EMPLOYMENT
INCOME
June 2025 – March 2026
BY SABI AKTHER 1
What to focus on?
• Employment or Self-Employment
• Practical Significance
• Why HMRC Prefers Employee Status
• Proof of Employee Status
• Employment Income
• Types of Income
• Pro Forma Computation
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What to focus on?
• Earnings (or Pay)
• Basis of Assessment
• Expense Allowances & Reimbursed Expenses
• Allowable Expenses of Employment
• Claiming Tax Relief for Expenses
• Conclusion
• Summary
• Technical Articles
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Objective: To describe the detailed rules for assessing income (i.e. pay and benefits) arising
from employment.
Employment or Self-Employment
• Practical Significance
• HMRC Preference
• Proof of Status
Employment Income
• Types of Income
• Pro Forma Computation
Earnings (or Pay)
• Basis of Assessment
• Expense Allowances &
Reimbursed Expenses
• Allowable Expenses of
Employment
• Claiming Tax Relief 4
Employment or Self-Employment
1.1 Practical Significance
It is normally quite easy to distinguish a self-employed person from one who is employed by a
business.
However, difficulty has been encountered in practice when dealing with persons engaged on
a sub-contract or freelance basis to provide personal services (e.g. musicians, actors,
teachers and lecturers, IT and business consultants, childminders).
Such persons will maintain they are self-employed because they do not have contracts of
employment and so are not entitled to employment benefits such as holidays or sick pay, they
are hired to provide a specified service with no certainly of getting repeat work and are paid
against invoices submitted.
An employee generally has a ‘contract of service’, whereas a self-employed person generally
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has a ‘contract for services’.
Employment or Self-Employment
1.2 Why HMRC Prefers Employee Status
HMRC is keen to establish employee status because:
• It generates more NICs (see Lecture 10 for details). The employers must pay Class
1 (on salaries) and Class 1A (on benefits) and the employees pay higher Class 1 as
opposed to the self-employed Class 4 contributions.
• It reduces the risk of income tax evasion by applying tax deduction at source
(PAYE); and
• It makes it more difficult to claim allowable expenses. For example, a self- employed
consultant maintaining an office at home will get tax relief for all their business-
related travel costs incurred between their office and clients.
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• It makes tax collection cheaper (i.e. PAYE is run by the employers).
Employment or Self-Employment
1.3 Proof of Employee Status
There have historically been several "badges of trade" which need to be evaluated in
each case in deciding whether an individual is employed or self-employed as follows:
• Can you send in a substitute? If you cannot send in a substitute to provide the
services, this is indicative of employment.
• Does the person for whom you are working have control over your work and the way
in which you do it? If the person providing work has control over the work and the
way it is done, this is indicative of employment.
• Do you work a set working pattern (i.e. fixed days/hours)? A set working pattern with
fixed days or hours is indicative of employment, whereas freedom to choose which
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days and hours are worked is indicative of self-employment.
Employment or Self-Employment
1.3 Proof of Employee Status
There have historically been several "badges of trade" which need to be evaluated in
each case in deciding whether an individual is employed or self-employed as follows:
• Are you paid a fixed hourly/weekly/annual rate? Fixed hourly, weekly or annual rates
could be indicative of employment.
• Do you receive bonuses/overtime? Entitlement to bonus and overtime is indicative
of employment.
• Do you bear the financial risk for unsatisfactory work? Bearing financial risk for
unsatisfactory work is indicative of self-employment, whereas someone with no
financial risk is more likely to be employed. 8
Employment or Self-Employment
1.3 Proof of Employee Status
There have historically been several "badges of trade" which need to be evaluated in
each case in deciding whether an individual is employed or self-employed as follows:
• Do you provide the plant and equipment necessary to do the job? Provision of own
equipment is indicative of self-employment, whereas equipment provided by
someone else is indicative of employment.
• Would work normally be quoted for on a fixed price, regardless of how long it may
take? Fixed price work is more indicative of self-employment.
• Do you decide the timetabling for carrying out jobs? Setting the timetable for jobs is
indicative of self-employment. 9
Employment or Self-Employment
1.3 Proof of Employee Status
There have historically been several "badges of trade" which need to be evaluated in
each case in deciding whether an individual is employed or self-employed as follows:
• Do you have to correct unsatisfactory work in your own time and at your own
expense? Correction of unsatisfactory work at own expense is indicative of self-
employment.
• Do you work for a number of different "customers"? Having many different
customers is indicative of self-employment.
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Employment or Self-Employment
1.3 Proof of Employee Status
These questions may be categorised in the following tests for consideration:
• The obligations test – i.e. if a person is obliged to perform the work offered using
equipment provided and methods determined by the employer during the hours
specified by the employer, this is indicative of employment.
• The similarity of work test – i.e. if the work undertaken is similar to the work undertaken
by the employer's own staff, this is indicative of employment.
• The exclusivity test – i.e. if the person is not allowed to do similar work for other
employers, this is indicative of employment.
• The uninsurable risks test – i.e. if the person does not take the uninsurable risks of self-
employment (e.g. unreliable, non- recurring income and no paid holidays or sick leave),
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this is indicative of employment.
Employment or Self-Employment
1.3 Proof of Employee Status
It is possible that a person can be employed for work undertaken for one employer but
otherwise remain self- employed.
No single badge of trade, or test, will be conclusive. Case law shows that all factors
must be taken into consideration to look at the full picture.
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Employment or Self Employment
1.3 Proof of Employee Status
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Employment or Self Employment
1.3 Proof of Employee Status
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Employment Income
2.1 Types of Income
General earnings for employment income consist of remuneration less allowable
expenses of employment. Remuneration may be paid in:
• monetary form (i.e. cash); and
• non-monetary form (i.e. taxable benefits).
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Employment Income
2.2 Pro-Forma Computation
Salary x
Bonus x
Commission x
Expense allowances (or reimbursed expenses) x
Less: Allowable deductions
Employee contributions into occupational pension schemes (x)
Subscription to professional bodies (x)
Payroll gifts to charity (x)
Allowable expenses (x)
Income from employment x 16
Employment Income
2.2 Pro-Forma Computation
Pension income is taxed in the same way as earnings from employment.
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Earnings (or Pay)
3.1 Basis of Assessment
Earnings are primarily wages and salaries, but also include commissions, bonuses,
gratuities, or other profit or monetary (or convertible into monetary) reward of
employment.
These amounts are assessed on an actual receipts basis (i.e. earnings received in the
tax year). The date earnings are received is normally the earlier of:
• the date payment is made; and
• the date on which the taxpayer becomes entitled to the amount. (These dates are
usually, but not always, the same.)
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Earnings (or Pay)
3.1 Basis of Assessment
A more complex version of this principle applies to company directors. Since such
people are sometimes in a position to award earnings to themselves at times and in
ways that could avoid or delay the payment of the tax, they are assessable on the
earliest of:
• date of receipt;
• end of the company's accounting period, if amount was determined (i.e.voted)
during the accounting period;
• when amount determined (i.e. voted), if determined after the end of the accounting
period to which they relate. 19
Earnings (or Pay)
3.1 Basis of Assessment
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Earnings (or Pay)
3.1 Basis of Assessment
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Earnings (or Pay)
3.1 Basis of Assessment
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Earnings (or Pay)
3.1 Basis of Assessment
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Earnings (or Pay)
3.2 Expense Allowances and Reimbursed Expenses
Generally, these are taxable in the hands of an employee unless the expenses are
wholly, exclusively and necessarily in the performance of duties of employment.
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Earnings (or Pay)
3.3 Allowable Expenses of Employment
3.3.1 Summary
An employee may claim an expense deduction for:
• their own contributions into an occupational pension scheme (see Lecture 2);
• payroll gifts to charity (see Lecture 2);
• professional subscriptions to approved bodies;
• entertaining, provided the actual entertainment costs are treated as disallowable
expenses in the hands of the employer;
• qualifying travel costs (see s.3.3.2);
• use of own car for business purposes (see s.3.3.3);
• working from home (see s.3.3.4);
• other expenses (e.g. accommodation and subsistence), that are wholly, exclusively and 25
necessarily incurred in the performance of the duties of the employment (see s.3.3.5).
Earnings (or Pay)
3.3 Allowable Expenses of Employment
3.3.2 Travel Costs
Travel expenses incurred by an employee are tax deductible provided that they are:
necessarily incurred in the performance of the duties of employment; or
incurred to enable an employee to travel to or from their home to a temporary place of
employment; or
incurred to enable an employee to travel between two (or more) temporary places of
employment, and the employee works for the same employer at each location.
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Earnings (or Pay)
3.3 Allowable Expenses of Employment
3.3.2 Travel Costs
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Earnings (or Pay)
3.3 Allowable Expenses of Employment
3.3.2 Travel Costs
The cost of regular commuting from the employee's home to their permanent place of
employment, even for exceptional reasons (e.g. weekend working) and any cost
incurred for purely personal reasons (e.g. attending an out-of-hours office party) are
disallowable.
A place of temporary employment is one in which an employee is expected to work
for a continuous period of ≤ 24 months.
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Earnings (or Pay)
3.3 Allowable Expenses of Employment
3.3.3 Use of Own Car for Business Purposes
Many employers reimburse their employees for the business use of their own car
rather than providing a company car.
Provided the mileage allowance is within the limit set by applying the HMRC
statutory mileage rates, no taxable benefit arises.
Statutory tax-free mileage rates are given on the tax rates and allowances provided in
the exam. They are currently 45p per mile up to 10,000 miles and 25p per mile
thereafter.
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Earnings (or Pay)
3.3 Allowable Expenses of Employment
3.3.3 Use of Own Car for Business Purposes
The operational effects of the scheme are:
• If the actual allowance received exceeds the statutory limit, the excess is taxable.
• If no allowance is paid by the employer, an allowable expense may be claimed
equal to the statutory limit.
• If the actual allowance received is less than the statutory limit, the allowable
expense claim is restricted to the excess of the statutory limit over the actual
allowance. 30
Earnings (or Pay)
3.3 Allowable Expenses of Employment
3.3.3 Use of Own Car for Business Purposes
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Earnings (or Pay)
3.3 Allowable Expenses of Employment
3.3.3 Use of Own Car for Business Purposes
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Earnings (or Pay)
3.3 Allowable Expenses of Employment
3.3.4 Working From Home
Employees who are required by their employers to work from home can claim the
following amounts as an allowable expense of employment:
• the cost of business telephone calls (but not rental charges) from a private
telephone;
• other household costs (e.g. heating and lighting) up to £6 a week (without
evidence) and larger amounts (if justified by evidence and calculations).
These tax reliefs may be claimed irrespective of whether the employer has
reimbursed the employee for these costs.
Employees working from home on a voluntary basis cannot claim expenses if they are
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not reimbursed by their employer.
Earnings (or Pay)
3.3 Allowable Expenses of Employment
3.3.5 Other Expenses
"Wholly and exclusively incurred" implies that the entire expense is related to the
performance of the duties.
"Necessarily incurred" means the expense must be incurred to perform the duties of
the employment and would be incurred by any person carrying out those duties.
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Earnings (or Pay)
3.3 Allowable Expenses of Employment
3.3.5 Other Expenses
Taken as a whole, the "wholly, exclusively and necessarily" rule means that:
• Expenses tainted by duality of purpose (i.e. the reason for incurring the cost was
not solely to undertake the duties of employment) cannot be treated as being
wholly, exclusively and necessarily incurred (e.g. lunches taken at work, unless
provided by an employer in a staff canteen, because the main purpose is to eat
rather than perform duties of employment). However, in some cases, expenses
tainted by duality of purpose may be reasonably apportioned between personal and
business (e.g. a business trip extended to incorporate a holiday). 35
Earnings (or Pay)
3.3 Allowable Expenses of Employment
3.3.5 Other Expenses
Taken as a whole, the "wholly, exclusively and necessarily" rule means that:
• Expenses incurred to put the person into a position to carry out the duties of their
employment are not allowable as they were not incurred in the performance of
the duties (e.g. the costs of training to obtain a professional qualification where
paid by the employee themself).
The cost of clothes for work is not a deductible expense, except in certain
circumstances where protective clothing is required. Even if an employee needs to
purchase expensive clothing, such a business suits, it is not an allowable
deduction, due to the duality of purpose in that an employee needs clothing to fulfil 36
the personal need of being dressed for decency.
Earnings (or Pay)
3.4 Claiming Tax Relief for Expenses
Expenses that are generally allowable in all employment situations, will normally be
deducted by the employer from salary before calculating the tax to be deducted at
source under PAYE (e.g. pension contributions to occupational pension schemes and
payroll gifts to charities).
Expenses that are clearly allowable and therefore qualify for an automatic exemption,
are not taxable income:
i. the employer does not have to inform HMRC of the expense allowance or
reimbursement paid to or on behalf of the employee; and
ii. the employee does not have to make a claim in their tax return for the allowable
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expense.
Earnings (or Pay)
3.4 Claiming Tax Relief for Expenses
Automatic exemption mainly covers situations where employers pay expense
allowances or reimburse expenses that relate to the duties of employment of many
employees of the business (e.g. out-of-office travel and subsistence costs, business
entertainment, phone bills, uniforms and tools for work).
To obtain tax relief for any other allowable expenses that are not addressed through
the payroll by the employer, the employee must claim the allowable expenses when
making their annual tax return.
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Conclusion
Syllabus Coverage
B. Income Tax and NIC Liabilities
2. Income from Employment
a) Recognise the factors that determine whether an engagement is treated as
employment or self-employment.
b) Recognise the basis of assessment for employment income.
c) Recognise the income assessable.
d) Recognise the allowable deductions, including travelling expenses.
e) Discuss the use of the statutory approved mileage allowances. 39
Conclusion
Summary
• HMRC prefers employee rather than self-employed status because allowable expenses
are more difficult to deduct and NICs are higher and collected at source.
• Considerations determining employment vs self-employment include level of control
over work, ability to provide a substitute, who bears financial risk, who provides
equipment.
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Conclusion
Summary
• For exam purposes, employment income includes general earnings (e.g. salaries,
bonuses and taxable benefits).
- Amounts are normally assessed on a receipts basis (i.e. when paid or due for
payment).
- Allowable expenses for income tax include pension contributions, payroll gifts to
charity, professional subscriptions, qualifying travel costs and entertainment
expenses that are disallowed in the employer's tax computation.
- Home workers may claim relief for telephone calls and up to £6 per week for
household costs without evidence.
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- Mileage allowance in excess of the statutory limit is taxable.
Conclusion
Technical Articles
In addition to the Finance Act 2024 Article, there are several technical articles for
Taxation (UK). However, there are no technical articles that relate specifically to this
chapter.
For more recent articles and other resources please visit the ACCA global website.
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