Pension tax relief is a way that the government uses the tax system to encourage employees to save for the future. With minimum auto enrolment pension contribution rates set to increase again from 6th April 2019, here is a useful guide for employees and employers to understand how tax relief works on pension contributions paid via payroll. There are 2 ways in which this works:

• By giving employees a top up on pension contributions that they make. This is called “relief at source”. NEST is one example of a pension scheme that uses this method. “Relief at source” works by applying only 80% of the full pension contribution rate to the amount to be deducted from the employee’s pay. For example, if the employee’s pension contribution rate is 3%, the rate that is actually applied to the payroll pension calculation is 2.4% (i.e. 80% of 3%). The remaining 20% of the employee’s pension contribution is topped up by HMRC who pay this direct to the pension scheme provider, to be added to the employee’s pension pot.
• By reducing the amount of tax that the employee pays via payroll. This is called “net pay arrangement”. Creative Pension Trust is one example of a pension scheme that uses this method. With a “net pay arrangement”, the employee pays the full pension contribution rate amount. For example, if the employee pension contribution rate is 3% then the rate that is actually applied is 3%. However, before tax is calculated in payroll, the pension contribution amount is first deducted from earnings thereby reducing the amount of taxable earnings and therefore the tax that the employee pays is less.

To show how these 2 methods work, let’s take the example of 2 employees working for 2 different employers. Both employees have the same tax code BR (i.e. all earnings taxed at 20%). Employee A’s employer uses a “relief at source” pension scheme and Employee B’s employer uses a “net pay arrangement” pension scheme. For a particular month, both employees have gross earnings of £2,000.00 and they are both set to make pension contributions at 3%. For the sake of simplicity, we will assume that pension contributions are made on total gross earnings.

Employee A
Pension contributions = £2,000.00 x 2.4% (i.e. 80% of 3%) = £48.00. HMRC top up the employee’s pension pot with the remaining 20% which is £12.00 (i.e. £2,000.00 x 0.6%). The employee ends up with £60.00 in their pension pot.
Tax at 20% = £2,000.00 x 20% = £400.00
Therefore, take home pay = £2,000.00 - £400.00 (tax) - £48.00 (pension) = £1,552.00

Employee B
Pension contributions = £2,000.00 x 3% = £60.00
Tax at 20% = £1,940.00 (i.e. £2,000.00 gross earnings less £60.00 pension contribution) x 20% = £388.00
Therefore, take home pay = £2,000.00 - £60.00 (pension) - £388.00 (tax) = £1,552.00

Comparing the two, we see that both employees end up with the same amount in their respective pension pots and the same take home pay: Employee A pays £48.00 via payroll and gets a top up of £12.00 from HMRC while Employee B pays £60 into the pension and pays £12.00 less tax as a result.

On the face of it, it might look like it doesn’t make a difference to employees if a pension scheme uses “relief at source” or “net pay arrangement”. However, for low earners who earn above the auto enrolment trigger (£10,000.00 per annum or £833.33 per month) but at or below the normal tax threshold (£11,850.00 per annum or £987.50 per month for 2018/19), a “relief at source” pension scheme is a better option than a “net pay arrangement” one.

As an example, let’s take 2 employees on £950.00 per month and same tax code of 1185L M1 (tax-free allowance of £987.50 per month). Again, we will assume that pension contributions are paid on all gross earnings.

For Employee A who is in a “relief at source” pension scheme, pension contributions via payroll would be £22.80 i.e. £950.00 x 2.4% (i.e. 80% of 3%) and £5.70 would be topped up by HMRC. Total amount in the employee’s pension pot would therefore be £28.50 (i.e. £22.80 plus £5.70). Because the earnings of £950 are below the tax-free allowance, the employee pays no tax and their take home pay is £927.20 (i.e. £950.00 - £22.80).

For Employee B who is in a “net pay arrangement” pension scheme, pension contributions would be £28.50 i.e. £950.00 x 3%. Since the earnings are below the tax-free allowance threshold anyway, there is no tax to pay. The take home pay however is £921.50 (i.e. £950.00 - £28.50), which is lower than that for Employee A.

Because of this anomaly between the 2 types of tax relief for low income earners, there are growing calls on the government to change the rules to make it fair for everyone.

Whether you have one employee or several, managing employee holidays can prove to be an admin hassle. Here are a few tips that might help ease the admin burden.

1. Set a holiday calendar year: It might sound obvious but having a set holiday calendar year means that you and your employees know when all the holiday entitlement has to be taken by. When it comes to choosing when the holiday calendar year should start, there is no right or wrong answer. Each choice has its own pros and cons. For example, choosing a holiday calendar year that coincides with your financial reporting year means that it is easier to manage the reporting requirements under FRS 102 while choosing a holiday calendar year that coincides with the tax year means that it is easier to manage within payroll software. Other common choices for holiday calendar year include the calendar year (January to December), and using the employee’s start date.
2. Work out what the holiday entitlement will be: An employee’s paid holiday entitlement starts from the first day of their employment. An employer can provide holiday entitlement which is more than the statutory minimum entitlement (28 days). For salaried employees working 5 days a week with no overtime, bonuses or commission, it is fairly easy to work out the entitlement. Things can get a bit complicated where there is overtime involved or there are bonuses/commission that are affected by holiday. If you are unsure about if and how these elements should be taken into account in your holiday entitlement calculation, please seek advice. We regularly help employers in this area.
   
3. Make sure that employment contracts include holiday entitlement details and keep these details up to date: One of the questions that we get asked frequently by employers when an employee leaves is “how much holiday is the employee owed”. In order to work this out, we have to ask the employer to confirm when the holiday calendar year starts and what the contract says about holiday entitlement. If a contract does have a holiday entitlement clause, make sure that it is appropriate for the employment arrangement. For example, if the employee is hourly paid and the hours are variable, does the holiday entitlement clause specify how holiday will be accrued? These are the types of issues that we routinely help employers with.
4. Have a system for keeping track of holidays taken: When it comes to having a system for managing holidays, you want a system that makes the admin hassle free. We come across employers that use Excel spreadsheets, Outlook calendars, and online HR systems to manage their employee holidays. There are a number of advantages that online HR systems like breatheHR have compared to Excel spreadsheets or Outlook calendars. These include: centralised holiday information which can be accessed from anywhere by managers and employees, no messing about with Excel formulas (especially as your team grows), and built in calculators to help work out things like pro rata entitlement.
5. Ask your payroll provider if they have the capacity to assist: There are many advantages for an employer in having their holidays managed by their payroll provider. Payroll has access to information that is relevant for calculating holiday entitlement, including hours worked, average pay, overtime, and bonuses/commission. At Questfp, we provide a number of solutions for managing holidays for those employers that need assistance. We can provide Excel spreadsheet templates (for the Excel lovers), we can track and accrue holiday entitlement within the payroll software and provide holiday reports as and when required, or we can provide access to an online HR system (breatheHR) that employees can also access to view their entitlement and book holidays.

If you are interested in finding out how we can help you manage your employee holidays, please do not hesitate to contact us on 01483 338 070 or email info@questfp.co.uk.

One of the areas that we frequently get asked about by our clients is in relation to tax codes and how tax has been calculated for a particular employee. Providing a clear and concise breakdown of the tax calculation is something that we do on a regular basis. If you are puzzled by the numbers and letters in your tax code, below is a brief and simple guide to help you understand what your tax code means.

Broadly speaking, there are 2 types of tax code:  cumulative and non-cumulative.
An example of a cumulative tax code is 1185L.
An example of a non-cumulative tax code is 1185L W1 or 1185L M1 or 1185L W1/M1 or 1185L X.

Cumulative tax codes calculate the tax due in the current pay period as the difference between the total tax due to date and the total tax paid up to the last pay period. As you will note from this, it is possible to get a negative difference if the total tax due to date is less than the total tax deducted up to the last pay period. This could be the case for example where an employee has received a bonus in the last pay period which results in more tax being deducted in that pay period than normal, or if an employee has had a gap in their employment. In this situation, the employee would receive a tax refund via payroll.

Non-cumulative tax codes are also known as Emergency Tax Codes. Non-cumulative tax codes calculate the tax to be deducted in each pay period by taking into account only those taxable earnings for that pay period.

The amount that an employee gets as their tax-free personal allowance is determined by the numbers that make up the tax code and also the letter that precedes or supersedes those numbers. If the tax code is made up of numbers followed by the letters L, M, N or T, multiplying the number by 10 will give you the total tax-free personal allowance for the tax year. Multiplying the tax code number by 10 and then dividing that by the number of pay periods (52 for weekly, 12 for monthly) will give you the tax-free personal allowance per pay period. Each tax year, HMRC will update the standard tax-free personal allowance. For the 2018/19 tax year, the standard tax-free personal allowance is £11,850 so most employees will end up with a tax code of 1185L. HMRC will adjust the tax code to collect more tax by reducing the value of the tax-free personal allowance. If HMRC need to collect tax on things like Benefits In Kind and the value of these is such that they are more than the value of the tax-free personal allowance, they will issue a K tax code (tax code with a K prefix). This tax code has a negative tax-free personal allowance which means that tax is calculated on all earnings (no tax-free personal allowance) as well as an additional amount determined by the value shown after the letter K.

What to do if you think your tax code is wrong
It is always a good idea to regularly check the tax code shown on your payslip. Remember, the lower the number shown before the letter in your tax code, the more tax you will pay. HMRC will issue revised tax codes from time to time and they are supposed to write to the employee to let them know that their tax code has been revised. At the same time, they will also issue a coding notice to the employer instructing them of the change. The coding notice that is issued to the employer will never tell the employer how the tax code has been worked out. If you think that your tax code is incorrect, you can use the HMRC Personal Tax Account service (https://www.gov.uk/check-income-tax-current-year). You will need to create an account first if this is your first time using the service. Alternatively, you can also contact HMRC on 0300 200 3300, making sure that you have your National Insurance number to hand.