01: Introduction

Directors and employees are generally subject to income tax on their earnings under the PAYE (pay as you earn) system. The aim of PAYE is to deduct at source the right amount of tax and national insurance contributions from salaries and other payments. The personal allowances and tax bands are spread equally throughout the year for employees who are paid on a regular monthly basis.

Taxable employment income includes regular salary, bonuses, overtime, tips, sick pay, and virtually every kind of payment.

Benefits in kind

Benefits in kind are also generally subject to tax and national insurance contributions (see Benefits in kind). Taxable benefits include the use of a company car, cheap or free housing or other assets provided by the employer, and interest free or low interest loans. There are special rules for calculating the taxable value of these perks. For example, company cars are taxed according to the level of their CO2 emissions and their value.

There are exemptions for the provision of bicycles and computers to directors and employees subject to limits. Employers’ contributions to pension schemes, life assurance and income protection schemes for directors and employees are normally free of tax on the benefit in kind, although there are various restrictions.

Expenses

The rules for allowing expenses are rather more restrictive for directors and employees than for self-employed people. In general, expenses have to be incurred wholly, exclusively and necessarily in the performance of the director’s or employee’s duties.

Status

Whether an individual is an employee or self-employed is a matter of fact, although HMRC tend to veer towards treating people as employees if there is some doubt about their status. There are special rules (commonly referred to as IR35) covering people who work for sub-contracting companies or businesses but have many of the characteristics of the main contractor’s employees. The aim is essentially to tax such people as employees. There are also specific rules for subcontractors in the construction industry.

Employer’s tax deduction

The pay of directors and employees is normally an allowable expense for their employers. But in a few cases, their pay might not be treated as being wholly and exclusively incurred for the purposes of the business - for example where a controlling director’s spouse is employed at a salary that is excessive in relation to the duties performed.

Essential Guides

Employee travel and subsistence rules  (324 kB)