When NET is not what you think!

What should be one of the most simplest terms in use turns out to be one of the most complicated. Much of the confusion is a result of whose point of view!

For what should have such a simple meaning, HM Revenue and Customs (HMRC) have such a different and varying use of the term. All related to whether something has tax relief, or whether something is deducted before or after tax.

Equally there is the confusion of what HMRC understand as Net in one place and confuse that with the more general meaning of the word net in the dictionary and as understood by the man on the street.

The result of the confusion and incorrect application can lead to chaos, a significant payroll headache to attempt to resolve. Often an expensive experience for employers who get the terms mixed up or wrong.

So who are the potential stakeholders of the term ‘NET’

The NET term stakeholders in relation to pay, tax, pensions and payments are:

• Employees – those receiving the payment
• Employers – who have a mixture of stakeholder to deal with from the organisation, finance, employees and also HMRC
• Payroll software – which has to handle the varieties of values which may be considered net pay for a variety of uses
• Banks – who simply want to know the net amount to deduct as a debit from an employer bank account to pay into the employee account as a credit
• HM Revenue and Customs (HMRC) – well their use of the term net becomes a little strange and confusing and will not be the common use of the term
• Pension Schemes – pensions operate two common forms of tax relief, one referred to as the Net Pay Arrangement (NPA) and the other as Relief At Source (RAS). The actual application can be the opposite of what the terms may appear to mean.

Dictionary

So what does NET or Nett actually mean in English language terms?

According to both Collins and Oxford, in relation to financial term of the use of Net:

A net amount is one which remains when everything that should be subtracted from it has been subtracted.

So that’s simple then – or is it!

Payroll and net pay

In payroll terms, net pay is often used to refer to take home pay.

Often this is the amount credited into an employees bank account. After everything has been subtracted.

This credited amount also often matches the ‘net pay’ declared on the employees payslip. It has little to nothing to do with whether a deduction is applied before or after tax.

However, this is often where confusion starts to occur, especially in relation to the application of deductions such as pension, charitable giving or even the purchase of shares via a Share Incentive Plans (SIP).

Why? – All because of tax!

Is a net deduction before or after tax?

The real question is whether something is to be applied before tax, or after tax. Similar question could also apply to National Insurance, is it before or after

However, many questions in relation to the point of where tax is applied is confused by mixing in the term Net with the HMRC definition and use of Net.

‘Is the amount to be deducted from net.’ Sounds reasonable, however, the reality is that net is always after every deduction so nothing is deducted from net as it’s the end result, or is it!

So why is the net term mixed in with tax? And then is the term the right way round?

The HMRC use of the term net!

HMRC like to call tax payers and employers customers, however, their terminology use is not overly customer centric but from the point of view of the internal HMRC view without thought to the general meaning in English language, or as a reference to taxation law and the amount to be taxed.

Unfortunately employers mimic the language but without understanding the real meaning.

HMRC and the Net Pay Scheme or Net Pay Arrangement

According to HMRC ‘A net pay scheme is where the employer takes your pension contributions from your pay before any tax is deducted’.

Oh! So that’s a deduction from Gross Pay which uses the term net! What’s that to do with actual Net pay?

Equally the HMRC describe the Net Pay Arrangement as: ‘….pension contributions will be by means of payroll deduction. The member’s employers will deduct the contribution from the ‘gross pay’ in the tax year the contribution is made. The employer is able to operate ‘PAYE’ on the net amount giving full relief at the marginal tax rate. Once relief is given on a contribution through this arrangement, relief will not be given on the contribution under any other provision to avoid a double deduction of tax relief.’

‘Full tax relief is received up front with this method. Here the contribution is deducted from a member’s pay but before tax has been deducted. If the contribution is £100, £100 will be deducted from the member’s pay and paid into the pension scheme. As the contribution is taken from the member’s pay before tax is calculated they have effectively been given full tax relief.’

So the term Net Pay Scheme or Net Pay Arrangement relates to a deduction before tax and not after – how confusing!

But it’s not just pensions, the reference could also be applied to payroll charitable giving (deducted before tax) and share purchase via a Share Incentive Plan (deducted before both tax and National Insurance).

So tax is assessed on Gross taxable pay minus tax approved pension contribution so the tax is applied on the resulting net after the pension contribution! Confused or what?

That will be a surprise to some who think it means the opposite, and consequently either describe their pension tax relief type incorrectly to their payroll software or in reverse to the HMRC application of the term net pay scheme!

What is even stranger is that a Relief At Source (RAS) contribution has no tax relief in the payroll calculation as tax relief is handled by the pension scheme.

It is known by the Pension Regulator and HMRC that a significant number of employer pension schemes are set up in the opposite way to they should be – employers are populating values on the Real Time Information (RTI) Full Payment Submission (FPS) fields incorrectly!

Real Time Information Data Items and the use of the term Net

The RTI data item guides outlines a number of fields that refer to net just to add to the confusion:

Data item 58B is used to report the value of deduction from the taxable net payment and has no reference to any real net pay value. It then confuses further by referencing pension contributions that are not paid under the net pay arrangement. This field was introduced to enable balancing the BACS hash to the BACS credit BACS hash value. The BACS hash itself has been withdrawn from use, however, the field ironically continues.

The next data item is 61 which is used to report pension contributions that were deducted before tax. Just to confuse these are referred to tax relief through the Net Pay Arrangement or a Net Pay Scheme, however, the amounts are deducted from Gross and not net. The reference to net is the amount to be taxed.

Data item 65 is to report pension contributions that are after the deduction of tax, this is where the value for Relief At Source (RAS) are reported, although there is no tax relief operated within the payroll!

Data item 150 is the year to date value associated with data item 61.

Data item 151 is the year to date value associated with data item 65.

When an employer makes the mistake of reporting RAS(not under net pay) contributions through RTI in the data fields for a net pay scheme. This results in providing tax relief through payroll incorrectly, in addition to the tax relief correctly provided via the pension scheme provider and HMRC PSS. The excess relief provided is considered an employer payroll failure, and the employer is liable for the tax under deducted and remitted to HMRC.

Any employer that is uncertain should check with their scheme provider on how the scheme is registered. If any employer then determines that their payroll is configured so that they have reported RAS contribution in the FPS reporting field for “contributions not under net pay” they should correct this immediately.

Any errors identified from previous periods should be reported through the HMRC digital disclosure facility.

What does The Pensions Regulator have to say about it!

The regulator issues instruction to Defined Contribution schemes on good communication on pensions tax relief methods.

Key points

• There are two tax relief arrangements that may apply to member contributions – ‘net pay arrangement’ and ‘relief at source’.
• These arrangements may affect higher and lower paid scheme members in different ways.
• The tax relief arrangement may affect how much it costs a member to contribute.
• We expect you to provide members with clear, accurate and relevant information about how they’re affected and whether they need to take any action.
• We expect you to review your tax relief communications and improve them if they don’t meet the needs of all members.

They also provide information on what to do when the wrong tax relief method has been applied:

Be clear – is it before tax or after?

So the use of the term net deduction can have multiple meanings in different contexts. Make sure your use of the term Net is clear when providing payroll instruction.

Just to be safe do not refer to anything as being Net as far as deductions and pensions are concerned, make it clear that something is to be taken before or after tax.

Also consider the application of salary sacrifice contractual reductions and that any pay elements associated are correctly and clearly defined.

There are too many employers and pensions schemes that may have used the wrong terminology when setting up their payroll parameters and calculations and the wrong application of tax relief has been applied.

Check and if necessary, correct.

PAYadvice.UK 15/4/2025