Employment Allowance Eligibility: The Full Rules

Around 1,418,000 employers benefitted from the Employment Allowance in the 2025 to 2026 tax year, a 16% increase on the year before ^[1]. The allowance is worth up to £10,500 per employer per tax year, set directly against employer Class 1 National Insurance liability ^[2].

That headline figure hides a more complicated picture. Eligibility is not a matter of size or turnover. It turns on the legal nature of the employer, the composition of its payroll, and whether it sits inside a group of connected companies. A business with fifty employees can be barred from claiming while a two-person company qualifies in full.

The exclusions are where most claims go wrong. Public authorities, employers of domestic staff, and limited companies whose only above-threshold earner is a sole director are all shut out ^[3]. Connected companies share a single allowance between them, no matter how many PAYE schemes they operate ^[4].

This article sets out who qualifies, who does not, how the connected company test works in practice, what happens when eligibility changes mid-year, and the record-keeping obligations that follow a claim.

Key takeaways

• The Employment Allowance is worth up to £10,500 per tax year and can only be set against employer secondary Class 1 National Insurance, never Class 1A or Class 1B.
• There is no longer any cap on an employer's Class 1 liability for claims covering the 2025 to 2026 tax year onwards.
• A limited company cannot claim if a single director is the only employee paid above the Secondary Threshold of £5,000 per year.
• Connected companies and connected charities share one allowance between the whole group, decided at the start of the tax year.
• Public authorities that are not charities, and employers of domestic staff, are excluded outright.
• Claims can be backdated up to four years after the end of the tax year they relate to.

What the Employment Allowance actually reduces

The Employment Allowance is a reduction in employer secondary Class 1 National Insurance liability, applied through payroll as the liability arises ^[5]. It is not a cash grant, not a tax credit, and not something an employer can bank for later.

Employer secondary Class 1 National Insurance is charged at 15% on earnings above the Secondary Threshold ^[6]. The thresholds that govern when that liability starts sit well below the allowance itself.

Because the allowance offsets liability as it accrues, an employer with a monthly employer National Insurance bill of £1,050 exhausts the full £10,500 by month ten of the tax year and pays the liability for months eleven and twelve in the normal way ^[5].

What the allowance cannot be used against

The allowance applies to employer secondary Class 1 National Insurance only. It cannot be set against Class 1A National Insurance on benefits in kind, nor against Class 1B on PAYE Settlement Agreements ^[5]. Nor can it be applied to income tax or student loan deductions in the first instance, although HMRC will offset an unused balance against other PAYE liabilities where a claim is made late in the year ^[7].

Employers should also note the ordering rule. The Employment Allowance comes off employer secondary Class 1 liability before any other deduction, including recoverable Statutory Maternity Pay ^[5]. Getting that sequence wrong understates the relief and overstates the amount payable to HMRC. Modern UK payroll software applies the ordering automatically, but employers running manual calculations need to apply it deliberately.

The core eligibility test

An employer qualifies if it has employer Class 1 National Insurance liabilities and is not caught by one of the specific exclusions ^[8]. For claims covering the 2025 to 2026 tax year onwards, there is no upper limit on the employer's Class 1 liability, which removed the previous restriction that barred larger employers from claiming ^[2].

That leaves eligibility resting on three questions. Does the employer actually incur employer Class 1 liability? Is the employer a type that is excluded by statute? Is the employer connected to another company or charity that is claiming?

Business structures that qualify

The allowance is available across most legal forms. Sole traders with employees can claim, provided the business pays employer Class 1 National Insurance on those employees' earnings ^[3]. Partnerships qualify on the same basis, as do Community Amateur Sports Clubs paying employer Class 1 on employee or director earnings ^[3].

Registered charities can claim even where they carry out functions that are wholly or mainly of a public nature, an exception that does not extend to non-charitable bodies doing the same work ^[9]. Schools, academies, further education colleges, universities and early years childcare providers qualify if they are private businesses or charities, including those funded by a local authority or central government provided charitable status is held ^[3].

The single-director exclusion

The most common disqualification is also the least intuitive. A limited company cannot claim the Employment Allowance where the director is the only employee paid above the Secondary Threshold ^[10]. The rule has applied since 6 April 2016 and it looks at earnings, not headcount.

HMRC's own worked example makes the trap explicit. A director paid above the Secondary Threshold who employs four staff, none of whom earn above the Secondary Threshold, cannot claim ^[11]. The company has five people on payroll and still fails the test, because only one of them triggers employer Class 1 liability.

The reverse also holds. Where a sole director earns below the Secondary Threshold but another employee earns above it, the company can claim ^[3]. A company with two paid directors, both above the Secondary Threshold, is eligible for the whole tax year ^[11].

Employers excluded by the nature of their work

An employer cannot qualify for a tax year if, at any point during that year, it was a public authority that is not a charity as defined in the Small Charitable Donations Act 2012 ^[3]. Local authorities, town councils and parish councils fall into this category unless they hold charitable status.

Beyond formal public authorities, the test extends to any employer carrying out functions wholly or mainly of a public nature, meaning more than 50% of its work is in or for the public sector ^[3]. HMRC names NHS services, General Practitioner services, managing housing stock owned by a local council, meals on wheels provision, refuse collection for a council, prison services, and debt collection for a government department ^[9].

The line is drawn at the nature of the function, not the identity of the customer. Providing security and cleaning services for a public building, or supplying IT services to a government department or local council, does not count as a function of a public nature ^[3]. A security firm that guards prisoners for 25% of its business and serves private clients for the remaining 75% is entitled to the allowance ^[3].

Where the proportion is unclear, an employer can measure it by the number of employees engaged in public-nature duties, the percentage of time spent on those duties, or the turnover derived from them ^[9]. Whichever basis is chosen should be documented, because it forms part of the evidence supporting the claim.

Employers of domestic staff such as cleaners, gardeners or nannies cannot claim at all, on the basis that the employment exists in a personal capacity to support the running of a household ^[3].

Connected companies and the one-allowance rule

Where two or more companies are connected at the start of a tax year, only one of them can qualify for the Employment Allowance for that year, and the companies decide between themselves which one claims ^[4]. The position is fixed at the start of the year and does not change if circumstances shift later ^[4].

The connected company rules do not apply to sole traders, partnerships or standalone companies ^[4]. For everyone else, the test is straightforward in principle: either one company controls the other, or both are under the control of the same person or persons ^[12].

How control is measured

Control can be established through any of four rights: the greater part of the voting power, the greater part of the share capital, the greater part of the rights to income, or the greater part of the rights to surplus assets on a winding up ^[4]. Holding over 50% of the share capital or voting rights in more than one company connects those companies automatically ^[4].

Several refinements sit around the basic test. Fixed rate preference shares held by a financing institution are disregarded where the holder is not a close company, takes no part in the management of the issuing company, and subscribed in the ordinary course of a finance business ^[4]. Loan creditors are similarly disregarded where there is no other connection and either the creditor is not a close company or the loan was made in the ordinary course of business ^[4]. Rights held in trust by a solicitor or a bank's trustee company are ignored where no other connection exists ^[4].

Substantial commercial interdependence

Family-owned businesses face a narrower test. Where two companies are connected only because rights are attributed between associated persons such as relatives, the connected persons rule applies only if the companies are substantially commercially interdependent ^[4].

HMRC assesses interdependence across three dimensions ^[4].

Two companies owned separately by siblings, trading in unrelated sectors from different premises with no shared staff or financial support, would not normally be caught. Two companies owned by a married couple, sharing an office, an accountant and a customer base, almost certainly would. Accountants managing this judgement across a portfolio typically track it in a multi-client payroll dashboard rather than reassessing it scheme by scheme each April.

Group structures and new subsidiaries

A parent company with several subsidiaries must identify at 6 April which company will claim ^[4]. The nomination should point at a scheme likely to carry at least £10,500 of employer Class 1 liability during the year, so the allowance is used as fully as possible ^[5].

A subsidiary acquired or created after 6 April is treated as having no connected companies for the remainder of that tax year and can make its own claim ^[4]. From the following tax year it falls within the connected persons rule and can claim only if no other group company does.

Connected charities follow a parallel rule. Charities are connected where the same person or connected people control two or more charities sharing the same or substantially similar purposes and activities, or where they belong to a group of charities ^[3]. A charity that controls a trading business is connected to it. A business that controls a charity, however, is not connected for these purposes, and both can claim separately ^[3].

Situations that change eligibility mid-year

Eligibility is not always static across a tax year, and several events reset or remove it.

Takeovers and demergers

Where a business takes over another during a tax year, the acquiring business gets no entitlement to any remaining balance of the target's Employment Allowance, whether measured against the acquired employees or against those carrying on the acquired work ^[3]. The same applies to employees moved under Transfer of Undertakings (Protection of Employment) regulations. Allowance already claimed by the seller before the takeover does not become repayable by either party ^[3].

Demergers are treated more harshly. Where a business splits during the tax year and creates new businesses, none of the new businesses is entitled to the allowance in that tax year, and none inherits any unclaimed balance from the original business ^[3]. Entitlement resumes the following tax year provided the resulting businesses are not connected or otherwise excluded.

Becoming eligible during the year

A company that starts the year with only its sole director above the Secondary Threshold, then takes on a second above-threshold employee in June, becomes eligible for the whole tax year rather than from the date of the change ^[11]. The claim can be applied retrospectively to employer Class 1 liabilities from the start of the year until the £10,500 limit is reached ^[5].

One qualification applies where the new above-threshold earner is appointed a director. Directors are assessed against an annual or pro-rata annual Secondary Threshold rather than a pay-period one, so their earnings must exceed the annual figure or its pro-rata equivalent for the company to qualify ^[11]. Employers running mixed director and employee payrolls need software that applies the correct National Insurance category and threshold basis to each individual automatically.

Ceasing to be eligible

Where a business stops employing staff during the year, no further action is needed. The existing claim remains in place but cannot be used until employer Class 1 liability arises again ^[5].

Where the nature of the business changes and eligibility is genuinely lost, the claim must be stopped through the payroll software or through HMRC Basic PAYE Tools ^[13]. Stopping a claim means no allowance is due for that year and any Class 1 National Insurance previously covered by the allowance becomes repayable ^[5]. Late payment penalties and interest can follow where the resulting liability is not settled on time ^[5].

Deemed payments, service companies and off-payroll working

Personal service companies and managed service companies occupy a middle position. The allowance cannot be claimed against any deemed payment of employment income, but it can be claimed against employer Class 1 National Insurance arising on earnings paid to actual employees ^[3].

This matters for intermediaries operating inside the off-payroll working rules, where a deemed employment payment is calculated at the end of the tax year ^[14]. Employers in this position need to separate the two streams of liability cleanly in their payroll records, because only one of them attracts the allowance. Platforms that embed an HMRC-recognised payroll API handle the split at the calculation layer rather than leaving it to a manual year-end adjustment.

Franchise arrangements follow a different logic again. A franchise holder is entitled to the allowance, but a holder who controls more than one franchise of the same business gets only one allowance across all of them ^[3].

Multiple PAYE schemes and unused allowance

An employer can claim only one Employment Allowance regardless of how many PAYE schemes it operates ^[5]. The claim attaches to one nominated scheme and cannot be moved to another scheme during the tax year, although it can be stopped at year end and re-nominated in the new year before any National Insurance or PAYE payments are made ^[5].

What happens to an unused balance depends on whether the business is incorporated ^[4].

For unincorporated businesses, the unused balance is the lesser of £10,500 or the total employer Class 1 liability across all schemes, minus the allowance already given against the nominated scheme ^[5]. Where a nominated scheme carried £1,000 of liability and total liability across all schemes was £1,800, the unused balance is £800 ^[5].

Where a business changes ownership before the full allowance is used, the existing claim ends at the point of transfer. The new owner can claim up to the full allowance in their own right, but only against secondary Class 1 liabilities arising before the transfer, and no balance passes between the parties ^[5].

Evidencing eligibility

A claim is made by setting the Employment Allowance indicator in the payroll software and submitting an Employer Payment Summary, which HMRC processes through Real Time Information ^[1]. The claim must be renewed for each new tax year with a fresh Employer Payment Summary ^[5].

Records supporting the claim must be kept for a minimum of three years after the end of the tax year in which the allowance was claimed, and must show why the employer was entitled, how much allowance was used or repaid, and which liabilities it covered ^[5]. For a business relying on the public-nature proportion test, or on the absence of substantial commercial interdependence, the reasoning behind that assessment forms part of the record.

Claims can be backdated up to four years after the end of the tax year to which they relate, with a separate Employer Payment Summary required for each year ^[15]. An employer that discovers it was eligible in an earlier year, perhaps because a second above-threshold employee was overlooked, can still recover the relief. Businesses reviewing historic entitlement alongside current-year payroll often start from small business payroll records rather than accounting extracts, because the Secondary Threshold test depends on pay-period earnings rather than annual totals.

Payroll software carrying the HMRC Recognised badge submits the Employer Payment Summary carrying the Employment Allowance indicator without manual reconfiguration, and reflects threshold changes at the start of each tax year automatically. Employers operating without that automation, including those using an instant payslip service for occasional payruns, need to confirm the indicator is set before the first submission of the year.

Conclusion

Employment Allowance eligibility is less a question of whether a business is small enough and more a question of how it is structured. The removal of the liability cap widened access considerably, but the exclusions that remain, the single-director rule, the public-nature test, the connected company rule, are all structural rather than financial. They do not soften as a business grows.

The practical consequence is that eligibility deserves a deliberate annual review rather than a rolling assumption. Group structures change, directors are appointed, subsidiaries are acquired, and the position that held on 6 April of one year may not hold on 6 April of the next. Employers that treat the assessment as a start-of-year decision, documented and evidenced, are in a far stronger position than those that simply carry the indicator forward.

Frequently asked questions

Can a company claim Employment Allowance if the director takes a salary below the Secondary Threshold?

Yes, provided at least one other employee is paid above the Secondary Threshold. HMRC's guidance gives the example of a company with a sole director and two employees, where the director and one employee both earn below the Secondary Threshold and a third person earns above it. That company can claim. The disqualifying condition is a sole director being the only person above the threshold, not the director's salary level in isolation.

What happens if two connected companies both claim the Employment Allowance by mistake?

Only one claim is valid, and the excess allowance becomes repayable. HMRC treats connection as fixed at the start of the tax year, so the position cannot be corrected by restructuring mid-year. The companies should agree in advance which one claims, stop the incorrect claim through the payroll software, and settle the Class 1 National Insurance that the allowance had wrongly covered. Penalties and interest may apply where the resulting liability is paid late.

Does the Employment Allowance apply to Class 1A National Insurance on company cars?

No. The allowance can only be set against employer secondary Class 1 National Insurance. Class 1A National Insurance on benefits in kind, including company cars and private medical cover, falls outside its scope entirely, as does Class 1B on PAYE Settlement Agreements. An employer with a large benefits bill and a small salary bill may therefore find the allowance covers only a fraction of its total National Insurance cost.

How far back can an employer claim Employment Allowance it failed to claim at the time?

Up to four years after the end of the tax year the claim relates to. A claim for the 2022 to 2023 tax year, which ended on 5 April 2023, must be made by 5 April 2027. Each year requires its own Employer Payment Summary, and previously reported figures such as statutory payments do not need to be resubmitted. Where PAYE is paid up to date, HMRC will normally set the award against future or existing liabilities unless a repayment is requested.

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