Employees are taxed on their salary at the earliest of:
- The date of physical receipt
- The date of legal entitlement
Employees may agree to give up a proportion of salary to help an employer in difficult circumstances. However, if not planned properly, PAYE and NIC may still be payable to HMRC on the waived salary.
For example, an employee is on a salary of £60,000 per annum. This is earned evenly over the year. The employee is entitled to £5,000 at the end of each month. The month end date is the date on which the salary is treated as receivable for tax purposes (whether or not actually received).
Let’s say that the salary was not paid on 31 March. By mid-April, the employer and employee agree to waive all salary until 30 June. The salary due on 30 April and 31 May but now waived, will not be subject to PAYE and NIC. However, the salary due on 31 March is subject to PAYE and NIC as it was waived after it was receivable by the employee.
Tax implications of giving up an employee bonus
Similarly, if a bonus is waived after the date on which the employee becomes entitled to the bonus, it is treated as having been received for tax purposes. PAYE and NIC is due on the bonus.
However if the bonus is waived before the entitlement date, no PAYE or NIC is due.
HMRC give the following example:
“A senior employee, who is not a director, is contractually entitled to a bonus each year. The amount of the bonus is based on the profits of the employing company.
The company’s year-end is 31 January. Accounts for the year ended 31 January 2003 are finalised on 31 July 2003, enabling the amount of the bonus to be calculated. The employee is not entitled to payment of the bonus until 31 October 2003. The employee is informed on 31 August 2003 that the bonus will be £10,000.
The letter informing the employee of the bonus asks the employee to give up her rights to the bonus as the company is now in a difficult financial position. The employee agrees to do this in a letter sent to the company on 30 September 2003.
The employee is not liable to tax on the bonus as employment income because it was given up, on 30 September 2003, before it would have been treated as money earnings for employment income purposes, on 31 October 2003.
If the bonus had been given up after 31 October 2003 the employee would have been liable to tax on the £10,000 as it would have been given up after it was treated as money earnings for employment income purposes.”
Tax implications for a director giving up salary or bonus
The date of receipt for a director is a little more complicated. Salaries/bonuses are taxed at the earliest of:
- Rule 1: the date of physical receipt or
- Rule 2: the date of legal entitlement or
- Rule 3: the earliest of:
a. The date when sums on account of his earnings are credited in the company accounts or the company records; or
b. At the end of the company’s accounting period if the earnings have been determined by the end of that period; or
c. At the date the earnings are determined if that date falls after the end of the company’s accounting period.
Looking at the example above of the senior employee and the bonus. If it was a director, Rule 3 (c) applies as the bonus is determined on 31 July after the 31 January year end. This is earlier than the date of legal entitlement on 31 October. The date of receipt for tax purposes is 31 July. The waiver on 30 September falls after this date. Therefore PAYE/NIC is due on the bonus.