The employment tax cycle – Part 1: hiring employees for the first time
There is so much to think about when you start adding to the team. We look at the key obligations you will face, from budgeting and payroll to pensions and HMRC requirements.
This is the first in a series of articles which follows the life cycle of a company from an employment tax perspective. Each article will give an overview of the employment tax obligations at different stages of a company’s growth. In a later edition, we will also look at what happens when the business suddenly hits hard times and needs to be wound up.
Most businesses start with an idea or a concept which one person (or a very small group), referred to now as the ‘idea owner’, had. They personally devote their time, energy and often money, to turn that idea into something that people want to buy.
As sales start to increase in the early months of having a marketable product, it becomes necessary to form a company to own/manage the product and the in/out flow of monies associated with it. The idea owner becomes the sole director of the company and continues to drive the product forward alone. They don’t take a salary in the early stages of the company.
The product and the revenue of the company grow exponentially until they are too much for one person to manage on their own. They need help. They need to hire an employee.
This is a fairly typical progression for most companies, so let’s consider what obligations and requirements the company will have to fulfil now they are an employer in the UK.
Employing someone in the UK gives rise to certain obligations, liabilities and responsibilities under two main areas: employment tax and employment law.
Before you even advertise the new role, you have to consider what budget is available to cover the many costs associated with hiring an employee.
What salary to pay? National minimum wage
Determining what salary to pay the new employee is the first stage and will be key to you being able to attract the right candidate to help the idea owner and company continue on the path of rapid growth.
Setting the salary too low to keep costs down may attract candidates without the necessary experience and qualifications. Set it too high and not only will it represent an unnecessary cost, it may attract overly qualified individuals who might not fully engage if they are only there for the generous salary.
Seek advice from recruitment consultants on the market rates for the type of role and level of experience you want.
But there is a legal minimum salary that you must pay an employee. Depending on their age, they must be paid at or above either the ‘national minimum wage’ (NMW) or the ‘national living wage’ (NLW) (for workers aged 23 and over and not in the first year of an apprenticeship). Based on an hourly rate, the Government increases these annually as part of the Chancellor’s budget speech to Parliament. Employees cannot opt out of the NMW/NLW rules and failure to comply is a criminal offence.
Currently, the NLW is £9.50 per hour, but with soaring inflation many expect the Government to increase both rates significantly as soon as it can.
NMW regulations can be a minefield and many companies accidently fall foul of them. For example, not all pay elements are considered wages. Certain deductions can be included whilst others cannot. Even the differing number of days in a month can cause a problem if employees are paid at or near the NMW/NLW amounts.
Additional costs directly linked to salary
So, the salary the company wants to pay the new employee has been determined, but that is not the end of the budgeting exercise. Other liabilities arise for employers. These are:
1. National Insurance contributions (NICs)
Employees have to pay Class 1 NICs. These have an employee and an employer element to them (and different rates apply to each). Managed through the PAYE system (see payroll section below), the employee element is withheld from their wage, but the employer element is an additional cost to fund on top of the wage itself.
The current employer Class 1 NIC rate is 13.80% (reduced from 15.05% in the mini budget) on wages above a certain threshold. It is therefore a significant cost for employers when they hire someone. It’s calculated and payable to HMRC via the PAYE system each time an employee is paid.
To encourage employment and growth, the Government does provide some assistance to small companies and start-ups. Companies whose NIC liability in the previous year (if they had one) was below a certain amount, and new employers, are entitled to the ’employment allowance’. This reduces their annual NIC liability by up to £5,000. For many companies, this support is the difference between being able to hire someone or not, so correctly accounting for it in the budget is important.
2. Pension contributions
Employers are legally obliged to provide a workplace pension scheme for eligible employees. This requires the company to set up a scheme, have a process to automatically enrol employees in the scheme at the right time (usually no later than three months after they employee start the job), and inform them about how to opt out of the scheme if they wish. The employer must also make contributions to the scheme on behalf of the employee at or above a minimum % of the employee’s wages.
Currently, employers must contribute at least 3% of an employee’s total earnings between £6,240 and £50,270 a year (before tax) however many choose to contribute more, in order to encourage employees to contribute more themselves. Enhanced pension contributions are a very attractive benefit for experienced individuals who often consider the total reward package on offer, not just the headline salary the company will pay.
3. Employers’ liability insurance
Less of a cost than the NIC amounts or pension contributions, employers’ liability (EL) insurance is another cost employers must pay over and above the wages, so should be included in the budgeting.
It is a legal requirement that EL insurance is in place from day one of being an employer. The policy must cover the employer for at least £5 million and come from an authorised insurer. EL insurance helps a company to pay compensation if an employee is injured or becomes ill because of the work they do.
Employers who only employ a family member or employees based abroad may be exempt.
It’s worth remembering that all these costs are deductible for Corporate Tax (CT) purposes so there is a knock on reduction in the company’s CT liability as a result of incurring the costs of employing someone.
The hiring process
So the company has crunched the numbers and determined the correct salary to attract the candidates they require and that they can afford to pay (inclusive of all add-on liabilities and costs). They have found the person they want, offered them the position – which has been accepted – and agreed a start date.
Now the employment law obligations kick in and impose certain requirements on employers.
The right to work
Employers must check that the person they’re hiring is legally entitled to work in the UK and evidence of the person’s right to work should be kept as a permanent HR record. Companies cannot assume that someone who sounds British must be British. They need to see and take a copy of the individual’s passport, as proof they are entitled to work in the UK.
The UK immigration authorities police this and penalties for not verifying someone’s right to work status can be severe. All the more so if it transpires that the employee did not have a right to work in the UK.
If the potential employee is currently on a visa in the UK, the company should seek advice from an immigration lawyer to fully understand the implications of employing that person in the immediate and longer term.
Certain sectors and professions may require employers to obtain a Disclosure and Barring Service (DBS) check to get a copy of the employee’s criminal record.
Both checks must be completed before the employee starts the job.
Employers must provide employees with a written statement of employment, or a contract. There are minimum requirements for a compliant employment and you may want to consult an employment lawyer to help with drafting of a contract and to provide you with some insight best practice. Not only should it comply with UK law, it must also provide protection for you and the employee should the relationship not go as planned.
Health and safety and data protection
Employers have certain legal obligations to make sure the workplace is safe and accessible for employees. For example, you will need to prevent discrimination. You must also keep employee information and data secure and know what it can and cannot be used for. You must also comply with fire and other health and safety regulations. An employment lawyer can provide advice on all of these.
Register with HMRC as an employer
Companies must register with HM Revenue and Customs (HMRC) as an employer before making the first payment of wages or providing an employee with any other form of income.
The registration can be completed up to two months before paying the first employee. HMRC will give them an employer PAYE reference number and an accounts office reference number unique to the business. Both are required in order to submit payroll information or payment to HMRC.
A company must register even if it only employs the sole director / idea owner, if they pay themselves any amount as a wage or other remuneration through the company.
Registration can be done online (www.gov.uk/register-employer) and HMRC aims to provide an employer reference within five working days.
Running the payroll
Employers have to report employee wage payments via a payroll system that links directly to HMRC. The payroll reports what is paid to an employee, calculates how much tax and employee NIC should be withheld, and also works out the net payment due to the employee’s bank account for a given pay period. We provide more details on submissions to HMRC below.
Companies either run payroll internally or outsource to a third-party payroll provider. There are many to choose from.
To run a payroll internally, an employee of the company inputs the relevant pay data into the payroll software and then checks and submits it to HMRC. They are also responsible for making payments to the employees and to HMRC (for the tax and NIC amounts due).
If outsourced to a payroll provider, they will input the data and submit it to HMRC on your behalf. Some payroll providers can also make payments to employees and HMRC, for which the company provides them with the necessary monies.
Using an external payroll provider means the company only needs to communicate the pay data at the start of the process for that period and then make any due payments at the end of the given period. All functionality and operational risk is taken by the payroll company which frees up the time of a company employee to focus on its business objectives rather than internal administration.
Before paying a new employee, the employer must:
- obtain employee information to complete HMRC’s starter checklist for payroll. If the employee had another employment in the tax year, they’ll need details of their P45 form
- find out if they need to repay a student loan
- set up the new employee on the payroll software. HMRC offers a basic PAYE toll for businesses with fewer than 10 employees.
Again, many payroll providers will do this on behalf of the company.
Submissions to HMRC when payments are made
UK tax months run from the 6th of one month to the 5th of the next. On or before the employees’ payday, the employer reports their pay and deductions to HMRC in a Full Payment Submission (FPS). This involves:
- recording each employee’s pay – include their salary or wages and any other pay
- calculating deductions from their pay, such as tax, NICs, and student loan repayments
- calculating the employer’s NICs
- producing payslips for each employee.
PAYE liability is payable to HMRC by the 22nd (or the 19th if paying by post) of the following tax month using the unique accounts reference number.
For any month during which the company did not make payments to employees, it should send an Employer Payment Summary (EPS) EPS to HMRC by the 19th of the following tax month.
Year end and leavers
At the end of each tax year, and when employees leave the company, the employer must submit certain data and forms to HMRC and provide a statement of their earnings and tax paid (via PAYE) for either the full tax year or year to date of the employees.
UK legislation obliges employers to make arrangements for the automatic enrolment of all their eligible jobholders into a qualifying pension scheme.
There are many pension providers to choose from. The National Employment Savings Trust (NEST) is a government-sponsored pension scheme available to employers with a small number of employees.
Minimum contributions to the scheme are 8%, of which employers must contribute at least 3% (in this case 5% will be contributed by the employee). Companies often choose to pay above the statutory minimum however when enrolling a new employee, the company provides their details and the level of contribution to the pension provider.
Employer contributions must be paid to the pension scheme by the due date set out under the direct payment arrangements with the pension scheme. Member contributions deducted from wages must be paid to the pension scheme by the 22nd (or 19th if the payment is by cheque) of the month following the deduction.
Whilst employees are automatically enrolled in the pension scheme at the start of their employment (or shortly afterwards), they can opt out if they wish. This has to be an active opting out, with a signed declaration not to enrol. An employee must automatically be re-enrolled in a pension scheme three years after opting out. The opt out procedure can then be repeated if necessary.
New responsibilities, more compliance
Employing someone for the first time is a milestone in the development of a company. It marks the moment when that company moved from operating only for the benefit of the owners to having to consider the wider interests, wellbeing and priorities of a new group of people – its employees.
Some companies embrace this and it can change their whole business focus, whilst others will do the bare minimum just to remain compliant. Either way, being an employer creates a lot more administration and requirements for the company. The potential cost of non-compliance is very high, so new employers should get proper advice from qualified accountants and lawyers to help them navigate the minefield of responsibilities they will face.
What is the next step?
This is not intended to be a comprehensive guide. If you would like further support on any of the tax-related issues covered in this article, please contact Daniel Kelly.
The employment law guidance is taken from information freely available online. For further legal support, please contact an employment lawyer.
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