Benefits in kind and the importance of contracts

Nick Giles from our tax team explores the issues that are raised by the use of mobiles within business and puts them in the wider context of P11D reporting.

Following the end of each tax year, an employer who provides their employees or directors with benefits in kind is required to report those benefits to HMRC. Businesses use form P11D(b) for the company and form P11D for each employee or director.

Benefits in kind are taxed on the employee at their marginal rate of income tax and the company pays class 1A national insurance at the current rate of 13.8%.

The benefits-in-kind legislation also provides several exempt benefits that employers can offer to their employees, without the associated income tax and national insurance consequences.

One thing you may not appreciate, however, is that for the legislation to apply, there cannot be any contractual obligation for the employee in the provision of the benefit.

The most common example of this is with mobile phones. An employer can provide each employee or director with one mobile phone as a tax-exempt benefit. But for this to apply, the contract for the mobile phone must be between the employer and the phone company.

The employer cannot pay for an employee's mobile phone contract and still treat it as a tax-exempt benefit. This is because the contractual obligation to pay for the contract, in this instance, rests with the employee. So any payment made by the employer is treated not as the provision of a benefit, but as the employer settling a debt that the employee owes to a third party.

This results in the payment being treated as earnings and not as a benefit in kind. The employee is therefore liable to income tax, while both the employee and employer are liable for class 1 national insurance contributions. What's more, the liability to class 1 national insurance means that it cannot be reported after the end of the tax year, but instead needs to be reported and paid in the tax year through PAYE.

This scenario is particularly common for individuals who operate through limited companies and who want to include a mobile phone as a business expense. They often don't appreciate the importance of the distinction between themselves and their company and so will often include contracts and bills in their personal name along with those of their business.

For director/shareholders, this can often result in the expense being debited to the director's loan account. Whilst this can avoid the necessity to operate PAYE and incur class 1 national insurance, the company will not get any tax relief on the payment and the director will have to pay the money back to the company. This is often done by declaring a dividend to clear the director's loan account balance which then results in an income tax charge for the director, albeit at the dividend rate rather than the non-savings rate.

It is also important to remember that if the outstanding amount on a director's loan account exceeds £10,000 in a tax year then they will also be required to pay interest on the balance to avoid a benefit-in-kind for a beneficial loan.

Businesses need to be aware of this distinction when entering into any contracts that are not wholly and exclusively for business purposes. Where there is an element of private use for a director or employee, it is important that contracts are entered into by the company to ensure the business can get full tax relief on the payment and the employee does not end up with an additional national insurance charge.

For more information, call us on 0115 955 5500 or email enquiries@pagekirk.co.uk.