Salary advance serves up tricky conundrum for HMRC

Several companies have emerged over the last few years, offering flexible wage solutions to employers, who in turn can then offer them to their employees. These arrangements seem to be spreading through all parts of the labour market. However in my recent article for Tax Adviser, on different ways employers can support employees with the cost of living crisis and the universal credit interactions of such, I hinted that there may be a technical tax issue with one type of flexible wage scheme – the salary advance scheme.

In this blog, I want to build upon this by exploring the tax technical position of these schemes and highlighting the areas that need urgent clarification from HMRC.

It is impossible to discuss salary advance schemes in the round without looking at the non-tax aspects – some of which are controversial and lay outside of LITRG’s remit. Any opinions or errors/omissions here, are therefore my own.

What are salary advance schemes?

Salary advance schemes are a fairly new type of financial product where employers work with salary advance companies to let employees access part of their salary as they earn it, rather than having to wait until payday.

Firstly, an employer signs up with a company which offers this service. Employees will be provided with access to an online app or platform where they can keep track of what they are earning in real time and how much is available as an advance. It is for the employer to decide what percentage of an employee’s salary can be used as an advance, for example, 25 per cent – 50 per cent of monthly pay.

A salary advance company will usually charge employees a fee per withdrawal for using this service, for example, £1.75 per withdrawal. Sometimes employers subsidise the cost of the fees, in addition to paying their own access fee to the salary advance company. An overview of the typical level of salary advance scheme fees, can be found in this Money Saving Expert article.

If an employee uses one of these schemes, when they receive their pay on payday, any amounts they have taken as an advance, plus any fees, will be deducted from the amount they would usually get. This means an employee’s pay will be less than usual. 

How does the money flow?

Flexible pay schemes come in all sorts of shapes and sizes, but the salary advance schemes typically work like this: 

• After an employer and an employee have enrolled, an employee can select the amount of money they would like to withdraw from a balance of earned wages from time worked (per the employer data which is shared with the salary advance company).
• The withdrawal is funded from the salary advance company’s own funds
• A nominee bank account is created by the salary advance company
• These bank account details are substituted for the employee’s bank account details in the employer payroll software
• On pay day, the employer processes the employee’s pay as normal but instead of sending the net pay to the employee, sends it to the salary advance company
• The salary advance company reimburses itself for any withdrawals and associated fees and then passes the remaining salary to the employee’s current bank account.
• The employee’s payslip from the employer does not show the salary advance activity. This is only visible from a separate statement from the salary advance company.

Why can they be helpful?

Many people these days are paid monthly. This saves quite a lot of payroll administration for employers. However, a monthly payroll sometimes does not match an employee’s cash flow needs. Salary advance schemes can let people simulate being paid weekly instead of monthly and allow them to access their own money for an emergency, say, without accruing debt.

Are there any downsides?

The main issue as I see it with salary advance schemes is that if used regularly, the fees, while appearing to be modest can soon add up to a significant amount. For instance, I understand that some withdrawals may be for as little as £10 – in which case a fee of £1.75, say, is quite high.

Employees might not appreciate the true cost and find it hard to compare it with the annual interest rate or APR on a standard short-term loan. However, it is possible to calculate an APR. Let’s say a £50 withdrawal, with a £1.75 fee is made two weeks (14 days) before pay day. A very basic calculation on a simple interest basis, gives us something like 90 per cenr APR (that is, £1.75 which is 3.5 per cent of £50, divided by 14 days and multiplied by 365 days).

Another key concern with salary advance schemes is the potential for employees to become reliant on making repeat withdrawals each month to make ends meet. If employees withdraw a portion of their salary early, they may find they are more likely to run short before the next payday, potentially leading to a cycle of repeat advances and escalating fees. By offering this facility employers could actually be putting some employees in more financial hardship.

There has been some media coverage around concerns about the annual APR and that they can raise similar issues to pay day loans, see for example here and here. 

The Financial Conduct Authority has highlighted the risks of using salary advance schemes - for both employees and employers. It has particularly raised concerns surrounding the fact that this type of activity is currently unregulated. There is also an interesting discussion of salary advance schemes in the FCA’s Woolard review of the unsecured credit market (page 52). 

What does it do to an employee’s taxes?

In terms of how I understand the schemes currently operate – it does nothing to an employee’s taxes (or National Insurance) - as the schemes say that payment of an advance does not impact on the employer’s payroll processes. In other words, the employers continue to report earnings through RTI on a monthly basis to HMRC. The schemes say that the advance is ignored for tax/NIC purposes at the time it is made and then, on the usual pay day, it comes off from the employee’s net pay after tax/NIC have been deducted as normal.

However, it is not clear, to me anyway, that this treatment is correct under current legislation.

For payroll purposes, strictly, where there is an advance of wages (which HMRC say is a payment on account of earnings, which is money the employee has earned but which is not yet due for payment and which is not recoverable by the employer), this is reportable by the employer and taxable/NICable on the employee on or before the time the payment is made. Although there is an easement for ‘ad hoc’ payments outside the normal payroll run, it is hard to see that this would apply to arrangements like these - where in many cases, there are not just one off or infrequent requests.

If an RTI report is due at time of withdrawal and it is not made, where does the risk lie?

There are lots of provisions in tax and NIC legislation relating to payments, awards, vouchers or benefits provided by third parties but arranged by employers that result in obligations for the employers - not to mention, of course, the Part 7A ITEPA 2003 anti-avoidance rules (although I can’t see that these would apply). In a situation like this, and in line with HMRC guidance, assuming there is an employer/employee relationship in the background, remuneration paid by a third party is still earnings of that employment. This means that in the case of a true advance, the employer needs to make an RTI submission and needs to operate PAYE, not the salary advance scheme (unless it is acting an an agent for the employer).

If the schemes are being marketed as a simple employee financial wellbeing solution that requires no payroll thought on the part of the employer, there may well be widespread, albeit inadvertent, PAYE non-compliance at employer level.

Yet, even if the need for action at the time of the withdrawal was an accepted principle, it creates all sorts of practical problems if the salary advance scheme doesn’t tell the employer when there has been a withdrawal, how much it is etc, in order to allow them to correctly deal with RTI/PAYE.

What if an employee is getting universal credit?

Universal credit (UC) is a monthly payment and the amount of UC a claimant is entitled to is based on their personal circumstances and also their 'net pay' in a monthly assessment period. Every time an employer pays someone, a copy of the payroll data is sent to HMRC. This data (known as Real Time Information or RTI data) is shared by HMRC with other authorities – such as the DWP, for example, for UC purposes.

As things stand then, with most salary advance schemes operating on the basis that the money is not reported to HMRC at the time that it is withdrawn by the employee, there should be no impact on UC because there is no report of the advance to HMRC/DWP. It would however potentially create some issues if DWP were to carry out a compliance check of a claimant’s UC award, for example by checking bank statements, because the payments in the bank may not match the RTI data held by DWP for a particular assessment period.

Problems could arise for UC claimants if HMRC consider that amounts withdrawn under salary advance schemes are true advances, as this could place an RTI reporting obligation on the employer each time that the employee draws some money. In this case, the report of the advance would feed through to the UC assessment, which could have knock on effects for a person’s UC award (of the type described in our guidance).

Maybe it isn’t an advance?

Alternatively, it could be a loan. As per HMRC’s guidance ‘if an employer and employee make an agreement under which the employer lends the employee money and the employee agrees to repay it at a future date or dates, then the amount is not reportable by the employer or taxable on the employee’. Although if the amount is large, an employer may be providing the employee with the benefit in kind of an interest-free or cheap loan.

There is a limit of £10,000 which would probably not cause a problem for most salary loans of this kind, however the limit of £10,000 refers to the aggregate of all loans in the year. Employers would need to ensure they are adding/tracking the amount to any other loans, for example a season ticket loan, to monitor the limit. They would also need to be prepared to do some potentially fiddly calculations if the ‘strict’ rather than average basis calculations were required.

In order to justify the treatment then (certainly for advances that are a regular occurrence and aren’t ad hoc), although the schemes call the money they are paying over an ‘advance’, it seems that in substance, they are in fact treating the money as a loan.

However if the salary advance companies are actually making loans, then there is a question as to whether this constitutes an FCA regulated activity. As they are essentially only loaning people their own money with no interest per se, I imagine they would say not, however this means that employees do not get any of the consumer rights or protections that they otherwise would from a regulated credit provider in terms of affordability checks, fees or service provided, for example.

Is there a national minimum wage (NMW) problem?

My understanding from HMRC’s guidance is that when the salary advance (or loan) is made the amount is not taken into account as part of NMW pay. The recovery of a salary advance (or indeed a loan) is not a reduction in pay for NMW purposes. To achieve this, it would be important for employers to make sure the documentation/payslip entries were absolutely correct.

However, in my mind, there is a question over whether the fees that are deducted from the employee’s pay should count as a reduction in their NMW pay (which could then bring their pay beneath the prevailing NMR hourly rate). Such fees could perhaps be seen as being in connection with work or as a deduction or payment for the employer’s own use and benefit (even if it is also benefiting the worker). This is because the worker using the third party service to essentially better align their work and earnings provides an advantage to the employer who might otherwise face quite a lot of payroll administration in running more frequent payrolls. This is something LITRG have sought to clarify with HMRC.

What do HMRC think?

It is worth noting that HMRC have not yet published any guidance on their view of salary advance schemes (that we can find).

We have therefore sought to clarify the payroll position with HMRC (that is, whether it is an advance or a loan), as well as whether these arrangements have any National Minimum Wage (NMW) implications. As yet, we do not have a definitive answer from HMRC.

HMRC’s quiet stance is perhaps understandable – if the withdrawal is deemed to be a true advance, this would render the schemes unworkable without legislative changes. Given all of the issues raised above, any such legislative changes would need to be fully consulted on, including how they would fit with the underlying rationale for RTI. Any consultation would also need to explore the underlying rationale for the schemes given they arguably fulfil a need in the market but also mean employees (often low paid employees) are paying to access their wages on a more frequent basis than monthly. Let’s not forget that the RTI system that HMRC imposed on employers has probably been the root cause of some of them turning away from weekly payrolls in the first place.

On the other hand, if HMRC were to decide the payments are advances where do you start to unpick the messy compliance issues that follow, and that have been allowed to drift for several years? Looking forward, do they really want thousands more RTI submissions to account for advances?

It is a very tricky conundrum for HMRC. I’m certainly not sure what the answer is or should be. A good and through understanding of the landscape/data will be crucial to help them arrive at a position. At scheme level – who are the main stakeholders, what bite do the schemes have, how difficult would it be to roll back the salary advance phenomenon? And at an individual level - the number of advance payments made under these schemes each year, the number of employees using them, how often employees take advances on average etc.…

What I do know is that if HMRC determine that these schemes are allowable under the current legislation or if the decision is taken to put measures in place – for example to allow multiple drawdowns of salary with just one monthly RTI report, then I hope that HMRC will ensure that it is possible for employers offer their employees this access directly, without having to resort to using a third party provider who will charge the employees a fee.

What else could employers do to help in the meantime?

If employees are struggling to manage their money, employers could signpost them to organisations where they can get free advice, for example Citizens Advice, StepChange or National Debtline.

If an employer is considering setting up a salary advance scheme, there is some good guidance from the CIPD, including on the pros and cons of salary advance schemes and other strategies that employers could use to promote employee financial wellbeing, available on their website. For example, as an alternative to using a salary advance scheme, it may be possible to do something inhouse or run a weekly payroll so that employees received their money more frequently – which brings me nicely back to my recent article in Tax Adviser!