Expenses and the Minimum Wage

Some umbrella companies have operated schemes, known as pay day by pay day tax relief models. These schemes are designed to increase the take home pay of low paid workers by using salary sacrifice arrangements. The scheme seeks to gain a tax and NI advantage. HMRC investigated the practice and identified a number of concerns surrounding compliance due to Expenses and the Minimum Wage:

The over-arching contracts used were potentially ineffective;
Dispensations used were either invalid or had been wrongly issued;
The terms of dispensations were not followed;
Expense payments were made that exceeded the level of the cost incurred;
Or were paid without a cost having been incurred;
Breaches of the laws surrounding the minimum wage.

Umbrella companies must therefore ensure that any expenses for travel and subsistence do not reduce the gross taxable income to a point where it will fall below minimum wage. As an aside they must also ensure that the contract value, less their margin, less employer’s national insurance is a figure not less than minimum wage.

Pay Day by Pay Day Models

Under pay day by pay day relief models, temporary workers engaged under overarching employment contracts who incur travelling and subsistence expenses were deemed eligible for a tax deduction under section 338 Income Tax (Earnings and Pensions) Act 2003 (ITEPA), are paid a gross pay which is intended to be compliant with the National Minimum Wage legislation. However, rather than then subjecting this gross pay to Income Tax and National Insurance, the employer applies tax and National Insurance contributions ‘relief’ to the amount of expenses which the employee has incurred. The effect is that only the balance is subjected to Income Tax and National Insurance. This tax and National Insurance contributions ‘relief’ is applied each pay day.

How tax relief is applied in a Pay Day by Pay Day Model

An employer operating such a model is not accounting for the correct Income Tax (PAYE) due to HMRC. Income Tax is an annual tax and is assessed in respect of a particular ‘year of assessment’. Any deductions from Income Tax (for example as provided for under section 338 ITEPA) are made from the total income for the year of assessment. There are various requirements which must be met in order to receive the benefit of the tax deduction at the end of the tax year. These include the claim for the deduction must be made to HMRC – there is no statutory framework for employers to operate the reclaim process.

National Insurance disregards

An employer operating such a model would also not be accounting for the correct employers’ and employees’ National Insurance contributions due to HMRC. For the purposes of calculating an employee’s earnings, the Social Security Contributions and Benefits Act 1992 provides that ‘earnings’ includes any remuneration or profit derived from the employment, including wages and salaries. The Social Security (Contributions) Regulations 2001 provide that payments made by the employer to the employee to cover certain travelling expenses incurred by an employee can be disregarded in the calculation of earnings for National Insurance purposes from the employed earner’s employment for the purposes of earnings related contributions (ie where such payments are made, those payments will not count as ‘earnings’ for the relevant earnings period).

However, the relevant legislation does not provide for a deduction from the amount of that employee’s earnings where the employee meets the travelling expenses out of total income/earnings.