based in Scotland need to ensure that this point is ‘captured’ within their PSA declarations and the tax gross-up etc. adjusted to recognise the different tax rates in Scotland.
Q | What happens if the initial PSA application is made between 6 April and 5 July following a tax year-end?
Advisers and employers need to understand that where a company applies for its initial PSA agreement on a delayed basis (i.e. before the absolute deadline of 5 July but after the end of the relevant tax year), it is not able to use the PSA declaration in that first year to report those items that have already been included in an employee’s PAYE tax code for the relevant tax year. Such benefits need to be reported on that individual’s P11D form. Similarly, benefits and/or expenses that were accounted for within the PAYE deduction system, or should have been captured in the PAYE system, cannot be accounted for via the PSA system.
Q | What about those taxpayers who earn less than the personal allowance threshold?
Many employers have traditionally assumed that no tax is payable for those employers who earn less than the personal tax allowance. However, HMRC’s guidelines in this regard are clear; in such cases, employers are required to treat the relevant PSA benefits as being taxable at the basic rate of tax (or the Scottish equivalent).
Q | What about National Insurance Contributions (NICs) and international employees?
While PSAs do as a default include a charge to class 1B employer NICs, some employers will have UK-based employees who are not actually liable to NICs. For example, individuals who commute between the UK and the EU may be liable to social security in another jurisdiction under the terms of the UK/EU Trade and Co-operation Agreement.
The good news is that in such cases it is not necessary to include the class 1B NIC charge when calculating the PSA liability. However, employers in this situation should ensure that they have the correct paperwork (e.g. an A1 certificate or a certificate of coverage) to support the fact that the class 1B charge is not due, in the case of an HMRC audit.
Q | What about non-taxable items?
Finally, advisers and employers need to ensure that they don’t ‘over-report’ perquisites in their PSAs. Experience shows, for example, that employers could often be reporting items that are innately non-taxable. This includes items such as:
- Trivial benefits (e.g. flowers with a value of less than £50)
- Business expenses eligible for ‘detached duty relief’ (e.g. they are associated with someone working at a temporary workplace)
- Valid long-service awards
- Incidental overnight expenses (£5 per night for the UK or £10 per night for overseas business trips)
