PAYE Settlement Agreements Explained: Save Time and Money on Employee Benefits
Would you like to reduce your tax obligations whilst increasing benefits to your employees? If that appeals, then PAYE settlement agreements could be something of interest.
PAYE settlement agreements let you make one annual payment to HMRC. This eliminates the need to process multiple employee benefits through payroll or P11D forms. Your agreement with HMRC sets up a formal arrangement to pay tax collectively for your employees. This saves you much administrative work.
What is a PAYE Settlement Agreement?
PAYE Settlement Agreements are formal arrangements between employers and HMRC that revolutionised employee benefits taxation back in the 1990s. These agreements started as a way to cut down paperwork. PSAs quickly became popular – from about 2,500 applications when they first launched to roughly 30,000 each year now.
Definition and purpose of a PSA
PAYE Settlement Agreements let employers make one yearly payment that covers all tax and National Insurance contributions for specific employee benefits and expenses. Companies can settle these obligations as a group instead of dealing with each benefit through PAYE or P11D forms.
PSAs specifically target three categories of benefits:
- Minor benefits: These include small gifts, vouchers, and staff incentive awards
- Irregular benefits: Benefits provided at unpredictable intervals, like relocation expenses or using an employer’s holiday home
- Impracticable benefits: Items where individual allocation proves difficult, including staff entertainment and shared taxis
Why employers use PSAs instead of P11D or payroll
Companies choose PSAs because they make tax compliance easier. Employers can take certain benefits ‘off record’ and handle the tax and NICs for their staff. This works great when companies want their employees to get the full value of perks without tax headaches.
PSAs are clearer and more convenient than P11D forms. P11D reporting needs separate calculations for each employee’s benefits. This takes too much time for small or irregular items. PSAs give companies a better option, especially when it’s hard to split up benefits among individual employees.
How it helps save time and reduce admin
PSAs cut down on paperwork. Once you have one, you don’t need to track every small benefit separately. Your company won’t need to include these items in P11D forms or process them through payroll.
This helps companies that offer many different employee benefits. The yearly single payment system helps avoid mistakes that pop up when processing complex benefit structures one by one.
PSAs are a smart way for businesses to stay on top of tax rules while making benefit administration much simpler.
What can and cannot be included in a PSA
Your PAYE settlement agreement needs HMRC approval. The benefits must fit into one of three categories: minor, irregular, or impracticable. This difference helps you figure out which employee perks qualify for tax simplification.
Minor benefits: small gifts, vouchers
Minor benefits don’t have a set money limit. These usually cover smaller items that would be a hassle to process one by one. The core team gets incentive awards like employee of the month recognition, telephone bills, small gifts and vouchers. Non-business expenses during overnight business travel that go over daily limits also count. Items that cost £50 or less fall under the “trivial benefits” exemption, so you don’t need to include them in your PSA.
Irregular benefits: relocation, holiday homes
Irregular benefits are perks that employees receive now and then throughout the tax year. These items can’t be part of contract entitlements or paid regularly. Common examples are relocation expenses over the £8,000 tax-exempt limit, costs of overseas conferences where not all expenses get relief, a spouse’s occasional trip abroad with an employee, and use of a company holiday flat.
Impracticable benefits: staff events, shared costs
Impracticable benefits are tricky to split up between individual employees. HMRC says employers “must demonstrate that they cannot follow normal procedures without a disproportionate amount of effort or record keeping.” Staff entertainment over the £150 exempt amount fits here. Shared cars, personal care expenses like hairdressing, and team-building event costs are also included.
What HMRC excludes: cash, bonuses, company cars
All the same, some items can’t go into a PSA whatever the situation. Cash payments like bonuses and round sum allowances are out. High-value benefits such as company cars and accommodation don’t qualify. Beneficial loans and regular wages are excluded too. These items need to go through normal payroll or P11D reporting channels.
How to apply and calculate your PSA
PAYE settlement agreements demand meticulous attention to processes and calculations. The original application procedures and calculation methods need proper understanding to avoid getting pricey mistakes.
When and how to apply to HMRC
A PSA application must be submitted online or by post before 5 July following the first tax year it applies to. Your agreement stays active until either party cancels it. HMRC will issue form P626 after reviewing your application if you are a first-time applicant.
Using the PSA1 form
HMRC prefers the PSA1 form as their method to report benefits included in your agreement. You need these details at the time of submitting the form online:
- Your employer PAYE reference
- The tax year the calculation applies to
- Types of expenses and benefits included
- Number of employees receiving each benefit
- Correct tax rate for each employee
Calculating tax and Class 1B NIC
The employer must pay Class 1B NICs on both the value of items covered by the PSA and the total tax amount. The Class 1B NIC rate will be 15% for the 2025-2026 tax year. Your calculations should separate employees by tax bands and regions because different rates apply for Scotland, Wales, and the rest of the UK.
Understanding grossing up
The simple method to calculate grossed-up tax follows this formula:
- Total benefit value × appropriate tax rate = original tax
- Original tax × 100 ÷ (100 – appropriate tax rate) = grossed-up tax
Key deadlines
HMRC typically requests calculation submissions by 31 July, though no statutory deadline exists. The payment must reach HMRC by 22 October (electronic) or 19 October (postal) following the relevant tax year. Penalties and interest charges may apply if you miss this payment deadline.
Common mistakes and how to avoid them
PAYE settlement agreements can present unexpected challenges despite careful planning. You can maximise their benefits and minimise compliance risks by avoiding these common pitfalls.
Including exempt items unnecessarily
Employers often make the mistake of including benefits in their PSA calculations that statutory exemptions already cover. This includes qualifying annual functions (under the £150 per head threshold) and trivial benefits costing less than £50. Higher rate taxpayers end up paying double the cost due to grossing up when exempt items get included in tax and National Insurance calculations. A careful review of all items should happen before finalising your PSA to identify potential exemptions.
Missing deadlines and penalties
HMRC expects PSA calculations by 31 July after the tax year ends, but payment deadlines are crucial – 19 October (postal) or 22 October (electronic). Missing these payment deadlines triggers penalties: 5% of outstanding amounts after 30 days, with additional 5% charges at six and twelve months. Late applications can create complications that might lead HMRC to revoke your agreement completely.
Incorrect employee banding in calculations
Your calculations must include employees without tax liability, taxed at their first marginal rate—Starter rate for Scottish taxpayers or Basic rate for the rest of the UK. Many employers simply copy previous years’ calculations without reviewing changes in tax legislation or benefit offerings.
Failing to separate UK, Scottish, and Welsh rates
Each UK jurisdiction needs separate PSA calculations according to HMRC. Scottish taxpayers have an ‘S’ prefix tax code and Welsh taxpayers have a ‘C’ prefix. Your calculations’ accuracy needs strong audit trails to ensure each country receives its proper devolved funding.
Conclusion
PAYE Settlement Agreements give businesses a practical way to streamline tax obligations on employee benefits. They can reduce administrative burdens while meeting HMRC requirements. Without doubt, knowing how to make a single annual payment instead of processing many benefits one by one saves your business substantial time. This allows you to focus on business growth instead of paperwork.
If you would like to know more or would like help setting this up for your business, please get in touch. We’d love to hear from you.
