How are tax and NICs liabilities handled when an employee pays for a benefit and the employer pays the employee's costs?

This question illustrates very well the issues that must be considered when deciding on the tax and NICs liabilities for many different benefits in kind. The two key questions are:

• who has contracted with whom to provide the benefit? and
• who settles the bill?

We can use the example of private medical insurance and treatment to illustrate the issues. The examples given below are for an employee whose private medical treatment costs, including any VAT payable, amount to £1,000.

The employer contracts with the provider

If an employer contracts with an insurance company to provide private medical insurance for employees and pays the premiums, the cost to the employer is reported in Section I of form P11D for each employee and the employer pays Class 1A NICs. That is probably the most common situation. Exactly the same reporting requirement would apply if the employer contracts with a private hospital to provide treatment for an employee and also pays the bill. There is no P9D reporting requirement and no Class 1A NICs to pay if the employee is a lower-paid employee, i.e. has an earnings rate of less than £8,500.

Example: The employer reports £1,000 in Section I of form P11D and pays the appropriate amount of Class 1A NICs. The employee will pay tax on the £1,000 by means of a tax code reduction.

But, there are two other situations to consider.

The employee contracts with the provider and the employer pays the bill

First, if the employee arranges to have medical treatment at a private hospital, with the effect that the contract is between the employee and the hospital, and then the employer pays the hospital, the employer must report the benefit

• in Section B of form P11D, or
• if the employee is a lower-paid employees, in Section A(2) of form P9D,

and both employer and employee must pay Class 1 NICs because the employer has settled the employee's debt (or "pecuniary liability").

The liability for primary and secondary Class 1 NICs must be met at the time the hospital's bill is settled by adding the amount paid by the employer to the employee's gross pay in that same earnings period, but for NICs purposes only.

Example: The employer reports £1,000 in Section B of form P11D and the employee will pay tax on that by means of a tax code reduction. In the earnings period in which the payment is made to the hospital, the employer (1) adds £1,000 to the employee's gross pay for Class 1 NICs purposes only, (2) calculates and deducts primary and secondary NICs at the appropriate rates, and (3) deducts £1,000 from the employee's net pay.

The employee contracts with the provider and the employer reimburses the costs

A different situation arises if the employee contracts with the hospital for the treatment, pays the hospital's bill, and then claims reimbursement from the employer. The employer is not now providing a benefit in kind, but is making a cash payment for what is otherwise a taxable benefit. The payment cannot be paid as an expenses payment to the employee, nor is it reportable on form P11D. Rather, the tax and Class 1 NICs must be calculated through the payroll by adding the amount to gross pay.

Example: The employer adds £1,000 to the employee's gross pay for both PAYE tax and Class 1 NICs. The net amount received by the employee is, of course, considerably less than £1,000.

If, however, the employer intends to meet the employee's costs in full, in effect by paying the tax and NICs, the amount reimbursed must be grossed up for tax and NICs. This is an expensive option.

Example: The grossed-up amount that gives £1,000 after deducting tax and NICs depends mainly on the employee's tax and NI status. It could typically be over £2,000 for a higher-rate tax employee, or £1,450 for a basic-rate tax employee. The employer adds the grossed-up amount to the employee's gross pay for both PAYE tax and Class 1 NICs and the employee's net pay is £1,000 more than it would otherwise be.

The same contractual and payment issues apply to most benefits in kind. Of particular interest are benefits in kind that have no reportable value if they are provided by the employer, such as a mobile telephone, a cycle and related safety equipment, and equipment for use away from the workplace. There is nothing to report on form P11D and no Class 1A NICs to pay. However, if the contract for the phone, cycle etc. is between the employee and the provider, and the employer settles the employee's bill or reimburses the employee, both types of benefit are liable to tax and NICs as discussed above.

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