Chapter 8 Employee remuneration Flashcards
1.1 Termination payments
For the employer payment on termination of employment, while trading the payments are allowable. On cessation of trade, the maximum deduction is statutory redundancy plus additional payment up to three times statutory redundancy.
For the employee, it depends on the circumstance:
- On shock (death or injury) this is tax free
- Surprise (compensation for loss of office and genuine ex gratia), the first £30,000 is tax free and the remainder taxable.
- Contractual or expected payments (contractual payment, reward for services provided, gardening leave and usual employer practice), this is employment income and taxable.
Statutory redundancy is fully exempt, although it reduces the £30,000 exemption for discretionary payments. Any income in excess of the £30,000 is treated as the top slice of income, taxable in the year received. If discretionary payments attracts the £30,000 exemption, then it is also exempt for employee’s NICs, same with employers NICs.
1.2 Benefits received after termination of employment.
Taxed in the same way of discretionary payments if there is no expectation of receiving the benefit. Otherwise, it is taxed as employment income. When a discretionary payment includes cash and a benefit, both elements quality for the £30,000 exemption but it is applied to cash first. Any discretionary benefits in excess of the £30,000 exemption are subject to Class 1A NICs.
Pension contributions, retraining, counselling or outplacement services are exempt benefits for employees and employers.
1.3 Payments in Lieu of notice.
On termination, an employer may end the employment immediately and pay them an extra amount in lieu of their notice period (PILON). The payment needs to be split into two elements:
- Post-employment notice pay (PENP): represents what the employee would have received if proper notice period is served. This is taxable in full as general earnings.
- Balance of the payment (non-PENP) is treated as a discretionary termination payment and qualifies for the £30k exemption.
The PENP is calculated as ((BP x D) / P ) – T:
- BP is the basic pay period immediately before the date notice was given. This excluded taxable benefits, bonuses and commission.
- D is the number of days/months from the last day of employment to the date that the notice period should have expired
- P is the number of days/months in the pay period immediately before the period in which the termination payment was paid
- T is the amount already taxed as earnings
Any amounts received that are statutory redundancy can be excluded from the calculation as they are automatically exempt. The rules apply to UK resident taxpayers and non-resident taxpayers to the extent the notice period would have been in the UK.
2.1 Share schemes
Share schemes can be tax advantages or non-tax advantaged. The types of tax advantages schemes are company share option plans, enterprise management incentives, save as you earn and share incentive plans.
2.2 Share option schemes
A share option is an offer to an employee of a right to purchase shares at a future date at a predetermined fixed price set at the time the office is made.
For a non-tax advantaged scheme, no tax is paid on grant. On exercise this is treated as part of the employment income (MV at exercise less cost – cost includes cost paid for the option and the shares). Then on sales a gain is made which is proceeds less MV at exercise. The employment income is also subject to class 1 primary and secondary NICs if the shares can be sold on a stock exchange (readily convertible assets).
For a tax advantaged scheme, no tax is paid at grant to exercise. Then the gain is taxed on sale as proceeds less cost.
For the employer, they can deduct the difference between the MV at exercise and the actual price paid. This is an allowable deduction from trading profits (does not matter if it is tax advantaged or not). The deduction is only allowable if the shares are ordinary shares and are in a listed company or a company not under the control of another company.
2.3 Conditions for share option schemes
- Company Share option scheme: share options are awarded to key employees (quoted company). Employees must own less than 30% if the issuing company is a close company. A maximum value at grant is £30,000. The exercise must be between 3 and 10 years of the date of grant, and no discount at grant. The option price must be more than the MV at the date of grant. The tax treatment on disposal is a normal gain based on proceeds less exercise price.
- Enterprise management incentives: share options awarded to key employees (unquoted company). To quality the employee must work for substantial amount of time for company and own less than 30%. The maximum price is £250,000 (total options in issue by company is equal to £3m at any one time). Exercise must be within 10 years of the grant and a discount can be issued. Gross assets of the company must be less than £30m for trading company. The company and subsidiaries must have less than 250 employees at grant. A discount can be issued, but the discount is taxed as employment income on exercise and can attract NICs if it is a readily convertible asset. The tax treatment is proceeds less exercise price less amount taxable on exercise.
- Save as you earn: employee save a proportion of income over 3 or 5 years, at the end the savings can be used to purchase shares or taken together with a tax-free bonus. Must be open to all employees. Maximum savings is £5-£500 per month from net income. The maximum discount is 20% on market value at grant, no tax consequences for any discount, however. Normal gain based on proceeds less exercise price on disposal.
2.4 Share incentive plans
This is a scheme that enables the issue of free shares to employees and/or the purchase of shares out of gross pay. The shares are held in a trust. There are four ways an employer can issue shares:
- Free shares: employer can gift up to £3,600 worth of shares to the employee each year.
- Partnership shares: employee can buy partnership shares out of pre-tax remuneration. Maximum is the lower of £1,800 or 10% of annual salary each year.
- Matching shares: employer can choose to issue further free shares on a 2:1 matching basis to the partnership shares.
- Dividend shares: an employee can use dividends received from the plan shares to reinvest in further plan shares. Dividends used to buy shares in the SIP will not be taxed.
Conditions for a SIP is that it must be available for all employees.
The relevant period is the period between the company allocating the shares in a trust, to the plan giving the shares to the employee.
- If this period is less than 3 years, IT and NICs payable are based on MV of the shares at withdrawal (for dividend shares the original dividend is taxable in the tax year of withdrawal)
- If the period is 3 – 5 years, IT and NICs are payable on the lower of MV at withdrawal and MV at grant (dividend shares may be removed from the plan after 3 years with no tax or NICs payable)
- If the relevant period is over 5 years, no income tax or NICs payable.
For CGT, the base cost in all cases is equal to the MV when the shares leave the plan. No CGT is payable if the shares at withdrawn when the employee intends to sell them at base cost.
4.1 Pension schemes tax relief
For employers, relief is gained by deducting the pension contributions from their trading profits. For employees the relief depends on the scheme. For occupational schemes, the contribution is deducted from employment income before the tax is calculated. For personal pensions, the contribution is made net of basic rate tax, and the employee can extend their tax bands by the gross amount.
If total contributions on which tax relief has been claimed exceeds the £40,000 annual allowance, a tax charge is made to the employee. The allowance can be increased by an unused allowance from the three previous tax years.
4.2 Tapering the annual allowance.
The allowance is tapered for individuals who have threshold income above £200,000 and adjusted income above £240,000. Threshold income is net income less gross personal pension contributions paid by the employee. Adjusted income is net income plus employee occupational pension contributions and all employer contributions.
If they exceed both the limits, the allowance is restricted by £1 for every £2 the adjusted income exceeds £240,000. The minimum allowance for 2022/23 is £4,000 (adjusted income of £312k or above).
If a taxpayer was a high earner in a previous year, the reduced annual allowance will be used to calculate if they have any unused annual allowance to carry forward.
4.3 Annual allowance charge
If total pension contributions exceeds the available allowance a charge arises for IT. Excess contributions are taxed as extra income was received, taxed after dividends at the non-savings rate and this charge is added to the IT liability. This charge is not added to the taxable income computation and does not affect the calculation of ANI (for restricting PA).
4.4 The lifetime allowance
When the taxpayer extracts money from their pension fund a tax charge will arise if their fund is worth more than the lifetime allowance, this is £1,073,100 for the 2022/23 tax year, and will have to pay tax on the excess.
