Planning a pay cut due to COVID-19? You could end up paying more tax

Whether you are employed, a senior executive or an owner-managed business, if you are giving up or planning to cut your salary or bonus due to the current health crisis, you could end up paying more tax.

Waiving of salary and bonuses

Across the country, there is a growing number of businesses, big and small, who have asked their senior staff to take a pay cut, and in some cases, even repay bonuses already received, to help support their company during the health crisis.

However, there are strict tax rules which apply to the waiving of salary and bonuses that you may not be aware of, and if not adhered to, could lead to a much larger income tax and national insurance contributions (NIC) bill.

The issue arises when the timing of reducing salaries or repaying bonuses is not considered as well as not formalising this change in writing.

To avoid these issues, a formal letter or change of contract should be put in place by the employer or company, signed by the employee or director. The important point to remember here is that this formal notification should be completed before the change is enacted.

I am a director of a limited company

As a director of a small business, there is an additional point to consider: whether the ‘tax point’ has already arisen or could arise earlier.

The tax point is when the income is declared to HMRC, for example in the company accounts. So as a Director, you need to be careful when making such changes to salaries that changes are made across your compliance reporting and declarations to HMRC, otherwise the income tax and NIC due will be on the original amount declared rather than the revised amount.

Bonus entitlements

Those who contractually receive bonuses could also fall foul of the rules.

For example, if a performance bonus for 2019 is paid out at a later date, as bonuses tend to be, there is not much point paying this bonus back to your employer as the tax point will be at the time the bonus due date, and you will still be eligible to pay income tax and NIC on it.

Calls have been made to relax the rules around bonus payments during the pandemic, albeit it is unclear whether HMRC will have the time or inclination to police the rules during the pandemic.

Saying that, even if HMRC do nothing now, there is every chance they will come back after a period of years to claw back the tax.

Stick to these simple rules

If an employer or a director of a limited company amend employment contracts or have written evidence of the change in salary before the salary is paid, this will suffice, and will not result in any tax consequences.

HMRC will consider email notification as written evidence bearing in mind the current social distancing rules.