Was the taxpayer entitled to deduct PAYE rebates without paying those amounts to the employees?

The taxpayer provided for rebates of PAYE payable to employees in its payroll records, deducted such rebates from the PAYE payments made to HMRC, but did not pay them to the employees. HMRC sought payment of the PAYE deducted together with interest.

The taxpayer's employees worked for periods of four weeks followed in each case by a four week leave period and were paid only for the weeks worked. The taxpayer ran its payroll throughout the year, and the employee's personal allowance was spread evenly over this period. As a result, the payroll showed a rebate due to the employee equal to their unused personal allowance for each week of leave. The rebates were never paid to the employees and as a result of complaints by the employees the matter was brought to the attention of HMRC.

HMRC inspected the taxpayer's records under regulation 97 of the Income Tax (PAYE) Regulations 2003 and issued determinations under regulation 80. Subsequently HMRC issued documents which they took to be certificates under regulation 79 and commenced proceedings under regulation 73, which required the submission of an annual P35 return. The taxpayer raised a number of defences to HMRC's claims; its primary defence was that the employees were engaged on the basis that their contractual entitlement was to a net amount after tax and NIC.

The Court held that regulation 73 did not itself impose a liability to pay any amount; the prescribed form P35 did so. Regulation 73 required that the annual P35 state ‘the total net tax deducted’ in relation to payments made to all employees during that tax year. If the total net tax was calculated by deducting “tax repaid to the employee” where such tax was not repaid then the taxpayer was liable to HMRC for the tax without such deduction.

The P35 submitted by the taxpayer for the years under review answered “no” to the question “Did you make any ‘free of tax’ payments to any employee?” Also, the employees denied that they were told anything about the net pay terms. Accordingly, the Court considered that the taxpayer could not support its case that the net pay or free of tax terms were agreed with employees. The taxpayer was held liable under regulation 73 to pay to HMRC the full amount of tax deducted without netting off the rebates. In turn, HMRC may be required to give credit to the employees through the tax system for the rebates.