Amended regulations to deal with issues highlighted in the Demibourne case

The Special Commissioner’s decision in the case of Demibourne Ltd v Revenue and Customs Commissioners highlighted a number of tax issues for employers and their employees which can arise as a consequence of an employer’s failure to operate PAYE (Pay As You Earn). These issues relate to a situation where Income Tax has been paid in relation to what is PAYE income, but by the wrong legal person (ie the employee rather than the employer).

The Demibourne case confirmed that where an employment relationship exists, the employer is responsible for deducting tax from payments made to the employee in accordance with the PAYE Regulations. Under the law as it stands, HM Revenue & Customs (HMRC) do not have the discretion to choose whether to collect tax from the employer or the employee. This can lead to a situation where HMRC are obliged to seek recovery of tax from the employer in relation to income on which tax has previously been paid by (or on behalf of) the employee under Self Assessment (SA).

HMRC have engaged with the main bodies of the tax and accountancy profession and business to identify a solution to the issues highlighted in the Demibourne case. As a consequence of this dialogue a legislative solution is being introduced from 6 April 2008.

Regulations have been made today which amend The Income Tax (Pay As You Earn) Regulations 2003 (The PAYE Regulations) to extend the limited circumstances where HMRC may make a direction to transfer an employer’s PAYE liability to the employee who received the relevant payments from which tax has been under deducted. Broadly, the new power to make a direction will apply where an employer has failed to deduct or account for tax in relation to a relevant payment (payments subject to PAYE as defined in Regulation 4 of the PAYE Regulations), while tax on that payment has been included in the employee’s SA, or where no SA has been made but tax has been paid as SA payments on account, or has been deducted as a sub-contractor deduction.

We will be publishing draft guidance on the practical effect of this new legislation in April but in the meantime please see further details on new legislation to transfer a PAYE liability from an employer to an employee.