Family. Gifts. Carols, baubles, tinsel on the tree. When it comes to Christmas time, these are the things that most Kiwis are going to be thinking about—but there’s one more thing that business owners need to keep in mind over the Season of Giving: how much they should be giving to their employees in pay over the holidays.
Read more: Specialist tax advice
It might not be as exciting as a beer and a barbecue, but getting holiday pay right over the Christmas period is integral to ensuring the IRD doesn’t leave a piece of coal (and a fine) in your stocking…
Here’s what you need to know:
What is holiday pay?
Inland revenue is more concerned with when holiday pay is paid rather than how it is calculated.
How is the tax on holiday pay calculated?
Salary and wages
The simplest and likely most common way of dealing with holiday pay over Christmas is paying it out as when your staff go on leave. They are taxed at whatever marginal rate you use for their regular salary and/or wage, and the amount paid is linked to the work days within a given pay period.
The simplest and likely most common way of dealing with holiday pay over Christmas is paying it out as when your staff go on leave.
This method is used when an employee elects to take holiday pay in lieu of a regular pay packet, and thus the tax applies to the same, regular pay period. You can use this calculator to calculate the distribution between PAYE, KiwiSaver, student loans and so on.
You can also pay holiday pay as 8 per cent of the employee’s total earnings which is then included in the person’s regular pay. These employees do not accrue paid annual leave, as their entitlement is already paid out in their regular pay.
An employee who is paid weekly goes on leave for 2 weeks over the holiday. This person is paid weekly as per their normal pay salary, but rather than their usual salary, they are paid 5 days of holiday pay in each weekly pay period.
The gross amount of holiday pay is to be allocated to the number of days taken in this instance.
If holiday pay is paid out as a lump sum, it is taxed as extra pay, rather than as PAYE. This may occur if an employee elects to take their pay out at the beginning of the holidays in addition to their regular pay, rather than in lieu over the course of the holidays.
Another situation in which a lump sum payment may be used is if you are ending an employment contract and are paying out the remaining leave days to an employee, or if somebody was “cashing out” their leave entitlement.
The office closes over the holidays, and the employees are required to take 10 days of paid leave. However, Mike has asked that his holiday pay is paid out before the holidays actually begin, as he is going on holiday and needs a lump sum to pay for the costs.
He receives this holiday pay in his next paycheque, i.e. it is not paid out over the course of the holidays. This is considered an extra pay and will be taxed as such.
What if you tax it incorrectly?
These differences in the way that holiday pay is taxed in comparison to regular pay can cause confusion, and has resulted in incorrect tax being applied more than a few times—particularly when payroll is operating across multiple jurisdictions.
For example, one recent case involved a company whose payroll admin was performed from Australia, but the business was actually based in New Zealand. Due to an administrative error, the incorrect tax was paid over holiday pay, and the IRD came down—hard.
These differences in the way that holiday pay is taxed in comparison to regular pay can cause confusion, and has resulted in incorrect tax being applied more than a few time.
The IRD considers the employer company as holding the funds “in trust” for all employees when dealing with PAYE obligations. As a result, the company was required to search through their records from years back to find out who was owed holiday pay, even those employees who had left the company and even some who had left New Zealand, causing a significant administrative headache—not to mention the tax shortfall issue and penalties.
Problems like these became so common that new rules were put in place as of August 2017 to allow for “remedial payments”. These occur when you realise you have made a mistake with holiday pay (usually as a result of not calculating the 8 per cent rule correctly), and need to top up an employee’s payments. You can read more about the exact details of this here, but the gist of it is that these backdated remedial payments will be considered as extra pay.
Before you crack into the Christmas wine and start celebrating, it pays to make sure you have your employees’ Christmas holiday pay calculated correctly. Alternatively, if you’d rather start getting jolly sooner rather than later, you can simply hand your tax troubles over to Bellingham Wallace.
To find out more, get in touch with our team today!