PAYE Regulations and impact on share-based payments to former employees

25th January 2012

This update is about new PAYE rules affecting share-based payments made to former employees, which will take effect on 6 April 2012. 

In our newsletter published in April 2011, we drew attention to the introduction of regulations making a significant change to the PAYE treatment of payments to former employees (Income Tax (Pay As You Earn) (Amendment) Regulations 2011 (SI 2011/729)), except in the case of payments in the form of shares and interests in shares.  HMRC has now indicated that all payments to former employees should in future be treated in the same way and has published draft regulations for consultation.

Before 6 April 2011, income tax on payments to former employees was deducted only at the basic rate.  Higher rate taxpayers met any additional liability under self-assessment.

For such payments on or after 6 April 2011, an employer must use the 0T tax code which applies on a “non-cumulative” basis. This means that none of an individual’s personal allowance is available and, for an employee who is paid on a monthly basis, only 1/12th of the basic rate band (and if relevant, 1/12th of the higher rate band) will be available in the month of payment. Any excess will be taxable at 50%.

If, therefore, a taxable payment of £20,000 in cash is made to a former employee, the first £2,916.67 will be taxed at 20%, the next £9,583.33 at 40% and the balance of £7,500 at 50% (resulting in a tax liability of £8,166.66, instead of £4,000 (£20,000 x 20%) under the previous rules).

Whether starting a new job or not, the employee can submit a claim to recover any overpayment of tax. There could, however, be a significant delay in securing reimbursement, especially if the payment from the former employment was made early in the tax year.

Following representations to HMRC that the 0T code could impose unfair levels of taxation, in particular on participants receiving shares under all-employee arrangements, such as HMRC approved Share Incentive Plans (SIP), special provisions were introduced regarding share-based payments.  As a result, with effect from 6 April 2011, the BR tax code, rather than the 0T tax code, has applied to all payments to former employees in respect of shares or interests in shares (Income Tax (Pay As You Earn) (Amendment) (No. 2) Regulations 2011(SI 2011/1054)).   This means that where a PAYE liability arises in relation to a former employee’s shares or interest in shares, tax will only be deducted at the basic rate, thus preserving the original position.

HMRC has now indicated, however, that, it has had discussions with employers and share scheme administrators, and identified a desire for a simple process and a single tax code. It is proposed, therefore, that, with effect from 6 April 2012, the 0T code should be used in relation to all share-based payments, thus aligning all post-employment earnings under the same tax code. Draft regulations (http://www.hmrc.gov.uk/drafts/tax-code-change.pdf) were published on 19 January 2012, and there is a four week period of consultation until 16 February 2012 during which interested parties are encouraged to provide feedback.

If you or your clients would like to discuss the impact of these provisions please contact us