Tax question regarding back pay

MarkBargain

I wonder whether anyone could help with the following question?

Employee A has been paid £40K p.a. for the last five years and Employee B £30K for doing the same job. The employer agreed this was unfair and so increased Employee B's salary to £40K, also paying the £50K backpay as a one off payment.

Employee A got £40K a year, so 20% income tax.

Employee B is getting £90K this tax year, so 40% income tax will be taken.

Can Employee B claim any money back from HMRC given that the money was EARNED over the last five years and so should have been taxed at 20%? Or, is 40% right as it was PAID this year?

00ec25

such (genuine) payments are arrears of pay and as such as taxable in the year the entitlement was earned not when it was paid, that is a pompous way of saying he can claim back overpaid tax as he should be taxed as though it were 40k pa not a lump sum in current year


there are numerous references to this on HMRC, here is one to start with if you need to convince anyone
http://www.hmrc.gov.uk/manuals/eimanual/eim02530.htm

MarkBargain

Excellent, thank you very much indeed for that.

nomunnofun

May not just be higher rate tax this year to worry about if he has children - £90k would invalidate any claim to child benefit - £30k or 40k would not

chrisbur

http://www.hmrc.gov.uk/manuals/pommanual/PAYE70023.htm


The above link gives details of how the tax should be dealt with and advises what to do if your employer has already done the back-pay as this year's wages. If this is the case probably have to wait until tax year end to sort out.
Also gives details of NI which are dealt with differently to tax.

System

But it's not back pay. The lower salary presumably was in accordance with the contract agreed by the employee and employer, so the employer was under no legal obligation to make any additional payment.

Why should it not be treated as an ex-gratia bonus?

Dead_keen

You haven't given us enough information to help. The key issue is why it was unfair.

The basic tax rule is that you are taxed on the earlier of two dates:

1. The date your earnings are paid to you, and
2. The date you are entitled to be paid those earnings.

So normally if you and your employer agree that to pay you a backdated lump sum and that it will be paid to you on 31 December 2013 then 31 December 2013 is when it is taxed.

But if, for example, the employer has got it wrong (e.g. admin error) and paid you less than you were entitled to then the tax point is when you where entitled to be paid it (e.g. last year) and not when the mistake is corrected and it is actually paid to you (e.g. now).

So the key question is why was it "unfair". If it was unfair because no one thought about the difference at the time but now they have they want to give you this extra bit then it is taxed now.

But if it was unfair because the two were, for example, doing the same work and had the same experience but lower paid person was a woman and the higher paid person was a man then the Equal Pay Act says that the lower paid person was entitled to be paid an extra amount each pay period. Hence, it should be taxed when it was originally earned, not when paid.