Employee tax risks
Susan Ball outlines the potential pitfalls of managing employment-related tax matters
Successful independent schools depend heavily on their staff and ensuring they offer competitive packages with a clear understanding of the tax treatment. The net reward for employees plays a pivotal role in this equation.
Additionally, it’s important to note an increase in HMRC activity as it has expanded its compliance team by more than 3,000 additional personnel. Given this heightened scrutiny, it is advisable to maintain a strong grip on your responsibilities regarding employment-related taxes, ensuring that your institution has well-established and resilient processes, policies and procedures in place.
This article looks at some of the key employment tax areas that frequently appear within the setting of independent schools.
This is an area of concern that HMRC has been focusing on extensively, and independent schools are no exception. Independent schools frequently engage off-payroll workers either directly or indirectly via intermediaries, meaning invoices are not subject to tax and National Insurance Contributions (NIC) deductions. Typical examples of off-payroll workers regularly engaged by schools include peripatetic teachers, sports or music coaches, as well as finance or IT staff and these types of working arrangements can therefore pose a potential risk.
To reduce this risk, independent schools should have a keen understanding of the contractual and working arrangements in place with each off-payroll worker, including how they are engaged (for example, directly, through limited companies, or via agencies/umbrella companies) in order to determine their obligations. Where relevant, they should exercise due diligence and establish well-defined processes and procedures for off-payroll workers, particularly in cases where personal service is involved. This ensures that they conduct thorough status assessments when necessary and safeguards them against the potential consequences of failing to deduct taxes and NIC correctly when required.
The first step is to understand the contractual nature of how the contractor has been engaged and we have summarised the most frequently seen arrangements below.
- Direct engagement
If a school hires a contractor directly (with no intermediary) it needs to be comfortable that it has correctly determined if the worker can be treated as off-payroll for tax purposes. Wider employment law implications should also be considered. If an incorrect employment status assessment is made, meaning the workers payments are not subject to tax/NIC, the school can be held liable for any underpayments of tax and NIC.
If the school uses a recruitment agency to hire a contractor, there’s still the requirement if the worker is not an employee of the agency to determine status. However, narrower tests for status of supervision, direction and control applies and the school can be liable for mistakes made in certain circumstances.
- Personal service company
If an independent school contracts for the provision of services of a worker through an intermediary (such as via a limited company), the school needs to consider if the additional rules under the off-payroll regulations (often coined ‘IR35’) apply.
Since 6 April 2021, additional rules have applied, however these are only applicable to those independent schools deemed to be ‘medium and large’ businesses. This is likely to capture most schools as it is based on meeting at least two of the following conditions:
- An annual turnover of more than £10.2 million.
- A balance sheet total not exceeding £5.1 million.
- More than 50 employees.
Schools which form part of a larger group will need to examine the turnover and value of assets for the entire group of schools.
If the IR35 rules do apply, then the school needs to undertake a status assessment for employment tax purposes and issue a Status Determination Statement (SDS) for each worker. Where a worker is engaged via an agency, the SDS should also be issued to the agency.
Should a worker be assessed as a ‘deemed employee’ for tax purposes, each individual should be placed on the school’s payroll (or agency’s payroll if it is the fee payer) for tax and NIC purposes.
Accommodation exemptions and treatment of utilities
Wherever a school provides accommodation to employees, the starting point is that the accommodation is a taxable benefit unless an exemption applies.
However, there are two main exemptions that are relevant in the independent schools sector. Broadly speaking, the exemptions will apply where the accommodation is:
- Necessary for the proper performance of the duties, or
- It is both customary to provide the accommodation and it is provided for the better performance of duties.
HMRC typically acknowledges that in the case of boarding schools where staff are accommodated on or near the premises, then the exemption can apply to a proportionate number of staff undertaking boarding house duties/pastoral care duties.
Note the reference to ‘proportionate’. Schools looking to rely on the exemption linked to pastoral care duties performed by boarding house teachers, will need to be able to demonstrate adequately to HMRC that sufficient on-call duties are performed, ideally supported by call out records. For example, the odd evening of late-night working is not enough to meet the requirements for exemption. Ensuring the school knows who qualifies for any exemptions and why, as well as how to calculate the benefit where it is due and maintaining a record with supporting evidence is key.
Where the exemption conditions are met, the accommodation will benefit from a tax exemption. But independent schools should not forget about any related items, for example utilities.
- The payment of council tax or utility bills (specifically council tax, water charges or sewerage charges) are not taxable if provided in connection with tax exempt living accommodation. In other cases, they should be reported on the P11d or via payroll; and
- Utilities that will not benefit from tax exemption include heating, lighting, cleaning and repairs. Where the employee is in exempt accommodation however the taxable benefit of expenses on these utilities is limited to 10% of the employee’s net earnings, minus any contribution the employee makes towards the cost.
In some cases, schools may have previously agreed an approach with HMRC regarding paying utility costs, particularly where an individual utility cost cannot be attributed to individual properties. It is important that this agreement is retained somewhere safely in case of HMRC review and, additionally, consideration should be given to any uplift in costs each year (depending on how this is calculated in light of the ongoing increase in household costs). The treatment of utility costs has been of particular interest to HMRC recently when undertaking PAYE compliance reviews.
Lastly, don’t forget that furniture, cleaning or gardening costs may also need to be considered and reported.
There are many other areas which impact independent schools – we have covered a few in brief below.
School fee remission – It is often common for the employer to give a discount on some or all of the fees payable by an employee for his or her children to attend the school. The amount of the discount can result in reporting requirements, and tax and NIC liabilities. However, provided employees pay at least 15%, no benefit in kind will arise. It’s worth noting that this only applies to normal school fees. Any additional benefits provided (for example, music classes, special trips etc) are not included within the 15% agreement.
- Canteen exemption – where meals are provided to staff, ensure they are available to all staff to attend, and that the dining room is not open to the public.
- National Minimum Wage – from 1 April 2023, the National Living Wage rate (payable to workers aged 23 and over) rose from £9.50 to £10.42 an hour. Workers aged 21 and 22 are now entitled to £10.18 an hour. In the future, there could be another nearly 10% increase in hourly pay if the government takes forward the Low Pay Commission’s recommendation to bring the threshold for National Minimum Wage down from 23 to 21 and recent prime minister comments to at least £11 per household (an additional 5% increase). It’s important for independent schools to understand what category of workers they have under the rules to determine what calculations need to be undertaken to make sure they don’t fall below. This is particularly relevant for low earners, including gap year students who might also be provided with living accommodation.
- Uniform provision – where employees are provided with uniforms (for example, IT support staff, sports teachers), the employee is entitled to a full tax deduction for the cost of the uniform only in certain circumstances. To qualify as uniform the clothing should be specialised and recognisable and identifies the wearer as belonging to a particular occupation or employer. A common case of clothing being regarded as uniform is for the logo of the school to appear on the clothing, however, the logo must not be removable from the clothing and appear on each item.
Susan Ball is a tax specialist and partner for accountancy firm RSM.