Dealing with minimum wage arrears

Should you ever find yourself needing to pay some minimum wage arrears to your PA, you need to understand how to calculate them and what should happen with tax, National Insurance and related matters such as pensions.

The National Minimum or Living Wage (NMW/NLW) is the minimum pay per hour most workers are entitled to by law. As you can see from our website guidance, the rules are complicated and underpayments can easily arise.

Should you ever find yourself needing to pay some minimum wage arrears to your PA, one option is to ‘self-correct’ rather than wait for the authorities to find you. By doing this, you should avoid any penalties and potentially being ‘named and shamed’ for not paying the minimum wage.

Please note that this article is not aimed at employers who have signed up to use the Social Care Compliance Scheme to sort out minimum wage underpayments. An update for these employers will be provided on our website shortly.

How to calculate underpayments

Employers are liable to pay minimum wage arrears going back up to six years, and further guidance on calculating minimum wage arrears can be found in the government’s NMW guidance, starting at page 48.

The main thing to note is that minimum wage arrears should be repaid at current rates for all the periods your worker was underpaid, even if these are higher than the rates that applied when the arrears arose. The way that you work out the amount you should pay is by using the formula (underpayment/original rate) x current rate.

Example – Jane, a care and support employer, underpaid her PA the minimum wage by £256, during the period May to September 2017. During this time, the PA’s minimum wage rate was £7.50. However it is now £7.83. Rather than pay the PA £256, Jane must pay her £267 (i.e. £256/£7.50 multiplied by £7.83).

The payment an employer needs to make is the total arrears less the tax, National Insurance (NIC) and any other deductions such as pension contributions. Here, we look briefly at the rules for such deductions and tell you where to find more information.

Tax

Arrears of pay in minimum wage cases are taxable as ordinary employment income. The tax liability for the worker arises in the year of entitlement not the year of payment. It may be the case that this is the same thing – the current tax year, in which case, any minimum wage arrears can just be paid through the payroll with Pay As You Earn (PAYE) tax and NICs calculated in the normal way.

However, entitlement to receive the arrears will often have arisen on an ongoing basis throughout the employment. Applying the ‘entitlement’ principle means that a lump sum of arrears may give rise to taxable earnings on the worker in several tax years. This treatment is usually beneficial to a worker because if the arrears are taxed in the usual way, in one go in the year of receipt, they could push the worker’s earnings into a higher tax bracket.

An employer should operate PAYE when they pay the arrears. However, in line with the ‘entitlement’ principle, an employer should allocate the arrears of pay between the tax years in which the payment should have been made and calculate and deduct tax for each year in accordance with the employee’s tax code for that year and as if the additional pay had been paid at ‘week 53’. (The ‘week 53’ procedure usually means giving a worker an extra weeks’ worth of tax free personal allowance to use against the relevant amount, with income tax being calculated at the appropriate rate on the rest.)

Further information on how to do this can be found in HMRC employer guidance (CWG2: further guide to PAYE and NIC in section 1.19.2).

Example – Jackie is a care and support employer. In October 2018, Jackie pays her PA £1,000 in minimum wage arrears. There are various component parts of this, which have been ‘earned’ and therefore need to be taxed as follows:

  • 2015/16: £200 (personal allowance was £10,600 per year or £203 per week. As the PA’s arrears are less than the extra ’slice’ of personal allowance, there is no tax due.
  • 2016/17: £300 (personal allowance was £11,000 per year or £211 per week. £17.80 is due in PAYE tax (£300 less £211 x 20%).
  • 2017/18: £500 (personal allowance was £11,500 per year or £221 per week. £55.80 is due in PAYE tax (£500 less £221 x 20%).  

Of the total arrears of £1,000, PAYE tax of £73.60 should be deducted by Jackie. 

In line with HMRC’s guidance in CWG2, Jackie must give a letter to her PA showing, amongst other things, the gross arrears of pay for each year and the tax deducted. The letter should say: ‘If you think you’ve overpaid tax for any of the years concerned you should contact HMRC National Insurance Contributions and Employer Office.’

This is important information for Jackie’s PA to understand because if her pay, including the minimum wage arrears, is under the tax-free personal allowance in any of the tax years concerned, then she can ask HMRC for a refund of the tax deducted on the arrears.

Employers should then submit an Earlier Year Update (EYU) for all relevant years to tell HMRC about the arrears. As EYUs are being submitted to account for the tax, HMRC say that each year will attract its own interest charge for late payment. For example – arrears paid for tax year 2016-17 will be subject to interest from 19 April 2017 until the day payment is made. HMRC’s guidance does not cover penalties – it is conceivable that these scenarios may slip past the PAYE penalty system.

If you use HMRC’s Basic PAYE Tools (BPT) software to send an EYU, then you can find a guide that gives you step by step help on GOV.UK. It contains examples of the screens you will see in BPT and simple to follow instructions. If you use commercial software, you may need to ask your software provider for help with how to send an EYU.

National Insurance

The NIC element is worked out differently, and is calculated on the basis of the year the payment is made only: it is not related back to prior years.

An employer should report the NICs through RTI on a Full Payment Submission (FPS) for the pay period in which the payment is made.

For current employees, the amount of arrears should be included in the overall amount in the ‘Earnings for NICs’ field, but should be excluded from the overall amount in the ‘Taxable Pay’ field.

Depending on which software you use, the fields may be called something slightly different. If you use BPT, then the box you need to include the arrears in is circled in red below:

So, carrying on the example of Jackie above, she decides to add the whole payment of £1,000 into her PA’s next payroll run for NICs purposes. If the PA’s normal income in the pay period is £250, then her ‘Pay amount for Income Tax purposes’ will be £250 and her ‘Pay amount for NICs purposes’ will be £1,250. As the PA’s other income in the weekly pay period will have eaten up her NIC 0% rate band (up to £162 per week) and some of the 12% band (up to £892 per week), National Insurance at 12% will be due on some of her arrears, with 2% due on everything else.

The £3,000 Employment Allowance may well cover any employer’s NIC due on this payment.

For ex-employees, the FPS should be completed for the current tax year showing the current FPS payment date. The payment should be reported as a Payment after Leaving with the original date of leaving. The ‘Pay amount for NICs purposes’ should be completed but zeros should be entered in the ‘Pay amount for Income Tax purposes’ fields. Code NT should be entered in the ‘Tax code’ field on the FPS as this is a mandatory field.

Those using other software may need to ask their software provide for help on how to process payments for NIC purposes but not tax purposes or how to process payments for previous employees.

Pension

If an employer identifies that they need to pay minimum wage arrears to a worker, they may need to put the worker into a workplace pension scheme when the minimum wage arrears for a pay period are included as income, or put them in from an earlier date. They may also need to calculate backdated contributions. If the employer has had their first re-enrolment date they will also need to repeat their re-enrolment assessment.

The Pensions Regulator (TPR) has detailed guidance available on its website to help employers/advisers dealing with pay arrears, however this has been specifically developed to assist those employers who have entered the Social Care Compliance Scheme (SCCS). Although it is likely to be largely applicable more widely, employers outside the SCCS with minimum wage arrears to pay, should seek further advice from the TPR

Other considerations

Other deductions an employer may need to consider in relation to minimum wage pay arrears include statutory payments, Student Loan deductions and Attachment of Earnings Orders. Hopefully what is in this article will help you to deal with most situations you come across but if you need help with any of the above, you should contact HMRC.

Finally, employers should be aware that arrears payments may impact any benefits or tax credits their workers receive. Non-declaration by a worker could lead to overpayments or even a penalty, so it is vital that they tell HMRC/DWP/local authorities etc. about any arrears as soon as possible (even if the increase in income then falls to be disregarded for benefits or tax credits purposes). So you should make your worker them aware of this when you pay them the arrears.

(26-10-2018)

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