Schedule E Remuneration : A Brief Overview
Author:
Declan Doyle
They say that first impressions last, so how do you imagine a new client will react if you are able to impart a nugget of information that should put a few more bob into his pocket- a client if not a friend for life? The purpose of this article is to set out a brief overview of the significant issues that need to be considered before advising clients on the tax aspects of paying or receiving Schedule E income.
"Contracts of Service" and "Contracts for Service"
The starting point to any analysis is to determine whether or not the individual is within the charge to Schedule E in the first place i.e. whether an individual is engaged under a contract of service (an employee) or a contract for services (self-employed).
While much has been written on the subject, it is useful to refer to the report issued by The Employment Status Group which was established under the Programme for Prosperity and Fairness for an analysis of the more significant issues. The remit of the group was to consider whether it was appropriate to "seek a uniform definition of 'employee' based on clear criteria, which will determine the employment status of an individual". Some of the key findings of the study (which have no statutory effect) were as follows:-
- Preferred to adopt a descriptive approach (based on criteria laid down by the courts) rather than a prescriptive statutory approach.
- Made reference to recent case law which stated that it is always necessary to consider "the facts or realities of the situation on the ground" and so to look beyond the written contract to arrive at the totality of the relationship between the parties. In this regard, statements in contracts such as "you are deemed to be a independent contractor", "you are not an employee" and "your are responsible for your own tax affairs" is of little value in drawing a conclusion as to the work status of the person engaged.
- It set out a code of practice in the form of an extensive, but not exhaustive, list of criteria or tests on whether an individual should be classified as either an employee or a self-employed person. The main tests include the following:-
- Ability to independently determine what, when and how the work is to be carried out.
- Ownership of materials and equipment used in carrying out the contract.
- Assumption of financial risk i.e. opportunity to make profits or incur losses
- Number of similar contracts.
- Opportunity to profit from sound management from scheduling of work.
- Right to delegate to others.
- It makes no attempt to extend contract of service status to situations when a corporate is the service provider, and therefore, the existing practice remains in Ireland that a body corporate cannot be an "employee" of any other person. It is notable however, that new legislation was recently introduced in the UK to counter perceived abuses (particularly in the area of UK National Insurance Contributions) by individuals providing services via a service company rather than directly in a personal capacity. This "IR35 legislation" operates by obliging the service company to operate PAYE on broadly all the consultancy income that it receives from its clients.
Statutory Provisions
The next step (once satisfied on employee status) is to understand the various legislative provisions that govern all Schedule E charges.
Prerequisites and BIKs
Section 112 and other related sections deal with normal pecuniary remuneration (pay, bonuses, restrictive covenant payments etc) and "perquisites", which is remuneration in non-money form which is convertible into money or money's worth e.g. vouchers, payment of subscriptions. The tax is chargeable by reference to the market value of the perquisite which is not necessarily the same as the cost to the employer.
Section 118 and related sections deal with taxable BIKs which, in the absence of any specific valuation rules, will be generally based on the actual cost incurred by the employer in connection with the provision of the benefit, less any amount reimbursed to the employee. Examples of exceptions to this general rule include:-
- The provision of company cars - based on 30% of the original market value or such reduced rate as is appropriate having regard to the level of business travel incurred;
- The provision of other employer owned assets - based on 5% of the market value of the asset when it was first provided as a benefit;
- Preferential loans - based on the difference between the preferential and the specified rates.
The normal benefit of receiving a perquisite or BIK over taxable "pay" is that tax is only payable on the net sum, which is usually calculated by reference to the expense incurred by employer less any reimbursement paid by the employee e.g. the benefit of a €300 club subscription will cost a top tax rate employee €144 in income tax, PRSI and the Health Levy tax whereas he / she would need to have earned approximately €577 in normal pay to yield a net €300, if the employer is not prepared to write the cheque. However, an employer should be mindful of the risks of adopting aggressive "salary sacrifice" / "application of income" schemes which may be challenged by the Revenue Commissioners as possibly ineffective for tax i.e. the employee remains taxable on the gross income payable under the terms of the contract of employment.
All non exempt perquisites and BIKs are now liable to income tax, PRSI and the Health Levy under the PAYE system. They are also liable to employer's PRSI which has resulted in a significant overall increase in the gross cost of paying non-pecuniary remuneration compared to the position which existed a few years back.
A number of perquisites and BIKs which are exempt from tax include small benefits (up to €250 p.a.), car parking, certain canteen facilities, on business premises accommodation, travel passes, employer owned/operated creche facilities and equipment (mobile phones, computers, broadband connections) where homes use is incidental to business use. In addition to these exemptions, you should consider whether any exemptions or reliefs are available against normal pay e.g. statutory redundancy payments and the seafarers allowance but remember that the foreign earnings deduction was abolished from 31 December 2003.
Termination Payments
Section 123 deals with non-contractual payments made in connection with the termination of the holding of an office or employment or for any changes in its functions or emoluments, which would not otherwise be chargeable to tax.
Understanding the distinction between amounts which are taxable under this section (non-contractual) and amounts which are taxable under the principle Schedule E charging provisions referred to previously (based on contractual obligations) is fundamentally important because the exemptions and reliefs that are set out in Section 201 and Schedule 3, TCA 1997 are only available if the income is taxable under Section 123. An uncapped exemption applies to payments for individuals whose employment has been unfortunately terminated on account of death, injury or disability whereas other payments are only tax free up to certain limits as defined.
Share Options
Under Section 128, an employee will also be taxable under Schedule E on any gains realised from exercising a right to acquire assets (usually shares) at a less than full market value price. Important issues which are often forgotten include the following:-
- Income tax may be payable at the time the option is granted if the option period exceeds 7 years.
- The employee is personally responsible to pay the income tax not later than 30 days after the date on which the right is exercised.
- Certain individuals may well be carrying forward gains, which they were allowed to defer under previous legislation, but which will be crystallised after 7 years or, if earlier, when the shares are sold.
- The income tax computation will need to be revisited if circumstances change and an employee is allowed to sell the shares before the end of clog period specified in any original Revenue approved abatement claim.
- While there may well be an opportunity to improve overall tax efficiency under a variety of Revenue approved schemes (e.g. profit sharing schemes, share option scheme, SAYE schemes) it is fair to say that their general take-up have been quite slow within privately held companies (although quite popular within plcs and public sector companies), for the following reasons:-
- Generally more costly to establish and to administer.
- Employers will not obtain Revenue approval if they only wish to extend share ownership to the most senior personnel.,
- There is a requirement that the share price must be struck at an amount which is at or near the market value of the shares at the date of the right is granted, which may act as a disincentive to certain participants who in privately owned companies do not foresee any obvious market for their shares
Conclusion
As you will see from the above brief remarks, the taxation of Schedule E remuneration is deceptively complex and generally not greatly understood by employers or wage earners alike. There is therefore ample opportunity for the well versed accountant to impress a client by improving his net income or at the very least ensuring that he only pays the correct amount of tax due.