Preparing for a PAYE Inspection

If you have experienced a visit from an HMRC “employer compliance review” inspection you will know they have come to look at more than your payroll records. The scale and scope of their review is likely to be far more wide ranging and is likely to cover areas such as:

  • Employment status
  • Expenses and reimbursement procedures
  • Shareholder-director dividends
  • Benefit in kind and non-cash remuneration

The Basics

Inspectors are likely to turn up in two’s and the visit will generally start with an interview with the person responsible for payroll and business finances. What they are looking to discover is any weaknesses in your procedures that may throw up any errors resulting in insufficient tax or national insurance contributions having been paid over to HMRC or illegal dividends being paid to HMRC.

They will begin by looking at the previous twelve month’s records and if they find any errors or omissions they can go back and look at the previous four years to see if the same errors occurred in the earlier years.

Employed or Self Employed

Many clients and their accountants/ tax advisors will disagree on whether staff/contractors are considered to be employed or self-employed. As a business can save PAYE/ NI costs by hiring a worker as a freelance contractor rather than taking them on as an employee, the status of self-employed workers is a favourite target.

To satisfy the inspectors that a hired worker is self-employed it must be obvious in theory and practice inter alia that:

  • The worker is not obliged to work just for you or your company and can appoint a substitute to do the work on their behalf.
  • You are free to ask a third party to work on the project (subject to any agreement between you).
  • You cannot exercise the right to control exactly how they do their job.
  • The worker can demonstrate that they run their own business, they bear the consequences of rectifying mistakes they make, issue invoices and have agreed payment terms.

If you have a signed  contract between your company and the contractor, setting out the terms and conditions of engagement, you are more likely to convince the inspectors that the worker is truly self-employed.

Directors’ tax returns – who pays for them?

Where a company pays for a director’s tax return this counts as a benefit in kind and therefore needs to be included on form P11D. The company will incur a class 1a national insurance charge on the cash equivalent of the benefit and the employee will pay income tax at their marginal rate of tax. If the benefit in kind is missed off the P11D the company may incur a penalty charge, in addition to having to pay the shortfall and any interest thereon.

To minimise the cost of the benefit in kind and consequent tax and national insurance costs, it is worth asking the accountant preparing and filing the accounts, prepared if they will split their fee.  In so doing their invoices will show that the director’s tax return has been done for a nominal fee, as a loss leader to the main company work. Be sure to include the nominal amounts on the director’s P11D and that the director includes the details on their own tax return.

Shareholder-director dividends

I have come across several of my director clients who pay themselves a dividend when there are insufficient reserves to cover this. These are called illegal dividends and an inspector will challenge any dividend payments to director shareholders where this is the case.

Company law states that you can only pay a dividend if the company has enough distributable reserves to meet the dividends. It is possible for the company to make a loss and still pay a dividend, provided prior year reserves will cover the dividend declared.

One way to ensure that there are sufficient distributable profits is to keep a spreadsheet which includes the date and amount of each dividend paid, together with the level of distributable profit at the time the dividend is declared.

Conclusion

If you are lucky enough not to have experienced an “employer compliance review” you should take on board the above discussion and tips. Moreover, do an audit of your company’s payroll records, expenses and reimbursement procedures for the previous tax year to ensure these are all water tight. That way the inspectors are more likely to walk away “empty handed”.

Posted in Compliance HMRC PAYE at 2015-02-10 by Alan Ovenden

Tags: Compliance Checks, HMRC, Payroll