PAYE20035 - Employer records: set up employer record: free of tax system
There is a system available to employers who wish to make payments to their employees ‘free of tax’ (FOT).
In establishing whether an FOT system is applicable it is important to know why the employer has made payments without deduction of tax. This will determine whether payments were ‘gross’ or ‘net’ (free of tax).
This will be where the employer has failed to deduct PAYE tax from payments. Tax on these payments should be calculated on normal PAYE lines.
This will occur where the employer has an agreement with their employees and
- Intends to bear the tax on behalf of the employee
- Considers the payment to be an amount after deduction of tax
Where net payments have been made, further tax is due on the employee’s earnings, which is borne by the employer. The correct tax due is to be calculated using special Free of Tax tables (Tax Tables G) and a special deductions working sheet P11(FOT).
Free Of Tax Employer Package
Where an employer contacts you wishing to make payments net to his or her employees for the first time, you should set up a P scheme in the normal way. See PAYE20135 for further details. In addition you will need to send them the following Free of Tax Package
- Leaflet FOT 1 (gives details of system) available to print locally in the ‘Index of Forms’
- Free of Tax Tables G available to print locally in the ‘Index of Forms’
- Deductions working sheets P11(FOT) which are available through the Enterprise Resource Planning System (ERP)
The employer’s details should then be entered in the ‘Free of Tax’ employer related electronic file, so that any new Tax Table G and FOT 1 can be issued to them.
Advising the employer
You should ensure that the employer fully understands that
- Payments made free of tax increase costs because the payment will include the
- Amount of the free of tax payment
- Tax due on the true gross pay (TGP) relating to that payment
- Employer's share of the National Insurance contributions due on the true gross pay
- May also include a free of National Insurance element
- They will be expected to operate special PAYE procedures in accordance with the FOT1 guidelines
- Only figures of true gross pay and tax should be shown on forms P45 and P14
- They will have to ensure that the employee(s) involved understands and agrees with the terms and effects of the free of tax arrangement, bearing in mind that as HMRC is not a party to the agreement it will not get involved
- The arrangement between the employer and employee should make clear that
- Any tax actually suffered by the employee must be repaid to them (usually when an employee is taken on during the year and a repayment is due for the period prior to commencement)
- A new employer or HMRC will repay any tax certified on forms P45 or P14 to the employee even though the employer has borne the tax
- Entitlement to refunds during the year, of tax paid under free of tax arrangements, can be agreed between employer and employee
An employee may bear some part of the tax due under a free of tax arrangement, provided that the employer and employee concerned agree to this and how it should be done. Refer to leaflet FOT1 for further details.
Ensure that you keep a record of any advice given to the employer for future reference.
Refer any problem that you are unable to deal with using this guidance to
Personal Tax Customer, Product & Process, PAYE Technical
(This text has been withheld because of exemptions in the Freedom of Information Act 2000)