“The hardest thing in the world to understand is the Income Tax.”
The Corona Virus Job Retention Scheme is somewhat analogous to a reverse employment tax. As a sound bite the scheme is simple, HMRC will pay 80% of the wages of furloughed employees.
However, when you dig into the detail of the scheme there are some peculiarities. One of the first things to understand is that a furloughed employee continues to be paid by their employer and pays taxes through PAYE as normal. The employer can choose to pay 80 to 100% of the furloughed employee’s contractual salary – on which the employer has to pay Class 2 National Insurance and auto-enrolment pension contributions.
The employer then recovers from HMRC:
(1) 80% of the employee’s contractual salary
(2) A formula relating to reclaiming Class 2 National Insurance
(3) A formula relating to reclaiming auto-enrolment pension contributions
The scheme is generous and possibly more generous than would initially be understood. However, this generosity creates complexity and, in some circumstances, perverse outcomes.
For example, the rules around Class 2 National Insurance mean that an employer can be penalised for paying their employees 100% of their contractual salary. Let’s use a worked example with some pseudo code to illustrate the point.
Firstly lets determine some parameters relating to an example employee who is furloughed within March 2020 and the grant the employer would claim for the month of March.
payroll_month = Mar-20
contractual_monthly_gross_salary = £2,333
date_furlough_commenced = 26-Mar-20
furlough_ongoing_at_month_end = True
payroll_frequency = monthly
number_of_days_in_payroll_month = 31
number_of_days_furloughed = 6
proportion_of_month_furloughed = 6/31
salary_grant = (6/31) * contractual_monthly_gross_salary * 80% = £361
secondary_threshold = £719 #the monthly threshold from which Class 2 NIC is paid
If the employee is paid 80% of the contractual_monthly_gross_salary then:
salary_paid_before_furlough = £2,333 * (1 – (6/31)) = £1,890
salary_paid_after_furlough = £2,333 * (6/31) * 80% = £361
salary_paid_in_month = £1,890 + £361 = £2,245
national_insurance_grant = £47
If the employee is paid 100% of the contractual monthly gross salary then:
salary_paid_before_furlough = £2,333 * (1 – (6/31)) = £1,881
salary_paid_after_furlough = £2,333 * (6/31) = £452
salary_paid_in_month = £2,333
national_insurance_grant = £34
This perverse and arguably unfair result arises due to the interaction of the secondary threshold and the timing of the commencement of the furlough.
The national_insurance_grant is the amount of Class 2 National Insurance due for the month, then ratcheted down by the proportion_of_month_furloughed and ratcheted down again by the ratio of the salary_grant and the salary_paid_after_furlough, which is calculated with the following formula:
(salary_paid_in_month – secondary_threshold) * 13.8% * ( salary_grant / salary_paid_after_furlough) ) * proportion_of_month_furloughed
So for 80% pay the calculation is:
= (£2,245 – £719) * 13.8%* (£361 / £361) * (6/31)
= £1,527 * 13.8% * (6/31)
And 100% pay the calculation is:
= (£2,333 – £719) * 13.8% * (£361 / £452) * (6/31)
= £1,614 * 13.8% * (£361 / £452) * (6/31)
= £1,614 * 13.8% * 80% * (6/31)
So if the employer pays 100% of their employee’s salary then it would receive £13 less from HMRC for the Class 2 National Insurance grant, notwithstanding the additional Class 2 National Insurance due on the higher salary_paid_in_month.
At a time of national emergency the oddities of the Corona Virus Job Retention Scheme are probably not of great importance and are the inevitable consequence of the speed at which the scheme was introduced and complexity of the UK employment tax regime.
This peculiarity has parallels with how poorly designed employee share schemes, which are often presented as ostensibly simple, can in fact be very confusing to execute and have perverse and unexpected results which typically emerge at the time of a company sale or corporate re-organisation and throw a metaphorical spanner in the works.