Taking pay cut ‘could trigger a tax bill’

People who give up a bonus or part of their salary to help their employer stay in business during the coronavirus lockdown could trigger some unexpected tax consequences, experts have warned.

Across the City, business leaders have pre-emptively taken the axe to their pay packets to show solidarity with staff and shareholders. However, senior executives and owner-managers of businesses and employers could all be caught out by strict rules which apply to the waiving of salary and bonuses.

If not followed correctly, these rules could lead to companies and individuals being pursued by HM Revenue & Customs for income tax and national insurance contributions, tax practitioners told the Financial Times.

Growing numbers of businesses have asked senior staff or those earning over a certain threshold to take a pay cut or even repay bonuses to help support their company during the pandemic.

But, under the Income Tax (Earnings and Pensions) Act 2003, the timing of when individuals waive remuneration is critical for whether they will have to pay tax on the amount given up. The requirement to make a formal declaration about their intention is also important.

Chris Thomas, legal director at law firm Pinsent Masons, said: “PAYE [Pay as you earn] liabilities for employers are calculated on the amounts which employees are entitled to. If the employer has not properly dealt with the formalities it could find itself still liable to HM Revenue & Customs for the PAYE on the full salary and not the reduced salary.”

To avoid this, the employer should put in place a contract variation, signed by the employee, to record an agreement to reduce the employee’s salary. Crucially, this would need to be done before the employee is next entitled to receive their salary, for it not to be treated as taxable earnings. A simple reply email or text confirming agreement would suffice if getting signatures in lockdown is difficult, Mr Thomas added.

Employers who take the lead in instituting pay cuts may be more likely to keep abreast of the tax rules. However, individuals who voluntarily choose to give up money are more at risk of not following procedure, experts warned.

Owner-managers of businesses are one such group who could, depending on their arrangements for extracting funds, fall foul of the rules — especially as there are additional requirements for an individual who is a director and waiving or reducing their salary, Mr Thomas said.

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