Business tax – guidance

Paying an employee in advance for holidays or from holiday pay scheme

PAYE procedures to follow if you pay holiday pay in advance or run a holiday pay scheme for your employees.

Overview

If you pay employees’ holiday pay in advance or use certain holiday pay schemes you’ll probably have to work out the PAYE tax and National Insurance contributions (NICs) in a different way.

Holiday pay paid in advance - work out the tax

Type of tax code How to work out the tax due
Employee has cumulative tax code Calculate and record the tax due using the free pay for the last pay period in which they got no pay
Employee has ‘Week 1’ or ‘Month 1’ tax code Divide the holiday pay equally between each full week of their holiday and work out the PAYE tax separately for each week - report the payment on the date you make it

Holiday pay paid in advance - work out the NICs

Split the payment and work out NICs due separately on the earnings for each pay period.

If your employee is weekly paid you can use a different method - you can work out the NICs on the whole sum based on the number of weeks it represents. But you can’t use this method if you’re paying someone from a holiday pay scheme.

Employee leaving after their holiday

If your employee’s leaving or retiring straight after their holiday, work out the tax due on their holiday pay using the free pay for the week in which you pay it to them. Report the payment on the date you make it.

Holiday pay set aside during the year

If an employee voluntarily sets aside some of their pay during the year, and you give it back to them later as holiday pay, work out the tax and NICs at the time it’s set aside.

Holiday credit schemes

If you run a holiday credit scheme where you set aside money from your employees’ pay each payday and then pay it in a lump sum when they take their holidays, what you do depends on whether they have a choice about when they get the money.

When they can get the money How to work out the tax and NICs
Employee can have the money whenever they want it Include it in their gross pay at the time it’s set aside
Employee can only have the money when they take their holidays Include it in their gross pay at the time you give them the money

Holiday pay funds

Less common now that all employers must give their employees paid time off, these schemes were mainly used by trades where people only worked for a few weeks at a time.

Holiday pay paid from this type of scheme or fund must be added to the employee’s gross pay to work out the NICs due.

For PAYE tax purposes, include the cost of holiday pay stamps or credits in their gross pay only if the fund you use hasn’t been approved by HM Revenue and Customs (HMRC). If it has been approved, you can disregard these costs, as well as any holiday payments made from the fund - approved funds already deduct tax from their payments to employees.