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Employers in the UK must ensure compliance with employment tax obligations to avoid unexpected liabilities. Using a PAYE Settlement Agreement (PSA) is a key part of that compliance, but applying best practice is crucial. 

PSAs are used by many employers to settle, on behalf of their employees, the tax and National Insurance contributions (NIC) due on certain taxable benefits and expenses. A PSA is a useful tool for ensuring that the tax and NIC on “hidden” qualifying benefits (such as taxable staff entertainment and staff gifts) is paid to HMRC without disturbing employees’ personal tax positions. For more information about PSAs, please refer to our previous article.

Why it is important to use a PSA?

• It simplifies the administrative process of reporting taxable benefits which are minor, irregular, or impracticable, as it eliminates the need to include the benefits via the payroll and/or on forms P11D.
• It supports compliance, helping to reduce the risk of unexpected tax and NIC liabilities, HMRC penalties and interest charges for the employer.
• It helps to increase employee satisfaction. In the absence of a PSA, employees would pay the tax (and in some instances employees’ NIC) on the types of benefits which would otherwise be included in the PSA. Employees are unlikely to welcome paying tax on benefits such as staff entertainment if it is reported on their P11D.

Once an employer has a PSA in place with HMRC, applying best practice when operating the PSA is crucial. 

Three best practice points on annual PSA compliance

Review the previous year’s PSA calculation approach

One of the most common issues we see is the tendency to simply follow what was done in previous years without conducting a thorough review, specific to each tax year, of what might need to be included in the scope of the PSA and the PSA calculation. 

While considering previous years is an important part of the annual process, tax and NIC legislation, HMRC guidance, benefit offerings and expenses policies and costs can all change year-on-year.

Therefore, it is essential for employers to consider the position for each year to identify changes which could impact the PSA. This should be done before the deadline for varying the PSA for a tax year (usually 5 July following the tax year but could be sooner) in the event that additional items need to be added to the scope of the PSA. 

Consider a scenario where ABC Limited provided hampers as Christmas gifts to their employees in 2022/23. Each hamper cost the employer £55 (including VAT and delivery charges) and the total cost was included in the PSA calculation. However, in 2023/24, the company changed its supplier of hampers, and as a result, the cost of each hamper dropped to £45 per employee. If ABC Limited merely copied its 2022/23 PSA approach and included the cost of the hampers in its 2023/24 PSA calculation, it could overstate its PSA benefits and pay too much tax and NIC to HMRC. The reason being that in 2023/24, proper consideration of the trivial benefit in kind exemption could result in the hampers being exempt benefits.

We recommend conducting a thorough review each year, with careful attention to any changes in tax legislation and HMRC guidance, employee compensation structures and business policies. While previous years’ PSAs can serve as a reference point, they should never be the sole determinant for approaching the PSA calculation for the next year.

Maximise the use of tax exemptions

An effective PSA strategy is not just about identifying which benefit costs to include in the calculation, but also about ensuring that only the cost of taxable benefits is included. 

By utilising available exemptions, businesses can reduce their tax and NIC liabilities and avoid overstating their PSA calculations. There are several exemptions to consider, including (but not limited to) the exemption for free or subsidised food in the workplace, the exemption for annual staff events and the trivial benefits exemption (mentioned in the example above). 

Take the example of DEF Limited. Every Monday and Friday, the company purchases food and refreshments and makes them freely available to all employees in the staff kitchen in its offices. The cost is coded to staff entertainment in its nominal ledgers and included in its PSA calculation as part of the annual cost of staff entertainment. However, as the food and refreshments are on a reasonable scale, are freely available to all employees and are not provided under a salary sacrifice or flexible remuneration arrangement, the costs could be exempted using the tax exemption for free or subsidised food in the workplace, meaning that the cost should not be included in the PSA calculation.

We highly recommend that employers review their expenses carefully to identify if any available exemptions could apply. As in the example above, by active planning and making the most of available exemptions, employers can reduce their tax and NIC liabilities.

Keep detailed PSA records

For tax purposes, good record keeping is mandated by law, and HMRC requires businesses to maintain accurate and detailed PSA records. These records should cover, for example, the cost of providing the benefits, the number of employees involved, the tax rates for these employees, the rationale for excluding certain benefit costs from the PSA calculation and the business purpose of certain events.

The HMRC guidance on record keeping for PSA purposes states the following:

Where items can easily be attributed to individual employees the employer must;

• retain the same records required for the completion of form P11D
• record details of cash payments to individual employees.

Items which cannot be attributed to individual employees

Where it is impracticable to allocate an item between employees, a record of the employees concerned will not be needed. Instead the employer should record information about;

• the overall cost of providing the benefits concerned (for example the total cost of providing a party which a number of employees attend)
• the number of employees, and
• representative samples of the tax rates of the employees involved.

Legally, employers must keep records relating to PSAs for a minimum of three years after the end of the tax year to which they relate. However, as HMRC can potentially go back six tax years to collect underpaid income tax and NIC from employers where reasonable care has not been exercised, it is best practice to keep records for that longer six-year period.

If HMRC reviews a PSA calculation for a previous year, they may challenge the treatment applied (for example, in relation to the use of exemptions) and request supporting documentation. If sufficient evidence is not available, HMRC could challenge the position taken and seek to recover any underpaid tax and NIC, together with penalties and interest charges. In this context, robust record keeping is essential to help protect the business from such HMRC challenges.

PSA compliance requires more than just filing paperwork. Our team of employment tax specialists can help you analyse your expense data, take advantage of all applicable exemptions, complete the PSA calculations and ultimately ensure that you pay the correct amount of tax.

For more information, or if you have any questions or concerns, please contact Lee Knight or Susan Ball.