HMRC guidance on the practical effect of the Demibourne case

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02 October 2008

On 16 September 2008 HMRC published guidance on the consequences of Demibourne Limited v HMRC [2005] which concerned an employer failing to operate PAYE and the employee paying tax on the income under self-assessment on the basis that he or she was self-employed. The Demibourne case held that where an employment relationship exists, the employer is responsible for deducting tax from payments made in accordance with the PAYE regulations. If the employer has not done so HMRC has to recover the underpaid tax from the employer even if the employee has paid tax under self-assessment on that income. 

New PAYE regulations came into force on 6 April 2008 permitting HMRC to make a direction to transfer an outstanding PAYE liability from an employer to an employee. The regulations do not result in the employee having to pay additional tax as a result of the direction but instead the amount of tax paid by the employee by the self assessment can be credited against the employer's PAYE liability. The PAYE regulations set out the circumstances in which a direction may be made by HMRC and the "trigger events" for the issue of a direction.

In summary, in order to make a direction and transfer liability for an outstanding PAYE liability from the employer to an employee:

  • an employee must have received a payment on which PAYE should have been operated
  • it must appear to HMRC that an amount intended to represent tax on the payment has been self assessed
  • a trigger event must have occurred
  • it appears that the amount which the employer was liable to deduct under PAYE from the relevant payment exceeds the amount actually deducted

A summary of the trigger events are as follows:

  • The issue of a regulation 80 determination of tax which includes tax on the relevant payment in question.
  • The receipt of the employee's SA return that includes tax treated as deducted on the relevant payment.
  • The receipt of an amended return from the employee including on adjustment for PAYE credit in relation to the relevant income in question.
  • The receipt of an error or mistake claim under section 33 Taxes Management Act 1970, which includes an adjustment for a PAYE credit in relation to the relevant income in question.
  • The receipt of a letter of offer agreeing to an amount in settlement of the employer's liability to pay an amount of tax. 

The recent guidance published by HMRC sets out when HMRC are likely to make a direction and provides some worked examples. The guidance states that if the conditions set out in the regulations are met, HMRC will always exercise its discretion to issue a direction other than in exceptional circumstances. Such circumstances will be where there is strong evidence to suggest that the employer has deliberately failed to operate PAYE in the expectation that the employer would benefit from the new legislation if discovered and there is no collusion on the part of the employee.

The worked examples from the guidance covers:

  • circumstances in which HMRC will or will not issue a direction
  • cases where the employee has more than one source of income and the issue is whether the employee has self assessed sufficient income to justify a direction by HMRC transferring the entire PAYE liability to the employee
  • cases where the employee has claimed deductions for expenses which reduce the amount of tax which has been self-assessed

In respect of VAT the guidance states that where the employee was incorrectly registered for VAT HMRC will determine any PAYE liability on the basis of VAT exclusive amounts. The VAT account will be rectified by repaying net VAT accounted for by the employee subject to the defence of unjust enrichment or recovery of any net VAT repayment claimed by the employee.

In respect of interest and penalties the guidance provides that the PAYE direction does not reduce the figure on which penalties are calculated. The employer remains liable for penalties on the full amount of tax which should have been deducted in accordance with the PAYE regulations. Interest however will only be charged on any balance of tax remaining payable by the employer after a direction has been made.  

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