Is the employee liable to income tax on employment earnings where employer failed to operate PAYE?

The main issue in this case was if the taxpayer was liable to income tax on his employment earnings to the extent that tax was not deducted by his employer under PAYE.

The Facts

The taxpayer commenced employment with Iris Financial Engineering & Systems (Europe) Limited (“Iris”) in February 2001. The taxpayer had not received a P45 from his former employer and he informed Iris that the form was to follow.

The payroll function of Iris was outsourced to Grant Thornton UK LLP. Grant Thornton had requested that either the taxpayers P45 or a completed P46 be returned to them in time for the monthly payroll. In the absence of either form the taxpayer was subject to tax at the basic rate. Throughout the taxpayer's employment with Iris, his PAYE coding remained at the basic rate. In a letter sent to HMRC, Grant Thornton confirmed that basic rate tax was operated as no P45 or P46 was received despite the fact that the taxpayer should be taxed at a higher rate. Grant Thornton understood that any tax shortfall would be picked up in the taxpayer's self-assessment tax return.

HMRC sought to recover the underpaid tax directly from the taxpayer. The taxpayer appealed against assessments made for the tax years ended 5 April 2001 and 5 April 2008. The issue also arose in respect of the tax years 2001/02 and 2003/04 for which no appeals were made but payment of the tax pended the outcome of the appeals.

The taxpayer's legal representation based their arguments against the assessment on three propositions:

1. The primary liability to deduct PAYE is on the employer, and not the employee;
2. The PAYE Regulations impose statutory duties on the employer and HMRC and that in this case Iris and HMRC were in breech of those statutory duties; and
3. HMRC would normally have proceeded against the employer but did not so in this case as Iris had ceased to trade and recovery of the underpaid tax was not possible.

Regarding the alleged breaches of statutory duty on the part of HMRC, it was argued that as no P45 or P46 had been received by HMRC and the taxpayer did not make any contact with HMRC regarding his PAYE position, HMRC would not be required to issue a revised tax coding for the taxpayer. HMRC also refuted the suggestion that the asset position of Iris had anything to do with the decision to seek the underpaid tax from the taxpayer.

The Decision

The Court rejected the arguments put forward by the taxpayer. The fact that Iris was liable to make deductions in accordance with PAYE regulations was not in dispute. The extent of the employer's liability depended on the particular circumstances. The Court referred to the relevant PAYE regulation. In accordance with PAYE Regulation 25(5) the employer is required to deduct tax in accordance with the appropriate code if a P45 is provided by the employee. If in the absence of a P45 a P46 is delivered to the employer, under regulation 30(2) the employer is required to deduct tax at one or more of the starting rate, the basic rate and the higher rate. Where neither forms are delivered, regulation 31 provides that the employer is liable to effect deduction at the basic rate only.

The Court found that the taxpayer did not provide his employer with a complete P46 and there was no evidence presented to the Court supporting the taxpayer's claims that he did deliver a P45. Therefore regulation 31 applied, under which the liability of the employer was to deduct tax at the basic rate. The taxpayer was held liable for the under-payments of tax.

The full text of the case can be downloaded from http://www.financeandtaxtribunals.gov.uk/judgmentfiles/j4626/TC00263.doc