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HMRC internal manual

PAYE Manual

Reconcile individual: end of year reconciliation: arrears of pay or pension

Arrears of pay may arise because

  • An employer or employee discovers that wages or salary paid in an earlier period were less than what should have been paid under the employee’s contract
  • The employer’s payroll or HR systems make an error
  • Equal pay legislation applies and the employer has to pay the arrears to the employee(s) or a court has ordered this

Legally, an employee’s tax liability on a payment of arrears arises in the tax year that the employee was originally entitled to be paid the extra amounts, not in the year that payments are eventually made. However, if arrears are paid in one lump sum in the current tax year then PAYE is due at the time of payment.

Where possible the employer should calculate the tax due for all closed tax years and deduct tax under PAYE.

Where the employer fails to calculate and deduct the tax due on the arrears in the closed year and instead pays the arrears as one lump sum in the current year, the whole amount of the arrears plus pay for the year will be included on the P14 or EOY Record for one year. When the P14 or EOY Record is received and the case is ripe, the arrears will be included in the reconciliation for the year.

Where the customer queries the reconciliation, they have the right to ask that the arrears are related back to the year in which they should have been paid. To deal with claims to reallocate arrears of pay or pension see action guide tax40121.