Insights

The current economic situation is difficult for almost every business and many people will have had to accept a temporary reduction in their salary – to enable the business to either preserve cash or to simply stay afloat during the Coronavirus crisis. This is a difficult situation on its own, but it can also have unforeseen tax consequences, because there are strict rules governing the tax position on the waiver of salaries and bonuses, based on timing and documentation.

Being unaware of the implications can result in tax being due on gross unreduced income; this article explains why this occurs and is relevant to all employers and employees considering agreeing a reduction in income.

Under the Income Tax (Earnings and Pensions) Act 2003, earnings are taxable for both employer and employee on the earlier of:

1. The date on which payment is made; or
2. The date on which the employee becomes entitled to the payment.

This means the timing of when individuals waive their remuneration is critical, because it impacts whether they will need to pay tax on the amount waived.

It is also important for both employer and employee to agree in writing any contract variations and agreements to reduce salary, or they may still be liable to PAYE on the full salary. This agreement should be signed by both employee and employer and completed before the earlier of the date on which the employee becomes entitled to the payment, or the payment date.

Owner-managers of limited companies are especially at risk of inadvertently breaching these rules, either by not documenting matters at the appropriate stage or by entering amounts in the company’s accounting records which are later not taken. Directors who usually take salaries and dividends will need to ensure that they either continue to do this as usual and utilise their basic rate tax allowance for both dividends and salary, or they should document a reduction in salary and ensure neither salary nor dividends which are to be waived are included in the company’s accounting records. Once included in the accounting records the director is entitled to payment, and hence the tax point is activated.

Other employees who are at a heightened risk of  breaching these rules include those who are contractually entitled to bonuses but voluntarily decide to waive them to preserve company cash. This situation can occur because bonuses are paid out after the year in which they were earned, sometimes as much as 9 months later; employees who are waiving a bonus now might have earned it for summer 2019 performance for example, in which case tax remains due on the bonus, even if it is not claimed, or it is repaid. This is because of the wording in the legislation as above.

The CIOT has asked the government to relax the strict wording of the legislation temporarily so that voluntary bonus reductions or repayments made because of Covid-19 will be accepted as non-taxable negative  earnings. We will monitor the situation and provide updates accordingly; it is hoped that HMRC will be lenient under the circumstances but of course in one or two years’ time, when any HMRC enquiries are likely to take place into this period, the tax landscape may be entirely different.

Our experience is that many company directors are now finding themselves in a difficult position due to the way government support packages have been structured, and this legislation further complicates matters. If you need any advice on how to survive and whether to adjust your salary and dividend levels, please contact us via partners@rjp.co.uk