Practical guide: when is a PSA worthwhile?

PAYE settlement agreements

The default reporting mechanism for taxable staff benefits and expenses is Form P11D . Employers can choose to “payroll” these benefits and expenses instead, although completion of a P11D(b) for declaring Class 1A NI is still required.

Sometimes, an employer will provide benefits (including expenses) that are minor or irregular and won’t want the employee to be issued with a tax bill. Examples include incentive awards, small gifts, or staff entertainment.

Where such benefits are small, they may be trivial, or they may be covered by another exemption. If that is the case, they won’t be taxable. For example, incentive awards up to limits related to the length of service can be exempt, as long as they aren’t in cash.

In other circumstances, it may be impracticable to place a value on a benefit provided on an individual basis, e.g. where a group of employees is provided with benefits with no fixed value.

Where a benefit is taxable, but is minor, irregular or impracticable, the employer can use a PAYE settlement agreement (PSA) as an alternative reporting method.

Under a PSA, the employer agrees to settle the tax on these benefits on the employee’s behalf. This may be as a goodwill gesture, or simply to ease the administrative burden of reviewing a large number of minor benefits. The employer will also pay Class 1B NI, instead of Class 1/1A.

Setting up an agreement

A PSA is set up by applying to HMRC to agree the categories of benefits that can be disclosed. HMRC reviews the categories to make sure they are either minor, irregular or impracticable, and if in agreement, will issue a PSA contract ( P626 ) which includes the details.

The contract must be signed and in place by 5 July following the first tax year the PSA is to apply to. Once authorised, it becomes an enduring agreement, i.e. it doesn’t need renewing annually.

You can add or remove categories from the PSA after the contract has been signed. This must be done by 5 July following the tax year for which you want the amendments to be effective. It is worth aiming to include all categories you want to include within the initial application, and then making amendments if circumstances change.

Gathering information

For each of the categories covered by the PSA, your process should require that all costs relating to that category, within the relevant tax year, are gathered. Costs need to be VAT inclusive. You can then filter out anything that can’t be included.

Costs can usually all be extracted from the nominal codes in the accounting system. However, there is usually not enough information in the nominals alone to determine whether a cost relates to a taxable benefit.

Further information can usually be obtained from other sources - including expense claim forms, credit card information, and as a last resort, asking people based on their memory. If you do all the accounting and bookkeeping for your business, you’ll likely have much of the data already. 

When gathering the data, you should not consider whether it is taxable or not at that point. This is regardless of whether the cost is actually taxable, that should be left to the analysing stage. 

Analysis

This is the part of the process most prone to error. There can be confusion around whether an item is a taxable benefit or expense. Remember that just because an item may be considered “for business purposes” that does not mean there is not a taxable benefit or expense.

Your process should include detailed guidance on identifying whether something might be a taxable benefit or expense. It is also recommended staff are well trained in this area, and that a thorough review process is in place to check others’ work.

Your process should require a methodical approach to analysing the data. In many cases, each item will need to be considered one at a time, but you may be able to group together items with same or similar facts and make a single decision to help with efficiency.

Example. An employer provides all staff with a £50 voucher for their birthday as a matter of course. A single consideration for all these vouchers can be made, reducing the amount of analysis.

As mentioned above, an item won’t be taxable if an exemption applies. Have a list of common exemptions relevant to PSAs, along with the conditions for the exemption to apply, that can be referred to when analysing costs. Common exemptions are annual functions, trivial benefits, subsidised or free meals, training, and long service awards.

It’s essential to keep a record of your analysis, including decisions and why they were reached. For example, if you’ve determined a cost is not taxable, have a record for why, along with the information used to make that decision.

Allocation

Once you have all the taxable costs, the allocation stage can be done.

Taxable items need to be allocated against the relevant PSA category, and then split between costs that relate to staff that are basic, higher and additional rate taxpayers, and costs split between ones that relate to those based in England and Northern Ireland, Wales or Scotland.

This is crucial because the taxable amount must be grossed up using the average marginal tax rate to reflect the fact that the employer settling the tax is in itself a benefit. HMRC’s view is that staff who are not taxpayers, e.g. because they earn under the personal allowance, should be treated as basic rate taxpayers. Where costs can be allocated to specific staff, HMRC prefers this to be done, although representative samples can be used.

Your process should include guidelines and rules for what methods should be used and when. These could include using tax rates in the payroll at the end of year for staff.

Completion and submission

Use the online PSA1 form. You will need to submit one form for each area there are employees in, e.g. two forms if there are employees in both England and Wales. The PSA1 automatically calculates the liabilities. The forms can be completed and submitted online, or printed and sent to HMRC: lbs.compliance@hmrc.gov.uk .

Payment must be made by 21 October if paying electronically, or 19 October otherwise. HMRC will provide a payslip which includes a reference number specific to your business. Don’t make payment without this, otherwise HMRC will think youhaven't paid. There are several ways to make a payment.

HMRC can be slow to provide the payslip, so make sure to chase it up to get the reference number in sufficient time before the deadline.