How To Stay Compliant With PAYE Settlement Agreement?

Managing employee expenses and benefits, such as vouchers, can be complex for UK employers, especially when those benefits are minor, irregular, or hard to allocate to specific employees. That’s where PAYE Settlement Agreements (PSAs) come in. This comprehensive guide explains what a PSA is, why your business might need one, how to apply, what you can and cannot include, and how to calculate and pay the tax due. It also covers how to stay compliant and avoid HMRC penalties.

Whether you’re an HR professional, payroll manager, or small business owner, this article will help you understand everything you need to know about PSAs so you can make informed, practical decisions for your company.

What Is a PAYE Settlement Agreement?

A PAYE Settlement Agreement (PSA) is a formal arrangement between an employer and HM Revenue & Customs (HMRC) that lets the employer make a single annual payment to settle the tax and National Insurance contributions (NICs) due on certain expenses or benefits provided to employees on behalf of their employees. Instead of putting these items through payroll management or asking employees to account for them on their own tax returns, the employer settles the liability in one annual payment.

In other words, with a PSA, the employer takes on the cost of the tax burden for specific benefits and expenses on behalf of the employees. HMRC treats the tax due as if the payment to the employee was net of tax, so the employer’s payment covers both the grossed-up tax and any Class 1B NICs due.

What to include in a PAYE Settlement Agreement?

The expenses or benefits to be included must be “minor”, “irregular” or “impracticable” to operate PAYE on the item:

1. Minor

There is no pre-determined limit to the value, but it might include items such as gifts and vouchers to mark good work, or small gifts not covered by the trivial benefits rules. These are generally low-cost, one-off rewards that aren’t part of regular pay.

2. Irregular

This includes items not paid at regular intervals over the course of a tax year. It might include, for example, relocation expenses not covered by the £8,000 limit. These payments are occasional and not part of a consistent pattern.

3. Impracticable

Items where it would be difficult to allocate a value to individual employees would fall into this category. This would typically include the costs of a staff entertaining event for a large number of employees. Such expenses are hard to track individually for PAYE purposes.

How to Apply for a PAYE Settlement Agreement?

If you decide you want to set up a PSA, you’ll need to formally agree it with HMRC.

1. Apply in Advance

You must agree the PSA with HMRC before the end of the tax year, specifically by July, for which you want it to apply in January. This means you need to plan ahead and allow time for HMRC to process your application.

How to Apply

You can apply in one of two ways:

• By using HMRC’s online PSA1 form or digital service
• By writing to HMRC’s PAYE Settlement Agreements team with details of what you want to include

You’ll need to describe the types of expenses and benefits you want to include and explain why they fit HMRC’s minor, irregular, or hard-to-allocate criteria.

HMRC’s Response

HMRC will review your request and, if approved, issue a formal PSA agreement. This sets out the categories of benefits covered. You can’t simply decide to add other items later without approval.

PSAs are ongoing agreements until cancelled or changed, so you don’t need to reapply every year unless you want to change what’s included.

How To Calculate the Tax and National Insurance Due?

Once you have a PSA in place, you must do an annual calculation of the tax and NICs due.

1. Grossing Up the Tax

Because the employer pays the tax on the employee’s behalf, you must “gross up” the value of the benefit. This means you calculate the tax as if the employee had received the net amount.

For example, if the total value of benefits is £1,000 and the employee is a basic-rate taxpayer (20%), you work out:

• Tax = £1,000 / (100% – 20%) = £1,250
• Tax due = £250 (20% of £1,250)

You need to do separate calculations for employees at different tax rates.

2. Class 1B NICs

On top of the grossed-up tax, you’ll pay Class 1B NICs at the prevailing rate (currently 13.8%). This applies to both:

• The value of the benefits
• The income tax due on them

3. Completing Form PSA1

Your annual submission to HMRC is done via form PSA1. You break down your calculations, showing:

• Each category of benefit
• The total cost per category
• The grossed-up tax due
• The Class 1B NICs due

HMRC will check your calculations, confirm the total amount payable, and send you a payment demand.

4. Payment Deadline

You must pay the tax and NICs due under your PSA by 22 October (or 19 October if paying by post) following the end of the tax year. For example, for the 2024/25 tax year ending 5 April 2025, your payment is due by 22 October 2025.

Failure to pay on time can result in interest and penalties.

What Are The Benefits of Using a PAYE Settlement Agreement?

Employers choose to use PSAs for good reasons. They simplify reporting and paying tax on certain staff benefits, saving time and reducing admin. A PSA lets you cover the tax for employees, boosting goodwill. Next, we’ll look at what can be included, how it works, and how to set one up with HMRC.

1. Simplify Payroll Administration

Instead of processing irregular or minor benefits through payroll each time, which can be fiddly and time-consuming, you handle them all together in one annual payment. This means less frequent admin work and simpler record-keeping. It streamlines reporting by allowing you to settle the tax in bulk once a year.

2. Improve Employee Satisfaction

Employees don’t face surprise tax bills for small benefits or events. The employer pays the tax on their behalf, removing any unexpected costs. This approach can boost employee goodwill and improve overall morale.

3. Ensure HMRC Compliance

A PSA is a formal agreement with HMRC. Using it properly ensures you meet your tax obligations accurately. This helps you avoid mistakes or penalties for incorrect PAYE or benefit reporting. It also gives you peace of mind knowing your employee benefits are handled compliantly.

4. Budget Certainty

Because the tax is paid once a year under a PSA, you can plan and budget for the total cost well in advance. This allows you to factor it into your annual financial planning rather than dealing with multiple small payments throughout the year. It also makes forecasting easier and helps manage cash flow more effectively. With clear timelines and one consolidated payment, there are fewer surprises.

What Should Employers Watch Out for Before Using a PAYE Settlement Agreement (PSA)?

While a PSA offers convenience, it’s not the ideal solution for every situation. Before opting in, consider these potential drawbacks:

1. Potentially Higher Overall Cost

Because tax is “grossed up” under a PSA, the total cost to the employer is often significantly higher than if the same amount were simply paid to employees via payroll. You’re not just covering the benefit—you’re also covering the tax that would have been deducted from the employee.

2. Additional Administrative Burden

Although PSAs simplify reporting for small, irregular benefits, they don’t eliminate all admin work. You still need to track eligible items throughout the year, calculate the tax due, complete the PSA1 form, and ensure timely payment to HMRC.

3. Not Suitable for All Benefits

Not every expense or benefit can be included in a PSA. Items like company cars or regular bonuses must still be reported via payroll or on P11D forms. Employers must remain aware of their full PAYE and benefits reporting responsibilities, even if a PSA is in place.

What Are the Most Common Mistakes Employers Make With PAYE Settlement Agreements?

Even with the best intentions, PAYE Settlement Agreements (PSAs) can go wrong if employers overlook key requirements. Here are the most frequent missteps to watch out for:

1. Missing the Application Deadline

You must agree your PSA with HMRC before 5 April of the tax year it applies to. If you miss this deadline, your agreement won’t be valid for that year—and you’ll need to wait until the next.

2. Including Ineligible Items

Not everything qualifies for a PSA. Attempting to include regular wages, cash bonuses, or salary top-ups will result in rejection or penalties if HMRC later finds out during a review.

3. Poor Record-Keeping

HMRC expects clear and accurate records showing what was included in the PSA, who received the benefits, and how the tax was calculated. Without this evidence, you risk miscalculations, compliance issues, or failed audits.

Direct Payroll: Simplify. Streamline. Succeed.

Managing payroll shouldn’t slow you down. Direct Payroll Services delivers fast, reliable, and stress-free payroll services designed for modern businesses.

Why Choose Direct Payroll?

• Accurate & Timely Payments – Never miss a payday.
• Full Compliance – Stay worry-free with expert tax and legal handling.
• Easy, Cloud-Based Access – Securely manage payroll from anywhere.
• Personalised Support – Friendly experts ready to help when you need it.
• Customised Solutions – Scalable for businesses, big or small.

Leave payroll to us so you can focus on what you do best.

Talk to us today to get started.

Conclusion: Make PSAs Work for Your Business

PAYE Settlement Agreements can be a valuable tool for UK employers looking to simplify how they handle certain employee expenses and benefits, which may be considered taxable benefits that employees do not necessarily have a contractual right to. By letting you pay the tax and NICs centrally, they reduce admin headaches and improve employee satisfaction.

However, PSAs come with responsibilities: you need to apply on time, keep accurate records, and ensure you only include eligible expenses. Done right, they can be an efficient, compliant way to manage the complexities of employee rewards.

If you’re considering a PSA for your business, review your expenses carefully, talk to your payroll advisor or accountant, and plan well before the tax year ends to ensure you meet HMRC’s requirements and deadlines.

Frequently Asked Questions

Do I need a PSA every year?

No, PSAs now renew every year on their own because of HMRC’s “enduring agreement.” You only need to send updates if you want to add or change something before the tax year deadline.

How are payments made under a PSA?

Payments must be made to HMRC every year by October 22. If you are paying by cheque, the due date is October 19. The taxes and NIC contributions have to be worked out and paid as a single total.

Can small businesses apply for a PSA?

Yes, small businesses in the UK can use PSAs and get many benefits. The PSA process helps you deal with small or rare employee benefits. It also helps if the benefit is hard to include in normal tax. This can make your tax work easier and faster.

What happens if I miss the PSA deadline?

If you miss the statutory deadline, you may have to pay penalties and extra interest for late payments. There is the risk that your PSA could be taken away. Sending your paperwork in late can also make the tax office look at your old benefits and ask for extra tax payments from before.

How does a PSA affect P11D reporting?

If you have an approved PSA, you will not need to use P11D forms for the benefits that are included in it. But, if the benefits given to people were from the start of the tax year and before you got approval, you may need to add these on a separate P11D to meet HMRC rules.