The right way to correct mistakes in employee expenses

Employer obligation

Since 2016 the initial burden of deciding if an employee is entitled to a tax deduction for job expenses has fallen on employers, i.e. the risk of non-compliance falls on you not your employees.

As the P11D deadline is approaching (6 July), it is a good time to review expense payments that have been made to employees during the year to ensure you are reporting what you should be.

Depending on what you decide there are three possible courses of action:

• expenses paid for or to an employee that qualify for a tax deduction are exempt from income tax and NI. You don’t need to report them on a P11D and no other action is needed
• expenses paid for an employee (not “to” an employee), e.g. a hotel bill, but which aren’t tax deductible, must be reported on a P11D and, for most types of expense, Class 1A NI contributions paid
• If you pay (reimburse) an expense to an employee and it’s not tax deductible, you must treat it as taxable pay (in effect, additional salary) and so deduct PAYE tax and Class 1 NI, plus account for employers’ Class 1 NI. You must also report the payment on Form P11D (usually at section N).

If you’re uncertain which category the expense falls into, follow the first instructions above. Even if it turns out you were wrong, HMRC cannot penalise you as long as you have considered the rules for tax deduction properly.

If in the third circumstance, you didn’t deduct PAYE tax and NI and you now realise you should have, you must immediately take steps to correct the error. As the employer you’re liable for any underpayment of PAYE tax and NI.

Correcting the position with HMRC

When correcting mistakes for a previous tax year, as soon the error is spotted you should submit a corrected full payment submission showing the correct pay, tax and NI figures for each period affected. You must, of course, also pay the resulting additional tax and NI.

Because the rate of NI changed from 6 November 2022, make sure you use the correct rate according to the date the reimbursed expenses should have been included in your employee’s pay.

Catching up with the employee

When you’ve paid HMRC the extra tax and NI resulting from the mistake you’ll be out of pocket. However, you’re entitled to recover the PAYE tax and employees’ NI contributions from the employee (but not the employers’ NI). Whether the amount you intend to recover is large or small, it’s good practice to explain the situation to the employee before you ask for payment.

Bearing in mind that it was not the employee’s fault that a mistake was made, take a fair and reasonable approach. For example, if the amount involved is significant you could agree with the employee that what’s owed is paid off over two or more pay periods. Once you’ve agreed terms, an easy way to collect what you’re owed is to get your payroll manager to set up a post-tax and NI deduction from the employee’s salary.