Employment Income
1 The scope of employment income
An employee is taxable under the Employment Income rules.
A self employed person is taxable under the Trading Income rules.
2 Employment -v- self-employment?
The following principles should be taken into account in deciding if a person is employed or self employed.
The main test of an employment as opposed to self employment is the existence of a contract of service (employee) compared with a contract for services (self employed).
You can use the mnemonic HIS CHORE to help you remember the tests.
H The employee is entitled to benefits normally provided to employees such as sick pay and holiday pay.
I The work performed by the employee is an integral part of the business of the employer and not merely an accessory to it.
S The employee is obliged to work personally and exclusively for the employer, and cannot hire his own helpers or send a substitute.
C The employer controls the manner and method of the work.
H The employee is committed to work a specified number of hours at certain fixed times, and is paid by the hour, week or month.
O An obligation by the employer to offer work and an obligation by the employee to undertake the work offered. An employee would not normally be in a position to decline work when offered.
R The economic reality of self-employment is missing - namely the financial risk arising from not being paid an agreed, regular, remuneration. The employee cannot profit from sound management - reward
E The employee does not provide his own equipment.
3 Employment income pro forma
£
Salary/wages | X |
Bonus/commission | X |
Benefits | X |
Reimbursed expenses | X |
Cash vouchers | X |
–––
X
Less: Allowable deductions
Expenses incurred wholly, exclusively and necessarily | (X) | |
Contributions to employer’s occupational pension scheme | (X) | |
Subscriptions to professional bodies | (X) | |
Charitable donations: payroll deduction scheme | (X) | |
Travel and subsistence expenses | (X) | |
Use of own car – mileage allowance shortfall | (X) | (X) |
–––
Employment Income | X |
–––
Individuals are generally assessed on the amount of cash received in the tax year. The date received is taken as the earlier of the date when the employee became entitled to the payment or the date it was actually received by the employee.
Benefits are assessed when they arise.
4 Deductibility of expenses from employment income
The following expenditure is deductible:
The general rule is that expenses must be incurred wholly, exclusively and necessarily in the performance of the duties of employment.
Employee contributions to approved occupational pension schemes (within certain limits see Chapter 10)
Fees and subscriptions to relevant professional bodies.
Payments to charity made under a payroll deduction scheme.
Travel expenses incurred necessarily in the performance of the duties of employment.
Capital allowances are available for plant and machinery provided by an employee for use in his employment duties.
5 Approved mileage allowances
Travel and subsistence expenses may be deducted if they are necessarily incurred in the performance of the employment duties, or for the necessary attendance at any place in the performance of the duties. NOT home to normal workplace - this is a private expense.
For 2025/26 the approved mileage allowance is 45p per mile for the first 10,000 business miles, and then 25p per mile thereafter.
Employees who use their own motor car for business mileage must use the approved mileage allowances in order to calculate any taxable benefit or allowable expense arising from any mileage allowances received from their employer.
Payments in excess of the approved mileage allowances = taxable benefit.
Payments less than the approved mileage allowances = allowable deduction.
Kelly uses her own motor car for business travel. During 2025/26 she drove 12,000 miles in the performance of her duties. Her employer pays her 30p per mile.
Calculate the effect on Kelly's employment income.
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6 Benefits (in kind)
The term earnings includes non-cash benefits received by the employee or provided to a member of his or her family (unless they are specifically exempt).
Exempt benefits include:
Canteen available to all staff.
Qualifying removal expenses up to £8,000.
Car parking spaces at or near place of work.
Workplace nurseries (crèches).
Contributions by an employer to an approved pension scheme.
Workplace parking for bicycles plus a tax free cycling allowance of 20p per business mile.
Provision of a mobile telephone for private use (one per employee).
Christmas parties etc for staff (up to £150 per person per year).
Sport and recreational facilities available generally for the staff.
Annual exemption of up to £500 per employee where employer pays for medical treatment to assist the employee in returning to work after a period of absence due to ill health or injury.
Outplacement counselling services to employees made redundant. The services can include counselling to help adjust to the loss of the job and to help in finding other work; i.e. retraining courses.
Contributions towards additional household costs (such as light and heat) incurred by an employee who works at home: up to £6 per week or if higher, evidence must be provided by the employee to justify the expense.
Long service awards up to £50 per each year of service (with a minimum requirement of 20 years service).
Trivial benefits which do not cost more than £50 per employee which are not cash or cash vouchers and are provided for a non-work related reason.
Use of employer bicycles and cycling safety equipment if used by employees to and from work.
Provision of eye care tests and/or corrective glasses for employees using VDU’s (if paid directly, by reimbursement to the employee or by providing vouchers).
Incidental overnight expenses provided by the employer for overnight stays from home. Up to £5 per night (UK) and up to £10 per night (overseas).
7 Taxable benefits
7.1 General rules
The amount assessed is generally the cost of providing the benefit.
Where in-house benefits are provided (for example, free air travel for employees of an airline company) the amount assessed is the marginal cost incurred by the employer. If there is no marginal cost, there is no benefit.
Benefits are time-apportioned if not available for the full tax year.
Any contribution by the employee towards the benefit reduces the benefit (unless the contribution is towards fuel for private journeys (see later).
7.2 Vouchers exchangeable for goods and services unless specifically exempt.
7.3 Living accommodation
There is no taxable benefit if the accommodation is job related:
where it is necessary for the proper performance of the employee’s duties (e.g. a caretaker); or
for better performance of the employee’s duties and (for that type of employment) it is customary for employers to provide living accommodation (e.g. hotel worker); or
where there is a special threat to the employee’s security and he resides in the accommodation as part of special security arrangements.
If the accommodation is not job related then the benefit is:
if accommodation is rented by the employer on behalf of the employee, the benefit is the higher of the accommodation’s annual value, and the rent actually paid by the employer.
If the accommodation is owned by the employer, the benefit is the accommodation's annual value and there could be an additional benefit (see below).
Where the accommodation is owned by the employer, there is an additional benefit where the cost of the accommodation was greater than £75,000;
(cost of accommodation – £75,000) × the official rate of interest (3.75%)
The cost of the accommodation is the purchase price of the property plus expenditure on capital improvements incurred before the start of the tax year.
If the employer bought the accommodation more than six years before first providing it to the employee, the property’s market value when first occupied by the employee is used in the calculation instead of purchase price but note that if the cost is less than £75,000 there is no expensive accommodation benefit irrespective of the market value when the employee first occupied the property.
Any accommodation benefit is reduced by any contribution paid by the employee (e.g. the employee pays the employer 'rent').
Jones, a sales manager, occupies a flat owned by his employer. Its annual value is £4,000 and Jones pays his employer £400 per month for use of the flat. The flat was originally purchased in 2010 for £100,000 and Jones moved into the property in 2024 when the property was worth £125,000.
Calculate the total benefit assessable on Jones for 2025/26 assuming an official rate of interest of 3.75%
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7.4 Expenses connected with living accommodation
Expenses such as lighting and heating are taxable on the employee if they are paid by the employer.
When the accommodation is job related, the taxable limit is 10% of 'net remuneration' which is the employee's employment income after expenses but before this accommodation benefit. In addition the payment of council tax by the employer is an exempt benefit if the accommodation is job related.
7.5 Use of assets (including furniture in accommodation provided by employer)
Amount assessed is the higher of:
20% × market value of the asset when first provided.
rent paid by employer (if asset is rented).
7.6 Transfer/gift of assets
If an employee is gifted a new asset, he is taxed on the cost of the asset.
If an employee is gifted an asset that he has previously had private use of, he is taxed on the higher of:
the market value of the asset when given to him.
the market value of the asset when first made available to any employee less the benefit assessed on the employee(s) during the time he had the use of it.
The above rule does not apply to the gift of a bicycle, motor car or van, where the benefit is simply the market value of the asset when gifted.
If it is not an outright gift; i.e. the employee pays something for the asset, then the employee contribution is deducted from these amounts.
Gerald’s employer purchased a TV for Gerald's private use on 1 June 2024, costing £900. On 6 April 2025 Gerald was given the TV by his employer when its market value was £250.
Calculate the benefit assessable on Gerald in respect of the gift if:
(a) Gerald made no payment for the TV.
(b) Gerald paid his employer £250 for the TV.
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7.7 Car benefit
When a car is provided to an employee and there is some private use, the assessable benefit for each car is: the list price of the car x CO2 emissions %.
The list price of the car is the list price when the vehicle was first registered, together with any optional extras NOT the price paid.
It is possible for the employee to make a one-off capital contribution towards the purchase of the car. For the purposes of calculating the benefit, the list price of the car can be reduced by this capital contribution up to a maximum of £5,000.
The CO2 emissions will be given to you in the exam as follows:
Petrol and Diesel cars:
The base level of CO2 emissions is 55 grams per kilometre.
The percentage rates applying to petrol cars (and diesel cars meeting the RDE2 standard) with CO2 emissions up to this level are:
51 grams to 54 grams per kilometre | 16% |
55 grams per kilometre | 17% |
Electric cars:
A 3% percentage applies to electric-powered motor cars with zero CO2 emissions.
Hybrid cars:
For hybrid-electric motor cars with CO2 emissions between 1 and 50 grams per kilometre. the electric range of the car is relevant in determining the car benefit percentage, as follows:
Electric Range
130 miles or more | 3% |
70-129 miles | 6% |
40-69 miles | 9% |
30-39 miles | 13% |
less than 30 miles | 15% |
The car benefit is calculated as follows:
List price x CO2 emissions %
For petrol and diesel cars with emissions over 55g/km, the base percentage is calculated as 17% plus 1% for every complete 5g/km over 55 grams
To calculate the additional percentage round emissions down to nearest 5g/km – deduct 55g - divide the excess by 5.
Add a 4% supplement for diesel cars that do not meet the real driving emissions 2 (RDE2) standard.
Maximum for all cars = 37%
The car benefit itself is proportionately reduced if:
a motor car is unavailable for periods of at least 30 days of the tax year, and
where the employee makes a contribution to the employer for the private use of the motor car.
Second motor cars
Where more than one motor car is made available to an employee, the benefit of each motor car is computed as above.
Pool cars
The use of a pool car does not result in a company car benefit. A pool car is one provided for the use of any employee to use for business purposes, is kept at the business place of work and not normally kept overnight at the employee's home.
During 2025/26, Speed Merchants plc provided the following employees with company cars:
Lewis was provided with a new diesel-powered company car on 6 August 2025. The car has a list price of £13,500 and an official CO2 emission rate of 117 grams per kilometre. The motor car meets the RDE2 standard.
Nico was provided with a new petrol-powered company car throughout 2025/26. The car has a list price of £16,400 and an official CO2 emission rate of 167 grams per kilometre.
Jenson was provided with a new hybrid electric-powered company car throughout 2025/26. The car had a list price of £16,000, an official CO2 emission rate of 38 grams per kilometre and an electric range of 110 miles.
Sebastian was provided with a new diesel-powered company car throughout 2025/26. The car had a list price of £14,000 and an official CO2 emission rate of 98 grams per kilometre. The car does not meet the RDE2 standard.
Calculate the taxable benefit for 2025/26 for Lewis, Nico, Jenson and Sebastian.
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7.8 Fuel provided for private use
The car benefit covers the running costs of the car with the exception of fuel provided for private journeys.
The amount of fuel benefit is computed on a base figure of £28,200 multiplied by the same percentage used for calculating the car benefit.
The fuel scale charge is reduced proportionately where private fuel is only provided for part of the tax year.
No reduction is made if the employee makes partial contributions towards the cost of petrol for private use, but if he pays for ALL fuel used for private motoring the charge is cancelled.
Using example 4 – calculate the fuel benefit for Lewis, Nico, Jenson and Sebastian assuming also that Lewis pays Speed Merchants plc £600 during 2025/26 towards the cost of private fuel, although the actual cost of this fuel was £1,000.
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7.9 Vans and heavier commercial vehicles (rates given in tax tables)
Where an employee uses an employer's van for journeys between home and work and other private use is insignificant, there is no benefit.
Where private use is not insignificant the tax charge is £4,020 p.a.
An additional charge is made for fuel provided for unrestricted private use equal to £769 p.a.
Both benefits are time apportioned if the van is unavailable to the employee for 30 days or more during any part of the tax year.
Vans producing zero CO2 emissions have a zero benefit charge. There is no fuel benefit charge.
7.10 Beneficial loans
A beneficial loan is one made to an employee below the official rate of interest (3.75% for 2025/26).
The benefit is the interest on the loan at the official rate, less any interest actually paid by the employee.
There is no benefit if the total loans do not exceed £10,000 in total at any time in the tax year.
The benefit is calculated using the average method or the accurate/strict/precise method.
Average method.
This uses the loan outstanding at the beginning and the end of the tax year.
If the loan is taken out or paid back during the tax year, that date is used instead of the beginning or end the tax year.
Accurate/strict/precise method
This calculates benefit day by day on the balance actually outstanding.
Either the taxpayer or HMRC can elect to use the accurate method.
Jack was given a loan of £35,000 by his employer on 31 March 2025. Interest is payable on the loan at 1% p.a. On 1 June 2025 Jack repaid £5,000 and on 1 December 2025 he repaid a further £15,000.
Calculate the taxable benefit for 2025/26 under:
(a) the average method and
(b) the accurate method
You should assume that the official rate of interest is 3.75% p.a.
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8 PAYE system
8.1 Pay As You Earn
The purpose of the PAYE system is to deduct the correct amount of Income Tax and National Insurance Contributions over the year.
8.2 Employers’ duties
The employer has a duty to:
deduct income tax from the pay of his employees,
calculate the amount of NIC that should be deducted,
keep a record of each employee’s pay and deductions,
send Income Tax and NIC information to HMRC electronically every time employees are paid (weekly or monthly) and make their monthly PAYE payments electronically on the 22nd of the month under the Real Time Information reporting system (see note),
send appropriate returns in addition to the employee when required.
Note - There are penalties if submissions made during the tax year are made late, though there is no penalty for the first month in a tax year that submissions are paid late. Thereafter a monthly late filing penalty of between £100 and £400 is charged depending on the number of employees. An additional penalty of 5% of the tax and NIC due may be charged where the submission is more than 3 months late.
8.3 Application of PAYE
The following count as pay:
salaries, wages, overtime, bonuses
pensions
It is now possible for an employer to choose to include most taxable benefits within their normal payroll, with the employee’s income tax liability being collected under PAYE. What are now referred to as “Payrolled” benefits do not now have to be reported on form P11D (which is a form submitted by the employer that lists the benefits provided to an employee in a tax year).
If taxable benefits are not payrolled, then they continue to be reported on form P11D. Income tax will then normally be collected by an adjustment to the employee’s PAYE tax code.
8.4 PAYE codes
An employee’s PAYE code indicates the amount of tax free pay he is entitled to and is notified to the employee and his employer by HMRC. This will allow the employer to deduct the correct amount of tax from the employee
The PAYE code will include the employee’s personal allowance and any allowable deductions and be restricted by various taxable amounts.
It is calculated as follows:
£ | £ | ||
Allowances: | |||
Personal allowance | X | ||
Expense deductions | X | ||
X | |||
Less Deductions: | |||
Benefits | X | ||
Untaxed income | X | ||
Tax under payments b/f (grossed up) × 100⁄20 × 100⁄40 × 100⁄45 for basic/higher/additional rate taxpayers | X | ||
(X) | |||
Allowance to set against pay | X |
To obtain the code number the last figure is removed and replaced with a letter
L - code for PA
K - increases taxable pay instead of reducing it (benefits exceed allowances) with no tax free allowances
BR - tax will be deducted at the basic rate
NT - no tax is to be deducted
Annabel earns £20,000 pa. She has annual benefits of £440 and unpaid income tax for 2023/24 of £132.
Calculate Annabel’s tax code for 2025/26.
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8.5 Changes to coding
An employer must use the last code notified to him for existing employees until new written instructions are sent from HMRC.
8.6 Year end returns
The employer must send P11D forms detailing benefits provided to employees to both HMRC and the employee by 6 July following the end of the tax year:
The employer must give P60 forms which details gross pay and tax deducted as well as NICs made in the tax year to employees by 31 May following the end of the tax year:
8.7 Employees leaving or joining
Employees leaving
The employer should complete form P45 and send part 1 to Tax Office and give parts 2, 3 and 4 to the employee.
Employees joining
When an employee joins and has a P45 the employer can operate PAYE
The employer uses the tax code on the P45 if it relates to the current year; otherwise he uses the emergency code.
If the employee does not have a P45, the new employee must complete form P46.
The topic of benefits appears regularly in the TX exam. They may ask a Section A MCQ such as the following:
Alternatively, the topics in this chapter may be examined in a Section B or C question where the calculation of the benefits (normally two or three different ones) form part (a) of a wider question including other income and a calculation of Income tax - part (b) on all the various incomes and an NIC (part (c)) calculation for a total of 15 marks.
Martin is employed by Global plc and he is also a member of a partnership. The following information is available in respect of the tax year 2025/26:
Employment income:
1 During 2025/26, Martin was paid a gross annual salary of £144,000 in respect of his employment with Global plc.
2 In addition to his salary, Martin was paid the following bonuses by Global plc:
Amount: | In respect of the six month period | Date of payment | Date of entitlement |
£18,200 | 28 February 2025 | 30 April 2025 | 20 March 2025 |
£21,400 | 31 August 2025 | 30 October 2025 | 20 September 2025 |
£13,700 | 28 February 2026 | 30 April 2026 | 20 March 2026 |
3 During the tax year 2025/26, Global plc provided Martin with the following petrol-powered cars:
Period provided | List price | CO2 emission rate |
6 April to 31 December 2025 | £16,400 | 108 grams per kilometre |
1 January to 5 April 2026 | £36,400 | 26 grams per kilometre (hybrid car with an electric range of 55 miles) |
Martin was not provided with any fuel for private use.
4 On 6 April 2025, Global plc provided Martin with an interest-free loan of £8,000 which he used to purchase a motor bike. No loan repayments were made during the year.
5 Throughout the tax year 2025/26, Global plc allowed Martin private use of a home entertainment system owned by the company. The home entertainment system cost Global plc £7,400 on 6 April 2025.
6 During the tax year 2025/26, Martin donated a total of £1,000 to charity under the payroll deduction scheme operated by Global plc.
7 Martin paid an annual professional subscription of £560, which is relevant to his employment with Global plc. Martin also paid an annual membership fee of £1,240 to a health club, which he used to entertain Global plc’s clients. Global plc did not reimburse Martin for either of these costs.
Partnership income:
1 Martin has been in partnership with Norma and Oprah since 1 January 2009. The partnership’s trading profit for the year ended 31 March 2026 was £54,600.
2 Until 30 September 2025, profits were shared 40% to Martin, 30% to Norma and 30% to Oprah. Since 1 October 2025, profits have been shared equally.
Other income:
1 During 2025/26, Martin rented out a furnished room in his main residence, receiving rent of £9,200 for the year. No additional expenditure was incurred as a result of the letting.
2 During the tax year 2025/26, Martin received dividends of £440.
3 On 30 November 2025, Martin received interest of £1,330 on the maturity of savings certificates from NS&I (National Savings and Investments).
Calculate Martin’s taxable income for the tax year 2025/26.
Note: You should indicate by the use of zero (0) any items which are not taxable or deductible.