History

2720.     Deductions from pay by employers have been part of the income tax system for a very long time. For example in 1803 tax on emoluments from public offices and employments of profit was actually assessed on the employer. The employer was, however, entitled to deduct it from the salary. But the real history of PAYE as such starts in the Second World War.

2721.     At the start of the war, manual workers and many other employees paid tax direct to the collector at half-yearly intervals. Manual workers were permitted to spread the payments over 13 weeks by buying "income tax stamps". But employers were not involved in this system.

2722.     The war saw a big increase in both the number of employees paying tax and in the rates of tax. Many found this hard. This led to the introduction in F(No. 2)A 1940 of arrangements for employers to deduct Schedule E tax from pay. These arrangements were widened in 1942 to any weekly wage-earners. But they were nothing like PAYE. The tax was still assessed every six months by the Inland Revenue. The Inland Revenue then told employers how much to deduct.

2723.     This left a lot of problems. Payment lagged on average some ten months behind earnings. So tax due on high earnings (for example when doing a lot of overtime) could end up being deducted when earnings were low. Changes of job (from higher to lower earnings) were another obvious source of difficulties. All this led to a search for a system of deductions from "current earnings". And one which did not deduct too much - leaving perhaps millions of people to have less to live on while they waited for a repayment after the end of the year.

2724.     These problems were discussed in a White Paper in 1942 (Cmd. 6348). That favoured sticking with pretty much the system of deductions in arrears despite its problems. But the reactions to that White Paper (and the fact that both the USA and Canada had come up with systems of deduction based on current earnings) led to a change of views. Another White Paper in 1943 (Cmd. 6469) proposed what is recognisably the current PAYE system. Crucially it involved deductions based on the cumulative pay and tax deducted in the year. (This is still the feature which distinguishes PAYE in the United Kingdom from most other countries' PAYE system. All major developed countries other than France have some system of deduction of tax by employers from wages and salaries. That in the United Kingdom is at the far end of the spectrum in requiring cumulative calculations and in the sophistication of its codes and procedures for trying to keep codes up to date.)

2725.     The system was proposed only for weekly-wage earners and pensions paid by their former employers. But the legislation introduced in 1943 was extended, in response to representations, during the passage of the Bill to others earning less than £600 a year. It was enacted as the Income Tax (Employments) Act 1943 (6&7 Geo. 6. (1942-43) c.45). The core provisions of the 1943 Act are recognisably the source of the current PAYE vires in section 203 of ICTA:

Income Tax (Employments) Act 1943 (6&7 Geo. 6. (1942-43) c.45)

Basis of charge and method of collection of income tax on certain emoluments

1.-(1) Income tax for the year 1944-45 or any subsequent year of assessment shall be assessed and charged in respect of the emoluments specified in subsection (2) of this section on the amount of those emoluments for the year; and, on the making of any payment of, or on account of, any such emoluments made during the year 1944-45 or any subsequent year of assessment, income tax shall, subject to and in accordance with the regulations made by the Commissioners of Inland Revenue under section two of this Act, be deducted and repaid by the person making the payment, notwithstanding that when the payment is made no assessment has been made in respect of the emoluments.

Regulations of Commissioners of Inland Revenue

2-(1) The Commissioners of Inland Revenue shall make regulations with respect to the assessment, charge, collection and recovery of income tax in respect of emoluments to which this Act applies, being tax for the year 1944-45 or any subsequent year, and those regulations may, in particular, include provision—

(a) for requiring any person making any payment of, or on account of, any such emoluments, when he makes the payment, to make a deduction or repayment of income tax calculated by reference to tax tables prepared by the Commissioners of Inland Revenue, and for rendering persons who are required to make any such deduction or repayment accountable to, or, as the case may be, entitled to repayment from, those Commissioners;

(b) for the production to and inspection by persons authorised by those Commissioners of wages sheets and other documents and records for the purpose of satisfying themselves that income tax has been and is being deducted, repaid and accounted for in accordance with the regulations;

(c) for the collection and recovery, whether by deduction from emoluments paid in any later year or otherwise, of income tax in respect of emoluments to which this Act applies which has not been deducted or otherwise recovered during the year;

(d) for the assessment and charge of tax by the surveyor in respect of emoluments to which this Act applies; and

(e) for appeals with respect to matters arising under the regulations which would otherwise not be the subject of an appeal,

and any such regulations shall have effect notwithstanding anything in the Income Tax Acts:

Provided that the said regulations shall not affect any right of appeal to the General or other Commissioners which a person would have apart from the regulations.

(2) The said tax tables shall be constructed with a view to securing that, so far as possible—

(a) the total tax payable in respect of any emoluments assessable under Schedule E for any year of assessment is deducted from the emoluments paid during that year; and

(b) the tax deductible or repayable on the occasion of any payment of, or on account of, emoluments is such that the total net tax deducted since the beginning of the year of assessment bears to the total tax payable for the year the same proportion that the part of the year which ends with the date of the payment bears to the whole year.

     In this subsection the references to the total tax payable for the year shall be construed as references to the total tax, other than surtax, estimated to be payable for the year in respect of the emoluments, subject to a provisional deduction for allowances and reliefs, and subject also, if necessary, to an adjustment for amounts overpaid or remaining unpaid on account of income tax in respect of emoluments to which this Act applies for any previous year (including any year previous to the year 1944-45).

     For the purpose of estimating the total tax payable as aforesaid, it may be assumed in relation to any payment of, or on account of, emoluments, that the emoluments paid in the part of the year of assessment which ends with the making of the payment will bear to the emoluments for the whole of that year the same proportion as that part of the year bears to the whole year.

2726.     The scope of PAYE was then further extended, before the system had come into operation, by the Income Tax (Offices and Employments) Act 1944 (7&8 Geo. 6. (1943-44) c.12) to all emoluments assessable under Schedule E (other than those payable for the armed forces)

The Income Tax (Offices and Employments) Act 1944 (7&8 Geo. 6. (1943-44) c.12)

Extension of principal Act (subject to exceptions) to all emoluments taxable under Schedule E

1-(1) Subject to the provisions of this Act, the Income Tax (Employments) Act, 1943 (hereafter in this Act referred to as "the principal Act") shall extend to all emoluments assessable to income tax under Schedule E, other than pay, pension or other emoluments payable in respect of any service in or with the armed forces of the Crown, and accordingly that Act shall have effect as if for subsections (2) to (4) of section one thereof there were substituted the following subsection -

"(2) The said emoluments (hereafter in this Act referred to as "emoluments to which this Act applies") are all emoluments assessable to income tax under Schedule E, other than pay, pension or other emoluments payable in respect of any service in or with the armed forces of the Crown".

2727.     Both the 1943 and 1944 Acts were short and contained mainly transitional provisions. The details of PAYE were then, as now, left for regulations made under section 2 of the 1943 Act.

The scope of PAYE

2728.     The scope of PAYE was extended by subsequent Acts to all income assessable under Schedule E; and the scope of Schedule E was itself also extended. Highlights were:

• section 27 of FA 1946 and section 24 of FA 1949 taxed as emoluments chargeable under Schedule E various National Insurance benefits;

• section 30(3) of FA 1946 extended PAYE to the armed forces for 1947-8 and subsequent years;

• section 38 of FA 1948 treated certain payments of expenses and benefits in kind as emoluments assessable under Schedule E and so brought them within the scope of PAYE;

• section 10 of FA 1956 moved foreign employments from Case V of Schedule D to Schedule E;

• sections 37 and 38 of and Schedule 4 to FA 1960 charged under Schedule E (and so brought within PAYE) some termination payments - the pre-cursor of section 148 of ICTA;

• Schedule 4 to the Income Tax Management Act 1964 amended sections 157 and 158 ITA 1952 (as the PAYE provisions had become on consolidation) to include in the meaning of emoluments all income assessable to tax under Schedule E. This brought non-approved retirement benefits within PAYE and removed doubts about the treatment of certain pensions;

• section 25 of FA 1966 charged under Schedule E any gain on the exercise of a share option obtained as an employee when the option is exercised (see now section 135 of ICTA);

• further charges were introduced in sections 79 to 89 of FA 1972 on shares acquired as a result of rights employees get by reason of their employment (some of which were then removed or replaced by sections 77-80 of FA 1988);

• section 38 of F(No. 2)A 1975 brought agency workers within Schedule E in 1975 - mainly so as to apply PAYE to their pay;

• section 30 of FA 1981 (see now section 149 of ICTA) made taxable under Schedule E any sick pay paid by reason of the employment as a result of arrangements entered into by the employer if it would not already be taxable;

• other reliefs and exemptions from time to time to encourage share ownership and/or employee participation also give rise to charges and may require the trustees of the scheme to operate PAYE: see for example Schedule 8 to FA 2000;

• section 27 of FA 1981 made unemployment benefit taxable as Schedule E income;

• section 29 of and Schedule 3 to FA 1987 (see now section 151 of ICTA) taxed some payments of income support as Schedule E income;

• section 139(1) and (3) of FA 1994 made incapacity benefit taxable under Schedule E (with important exceptions); and

• the Jobseekers Act 1995 inserted section 151A of ICTA which made jobseeker's allowance (broadly the successor to unemployment benefit) Schedule E income.

2729.     The point of this selective list is two-fold:

• PAYE extends to much more than "ordinary" wages and salaries; but

• PAYE copes with all this (and more) because something either is or is not income assessable under Schedule E; and either is or is not a payment of such income.

What is and is not a payment for PAYE

2730.     The distinction between what is and is not a payment of Schedule E income matters because:

• a person making a payment of Schedule E income must, subject to the PAYE regulations, deduct tax in accordance with the regulations;

• a person providing income without making a payment does not have to deduct tax (but may still have to comply with requirements in the regulations to report it - for example the report of benefits in kind and expenses on form P11D).

2731.     The boundary between what is and is not a payment was used to avoid PAYE (often as part of attempts also to avoid National Insurance Contributions). This led to legislation to treat income as paid - mainly in:

• section 127 of FA 1994 which inserted section 203F to 203L of ICTA. These, broadly speaking, treated as payments any income provided in the form of tradeable assets; and

• section 65 of FA 1998 which amended and extended the 1994 legislation to cover a wider range of things which could readily be converted into money.

Machinery of PAYE

2732.     There have also been a few changes to the machinery of PAYE - but remarkably few given the nearly 60 years since the 1943 Act:

• section 30 of FA 1948 (see now section 205 of ICTA) removed the need for assessments in some cases;

• section 28 of FA 1961 (see now section 206 of ICTA) dealt with an unintended effect of the legislation in 1948. See the commentary on clause 709;

• section 92 of F(No.2)A 1987 provided powers to charge interest on amounts outstanding from employers after the end of the tax year. Section 128 of FA 1988 extended this to provide for interest to be paid by the Inland Revenue to employers who have overpaid. See clause 684 of the Bill;

• section 45 of FA 1989 inserted section 203A of ICTA which defines when a payment is made for PAYE purposes (in step with the changes made in 1989 to tax earnings on the basis of when they are received). See the commentary on clause 686;

• FA 1995 made minor amendments to the legislation for the introduction of self assessment for income tax - see for example Note 62 in Annex 2; and

• section 110 of FA 1996 made provision for "PAYE settlement agreements" (PSAs) in place of long-standing informal arrangements for employers to meet employees' tax: see paragraph 2847.

Chapter 1: Introduction

Overview

2733.     Clause 682 introduces the Part.

2734.     Clause 683 defines PAYE income.

Clause 682: Scope of this Part

2735.     This clause is purely introductory. It gives readers an indication of what they will find in the Part.

Clause 683: PAYE Income

2736.     This clause defines "PAYE income". It is new.

2737.     The term "PAYE income" takes the place of "income assessable under Schedule E" which is used in section 203 of ICTA. The meaning of "PAYE income" might be thought to be different from "income assessable under Schedule E". But on close examination it has the same meaning. See Note 55 in Annex 2.

2738.     Subsection (1) defines PAYE income as the sum of the three amounts defined in this clause.

2739.     Subsection (2) defines PAYE employment income using the terms introduced in Chapter 3 of Part 2 of the Bill (see the commentary on page Error! Bookmark not defined.).

2740.     Subsections (3) and (4) define PAYE pension income for the year. This is taxable pension income (as defined in Part 9 of the Bill) which:

• is taxable pension income for the year; and

• would be charged under Schedule E in ICTA.

2741.     Subsection (5) similarly defines PAYE social security income as the total of any social security income (as defined in Part 10 of the Bill) which:

• is taxable social security income for the year and

• would be charged under Schedule E in ICTA.

2742.     Finally, the label "PAYE income" may not be ideal in all respects. This is because:

• it is accurately labelling all the income which is subject to PAYE in the sense that PAYE must try to collect the tax on it; but

• not all PAYE income will be subject to PAYE in the sense of deductions: only payments of PAYE income will be subject to those.

2743.     But this is no different from the present position with income assessable under Schedule E. In the course of consultation users welcomed the label "PAYE income" as plain language; and felt the subsequent clauses (and the PAYE regulations) would make clear the distinction between PAYE income and payments of PAYE income.

Chapter 2: PAYE: General

Overview

2744.     Clause 684 requires the Board to make regulations to collect income tax on PAYE income. These regulations include in particular requirements for those making payments of PAYE income to deduct tax by reference to tax tables.

2745.     Clause 685 requires the tax tables to try to collect the right amount of tax on the PAYE income by the end of each tax year and to try to do so evenly.

2746.     Clause 686 defines when a payment of PAYE income is made for PAYE purposes (in the same way as clause 18 defines when earnings are received for the purposes of Part 2).

Clause 684: PAYE regulations

2747.     This clause provides powers for the Board of Inland Revenue to make PAYE regulations. It derives mainly from part of section 203 of ICTA.

2748.     Item 5 derives from section 203(10). It allows PAYE regulations to provide for the way in which any matters dealt with in the regulations are to be proved - for example in proceedings to recover tax. Section 203(10) also includes provision for proving the contents or transmission of anything that, by virtue of the regulations, takes an electronic form or is transmitted to any person by electronic means. This Part of the provision was enacted to deal with electronic filing, a predecessor of filing by internet. It is due to be repealed by section 139 of and Part VII of Schedule 20 to FA 1999 from a date laid down by Order, and is therefore omitted. Paragraph 89 of Schedule 7 to the Bill preserves the omitted words in the meantime.

2749.     Items 10 and 11 derive from sections 203L(4) and 206A(6) of ICTA but are applied more widely in the Bill. See Change 147 in Annex 1.

2750.     Subsection (8) defines the term "PAYE regulations" for the purposes of the Bill and of other legislation. This allows other legislation to refer more briefly and naturally to "PAYE regulations" rather than to "regulations made under section 684 of the Income Tax (Earnings and Pensions) Act 2003".

2751.     This clause omits as unnecessary the provision in section 203(1) that deductions are to be made from payments "notwithstanding that when payment is made no assessment has been made in respect of the income". See Note 57 in Annex 2.

2752.     Section 203(3A) is also omitted from this clause as unnecessary. Section 203(3A) is a transitional rule from the introduction of independent taxation in FA 1988. It cannot affect any tax year to which the Bill applies.

Clause 685: Tax tables

2753.     This clause requires the Board to produce tax tables for PAYE which aim to collect the right tax for the tax year. It derives from section 203(6), (7) and (8) of ICTA.

2754.     Subsection (1) requires the Board to produce tax tables which, where possible, result in:

• tax on PAYE income for a year being deducted from PAYE income paid during that year; and

• even deductions of tax through the year so, for example, a twelfth of the total tax estimated to be due for the year is collected after one month, a sixth of the (possibly revised) total tax is collected after two months, and so on.

2755.     The main practical effect of subsection (2) is to collect underpayments through PAYE rather than by the taxpayer making a lump sum payment.

2756.     Subsection (3) provides that, in trying to collect tax evenly, it can be assumed that the rate of past payments in the tax year is a guide to the rate of future payments.

Clause 686: Meaning of "payment"

2757.     This clause deals with the meaning of "payment" in this Part. It derives from section 203A and part of section 202B of ICTA.

2758.     Section 203A was introduced in 1989 as part of the package of changes dealing with the switch to a receipts basis of assessment. Prior to 1989 income under Cases I and II of Schedule E was assessed on an arising basis, whereas PAYE deductions were made when the emoluments were paid. The 1989 reforms made the emoluments assessable at the same time that they were paid for PAYE purposes. They provided :

• a definition of receipt in section 202B of ICTA to determine the time that emoluments were assessable, and

• a definition of payment in section 203A of ICTA.

2759.     These definitions are essentially the same. This clause therefore matches clause 18, which derives from section 202B.

2760.     In consultation leading up to this Bill some users said that the heading of the clause was inappropriate because it deals only with the timing of a payment. The clause reproduces the heading from section 203A. It is on close examination appropriate. Section 203A and this clause are not only giving the time of a payment. They also make some things which would not be payments into payments for PAYE purposes. A simple example is where an employee is entitled to collect a bonus of £1,000 on Monday. That is a payment for PAYE purposes on Monday even if the employee does not get around to collecting the money until later.

2761.     Subsection (1) provides that for the purposes of the PAYE regulations, any payment of (or on account of) PAYE income is a payment for PAYE purposes at the earliest time given by any of the dates derived from the rules given.

2762.     Rule 3 derives from section 203A(2), and Rule 3(a) from section 203A(4).

2763.     Subsection (2) provides that a person is treated as a director for the purposes of rule 3 in subsection (1) if he or she is a director at any time during the tax year.

2764.     Subsections (3) and (4) derive from section 203A(5), and from section 202B(5) and (6). In section 203A(5) reference is made to the definition of director in section 202B(5) and (6). It is more helpful to readers to repeat the definition here.

Chapter 3 PAYE: Special types of payer or payee

Overview

2765.     This Chapter deals with PAYE obligations where there are special types of payer or payee. The majority of these provisions were introduced to counter avoidance of PAYE - see paragraph 2731.

2766.     Clause 687 treats certain payments of PAYE income actually made by an intermediary of an employer as made by the employer.

2767.     Clause 688 treats agency workers who are treated as having earnings by clause 44 as employees of the agency for the purposes of most of the provisions for special types of payer, payee and types of income in this Chapter and Chapter 4. It also treats the client rather than the agency as the employer for the purposes of those provisions in relation to some payments.

2768.     Clause 689 deals with employees who work in the United Kingdom but whose employer is not subject to PAYE regulations, typically where the employer has no UK presence. It treats the person for whom an employee works in the United Kingdom as if that person had made certain payments which are actually made by the employer or an intermediary of the employer.

2769.     Clause 690 applies only to employees who are not resident (or not ordinarily resident) in the United Kingdom and who work partly in the United Kingdom and partly not. It treats payments of income of the employee as payments of PAYE income. It also provides for the Inland Revenue to direct that only a proportion of such payments be treated as PAYE income.

2770.     Clause 691 deals with workers provided by contractors. It provides for the Board to direct that PAYE must be operated by the person employees actually work for rather than their employer if that person pays for their work and the employer is not likely to operate PAYE properly.

2771.     Clause 692 provides for regulations to require PAYE to be operated on tips which are collected and shared among a group of employees by the person who runs that arrangement. It also provides for the employer to operate PAYE in some circumstances if the person who shares out the tips fails to do so properly.

Clause 687: Payments by intermediary

2772.     This clause deals with payments made by intermediaries. It derives from section 203B of ICTA.

2773.     Section 203B was introduced as part of a package of PAYE provisions in FA 1994. It prevents avoidance of PAYE by using an intermediary not subject to PAYE regulations to make payments. An example is an intermediary outside the UK tax net.

2774.     Subsection (1) states the basic proposition that a payment of income by an intermediary is treated as a payment by the employer. This clause (like others in this and later Chapters) refers explicitly to "employer" and "employee". These terms take their meanings from clause 712. The commentary on them uses the words in the same sense.

2775.     Subsection (2) disapplies subsection (1) if the intermediary complies with the PAYE regulations. The wording in the Bill makes it clearer that the intermediary must both deduct and account for tax in accordance with the PAYE regulations. See Note 58 in Annex 2.

2776.     Similar clarifications have been made in clauses 689(1)(d) and 691(1)(c).

2777.     Section 203B(5) applies section 839 of ICTA to give the meaning of connected persons. Clause 718 of the Bill does that for the Bill as a whole so no provision to that effect is needed in subsection (4).