Deduction of PAYE from holiday pay

Who is responsible?
A solicitor assists employees in recovering unpaid holiday pay from current or former employers on a no win/no fee basis. He recovers his fee from any payment made
A client of ours is a solicitor and has recently started a new service helping employees claim holiday pay from their employers who, for one reason or another, have failed to make the due holiday payment.
The solicitor charges his clients on a no win/no fee basis. Once his work is completed and any unpaid holiday pay has been recovered from the employer, this is mandated to be paid to his firm under the arrangement he has with his client. The employer therefore pays the solicitor, who takes a percentage fee from the holiday pay.
Is the solicitor obliged to deduct PAYE before he pays the net of commission amount to his client? And, if so, can he first offset his commission?
Does it make any difference if the employee has already left the employment and finally, out of interest, should the employer/former employer deduct PAYE before paying the solicitor the outstanding holiday pay? Naturally, our client is keen not to fall foul of any PAYE obligations.
Readers’ thoughts would be very much appreciated here.
Query 18,255 – Working Man
Reply from David Kirk, author of Employment Status – the Tax Rules
The Income Tax (Pay As You Earn) Regulations SI 2003/ 2682, Reg 21 specifies, “On making a relevant payment to an employee during a tax year, an employer must deduct or repay tax in accordance with these regulations by reference to the employee’s code, if the employer has one for the employee.”
On the face of it, this would indicate that the payment from the employer to the solicitor was not covered, because PAYE would only apply to payments “to an employee”.
However, it probably is covered: the solicitor would normally be the agent of the employee for this purpose, in which case the payment is treated as being made to the employee under the laws of agency.
If the solicitor does receive the pay gross, he is under no obligation to deduct PAYE from the payment. He is not the employer’s agent or intermediary, but the employee’s, and this particular payment therefore does not come within the PAYE regulations.
While the payment is one of PAYE income, and thus a “relevant payment”, it is received by the employee in their capacity as employee and therefore only subject to deduction of PAYE if paid by the employer or someone paying on their behalf. The High Court judgment in R oao Oriel Support Ltd v HMRC [2008] EWHC 1304 (Admin) goes into this in some detail, if somewhat confusingly.
There are some special rules in the PAYE regulations for holiday pay, but these do not apply here. They are aimed at holiday pay funds, and require the payment to be “in exchange for a voucher, stamp or similar document”.
The situation is no different if the employee has left, except that code 0T should be used if the P45 has already been issued, on a week 1/month 1 basis, using the normal payment interval non- cumulatively.
The situation with National Insurance is somewhat simpler: liability arises when earnings are paid “to or for the benefit of an earner” (SSCBA 1992, s 6). This covers the payment to the solicitor. SSCBA 1992, s 7 specifies the employer to be responsible for the employer’s contribution, and SSCBA 1992, Sch 1 para 3 specifies the employer to be responsible for the employee’s contributions.
If the employee has left, then HMRC’s booklet CWG2 says that “for an irregular sum, such as accrued holiday pay” National Insurance should be applied using a weekly earnings period.
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OnSeptember 11, 2012, posted in: Articles by

Why the Revenue had to stop a managed service company Invistigation

What do you do when your client rings you up and says that she has just received … no ordinary letter from the Revenue & Customs, but one suggesting that she might be running a managed service company? This happened to me last year, and she knew and I knew the implications at once – certain bankruptcy for her if they prevailed, and considerable damage to my reputation as I had advised her (with the help of learned counsel, be it said) how to make sure that she was on the right side of the law here. Fortunately I had also warned her at the time that, with the sector that she was in, her card was marked, and a Revenue investigation on these lines was more likely than not. Forthrightness with one’s clients generally pays off.

The managed service company (‘MSC’) rules are possibly the most deadly in the whole of the tax code. They were introduced in April 2007 as sections 61A to 61J of the Income Tax (Earnings and Pensions) Act 2003 (‘ITEPA’) and the Social Security Contributions (Managed Service Companies) Regulations 2007, to combat mass market avoidance of PAYE and NI amongst service companies. They followed on from the IR35 legislation, which had come to be widely seen as ineffective. The MSC legislation is particularly punitive as it can be used to transfer PAYE and National Insurance debts to directors and owners of companies. For the kind of company that it is aimed at, the tax liability will frequently be in the order of fifteen times its profit margin. No-one is going to be able to afford to pay that.

I was confident that we would be able to ward off this threat by conventional means – I had after all advised the client how to arrange her affairs. However nothing is certain in law, and it turned out that we had another interesting weapon in our armoury, so we decided to leave nothing to chance. A VAT inspector had come along some years back and determined that our client was supplying medical services (exempt), not medical staff (standard-rated). The difference between the two is too arcane to go into here; suffice it to say that it looked to me like an exact mirror of the test in S. 61B(1)(a) of ITEPA, which says that a company is an MSC if ‘its business consists wholly or mainly of providing … the services of an individual to other persons’. Counsel then confirmed his view that this was just so.

So – what is sauce for the goose is sauce for the gander. We wrote to HMRC and pointed out that they had in effect already made a decision on this one, and it was negative. We did, of course, supply them with enough information for them to be able to see that the clients’ contracts had not changed since the VAT inspection, but told them that they were not getting anything more. Needless to say they issued an information and documents notice compelling us to disgorge rather more than this, so we lodged an appeal with the Tax Tribunal against the notice. Some months later HMRC told us that they were not going to contest our appeal. No reasons were given for backing down, so one can only guess at what might have caused this change of approach. However it seems likely that there were some or all of three factors at play, as follows:

 1 – The Tax Tribunal can now hear points of public law (at least sometimes).Public law concerns the behaviour of public bodies, and until recently it was thought that the Tribunal could not concern itself with these. One had to bring a judicial review (often in proceedings parallel with those that the Tribunal could hear) – a very expensive, cumbersome and uncertain process.

This all changed with Oxfam v. H.M. Revenue & Customs [2009] EWHC 3078 (Ch.) in 2009, in which Sales J. explained that there were quite a number of circumstances in which the Tribunal could hear points of public law, although in tax matters this did have to be explicitly laid down in statute. What we were complaining about was not that HMRC were necessarily wrong in their approach to MSC’s, but that they were bound by what they had decided previously in our client’s case: we had what lawyers know as a ‘legitimate expectation’. The Revenue notice had been given under paragraph 1 of Schedule 36 to the Finance Act 2008, which enables a Revenue officer to require someone to provide information or documents ‘if the information or document is reasonably required by the officer for the purpose of checking the taxpayer’s tax position’ [my italics]. Whenever one sees the word ‘reasonably’ in a statute one knows that one is in public law territory. However paragraph 29 is quite explicit: an appeal against this kind of notice is to the Tribunal.

2 – A decision made with respect to one tax can be binding on HMRC’s approach to other taxes. Legitimate expectation is a fast-changing area of public law that has developed hugely over the last twenty years, and we could find no exact precedent for this. A publicauthority is bound by a promise made or a procedure laid down (either formally or well established in practice). What we had here was neither of these: it was an unsolicited decision made as to the character of our clients’ contracts. Had the clients asked HMRC for clearance as to the VAT treatment of their supplies, the legitimate expectation would unquestionably have been confined to VAT. It was the fact that the decision was made on HMRC’s initiative that would have been crucial here in extending it to another tax.

3 – There may be public policy reasons for HMRC to refrain from challenging cases in the Tribunal. With their vast resources, £14 million at stake (or so they said), and a well-known desire to make their MSC legislation stick, why would HMRC so suddenly back off? Our case on the first point above – that the tribunal could hear this point – might look pretty robust, but on the second? This, surely, was novel territory: there were no precedents, and add to this the fact that public law remedies are always discretionary – would that not have been worth their while fighting? Well, evidently not. We do not know why, but there is a possible – indeed, quite likely – reason which has all to do with the fact that tribunal judgments are public. If they had taken this battle on and lost, they would effectively have broadcast to the whole of the UK tax profession a novel method of challenging them. Even if they had won, they might have been handed down a judgment that gave some other taxpayer with slightly different facts grounds to defeat them next time. Better from their point of view to keep people guessing. The First-tier Tax Tribunal does not set precedents, but is quite capable of delivering a robust rebuff to the authorities when its judges feel that this is warranted.

In this instance, how many other potential managed service companies had had VAT inspections that might cast doubt on what HMRC was trying to assert? Judged by the facts of the little-known case of Moher v. H.M. Revenue & Customs ([2011] UKFTT 286 (TC)) there could be quite a number. Here they stated that they had reviewed the law in the area of supplies of staff in 2007 and that their understanding of it had changed. However there was never any publication of this different view, and, extraordinarily, they went on to admit that they had continued to allow exemption to businesses whose supplies continued to meet the criteria applied before their change of interpretation. One can well understand that they would not want another case publicised that might draw attention to this.

The lessons to be learned from this are, firstly, that the Government can be held to what it has said; secondly, that points of public law are well worth trying if you have any novel or unusual points; thirdly, that challenging HMRC on public law is easier and less expensive than it was.

That is not to say that it is cheap. We used two barristers on this – one a tax specialist and the other a public law specialist. So my final tip is: get the right specialists on board. As an employment status specialist myself I would always use an employment barrister in a status case, even in the Tax Tribunal. So it is with public law questions: use a public law specialist for public law matters.

The author runs a tax consultancy specialising in PAYE, National Insurance and employment status, and he can be contacted on 0845 519 5041 or at

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OnJuly 9, 2012, posted in: Articles by

Tax avoidance in the public sector

The Government is finding it mighty hard to clamp down on tax avoidance, and frequently appears not to know quite what it needs to do to raise more revenue to replenish its ever-leaking coffers.

This is not surprising. One would have thought, though, that it would not be so difficult toprevent some of the more obvious tax avoidance ideas taking root in the public sector. One thing that seems particularly to have become popular there is the use of personal service companies belonging to highly paid individuals in senior positions. This matters at three levels: firstly, are the contracts with the government body made with the service company or with the individual doing the work? Secondly, should IR35 be operated, and is it being? Thirdly, are these arrangements shifting income to people (generally spouses) on lower tax rates? The sums involved can be large. One man in the news recently was Ed Lester, of the Student Loans Company, and a very revealing article in Taxation on 16th February took a good look at those aspects of his arrangements that have become public (see http://www.taxation.co.uk/taxation/Articles/2012/02/15/35851/something-fishy). The author, Richard Curtis, had clearly done some digging. He did not get as far as to find out (or to reveal) what Mr Lester is on, but it looks as though it is in the region of £200,000 a year. Someone on this pay can expect to receive £114,619 in take-home pay as an employee, whereas if he operates a company outside IR35, jointly owned with his spouse, he ought to be able to get £136,811, a considerable increase.

The Government ought to be able to raise its tax take considerably by a few simple measures that will not require any legislation. This would only apply to central Government, but that does seem to be where much of the problem lies. It simply needs to introduce a few policies, and the great thing about policies is that they can just be imposed by ministers with the minimum of fuss.

So, to take the first level: with whom is the Government making its contracts? If with the individuals, then matters are quite simple: PAYE and NIC’s must be deducted from the payments, whether they be paid to Mr Lester or to his company. It should surely be a simple matter to say that in all cases where the Government, or any of its quangos, requires the personal services of an individual then it must contract with that individual and not with any company of his. It could make the agencies that it uses agree to the same condition as well. All that that would require is a policy decision.

However it appears that this is not what is happening now, if the Taxation article is anything to go by: the contortions that some of the officials and advisers that have responsibility for Mr Lester’s pay have gone through are otherwise inexplicable. So, even if Government accepts that it can make payments through companies, is IR35 being operated? In Mr Lester’s case we have no means of knowing, but I hope that it is, as it seems to me inconceivable that for a role like this the arrangements are such that it need not be.

Whether it is or nor, this ought to be a much easier matter for HMRC to police than private sector IR35 cases. All they have to do is to ask all central government organisations to give details of all companies that they have paid for personal services rendered by individuals, and then investigate them. The Finance Act 2008 gives them the power to do this with the consent of the Tribunal, which on an issue of as much public as this I am sure would be forthcoming. It might even be legal for Government departments to respond to requests from HMRC voluntarily – if so, it ought to be Government policy that they do so.

The difference between this and a private sector engagement is two-fold: firstly, they know where to look (and the organisations are generally very big, so one request may well net a lot of fish); secondly, one would expect both the contracts and the reality to be far more obviously ones to which IR35 applied.

There nevertheless seems to be some reluctance in Government to grasp this nettle, and one has to ask why. One suspects that it is high-earning individuals wanting to be paid through companies that is driving this at the top end, although lower down it may be more the effect of recruitment freezes and driven by Government itself. Either way, the fact that the public sector does not want to address this issue suggests that many people there know that they would have to pay substantially more to some of these high earners if they are going to be able to attract their services without using companies. This in turn suggests that either avoidance or evasion of IR35 is taking place in this sector, because if the rules were being operated the individualsconcerned would not have much to gain.

Is it, then, avoidance or evasion that is taking place? This depends on the contracts, and on the basis of what is in the public domain it is not possible to tell for sure. However, avoidance is unlikely: at the top level (and certainly in Mr Lester’s case if the Taxation article is to be believed), the individuals concerned are either officers of their organisations, or would be but for the interposition of their companies. This means that their companies are subject to IR35 at least on NIC’s. A contract that suggested that this was not so would require considerable collusion on the part of the Government body concerned, and if that collusion is taking place that is a cause for concern. Eradicating this ought to be a priority for the Treasury and ought not to be difficult. It just requires taking on other arms of Government – something at which it is already adept and, indeed, notorious.

© KDGK Limited, March 2012.

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OnJuly 9, 2012, posted in: Articles by