The events from the last 18 months have led to financial difficulty for many businesses across the UK, and unfortunately in these circumstances, some employers may find that it’s not always possible to continue the employment of their workforce. Should your business face these issues and you have to make the tough decision to let team members go, it’s paramount that you understand the rules surrounding termination payments to ensure any tax and NIC liabilities are properly accounted for.
This area of payroll has undergone various changes in recent years so to help you understand the latest rules, our payroll director, Julie Mason, outlines everything you need to know below…
Determining income tax and NIC on termination payments
The correct income tax and NIC treatment of a termination payment will differ for each departing individual depending on their circumstances.
Part of this includes determining why the employment is ending. For example, if an individual’s employment is ending for a reason other than redundancy (such as retirement or poor performance) and where you plan to hire a replacement for that role in the future, any termination payment will be subject to income tax and NIC.
You may be aware of the £30,000 exemption which may be available to employers as a means of reducing the income tax payable on termination payments, however it is often assumed that the first £30,000 of all termination payments will always be exempt from income tax and NIC. We wanted to make you aware that this isn’t always the case.
When determining the income tax and NIC treatment of a termination payment, employers should consider which of the below categories the payment falls into:
- Contractual or a specific type of taxable payment / subject to NIC (such as a restrictive covenant)
- Exempt (for example, in relation to disability / death)
- A payment in lieu of notice (PILON)
- Statutory or enhanced redundancy payment
- Ex-gratia (such as compensation for loss of employment, and NOT a reward for past performance)
Once you have established whether the payment falls under the exemption bracket, or is subject to income tax and NIC (either fully or partially), at this point, you can then work out whether any leftover elements of the payment also need to be reviewed.
For these payments, employers should consider the Post Employment Notice Pay (‘PENP’) rules and calculations, which apply when an individual hasn’t worked their full notice period. Previously, where a PILON had been issued, it was only required to consider whether the payment was contractual / expected by the employee. Under the current PENP rules, all PILONs are treated as taxable and are subject to NIC. Although these rules are generally straightforward (with the objective of taxing the amount the employee would have received had they worked their full notice period), the calculation can be confusing. For example, complexities arise when an employee receives allowances, has been on sick / maternity leave or has been on furlough.
If the full notice period has been worked, or part of the termination payment remains after the PENP calculation, the £30,000 exemption may be applicable.
It’s worth being aware that in April 2020, a new employer’s NIC charge of 13.8% was introduced on the excess of termination payments over the £30,000 exemption. This, alongside the new PENP rules, means that termination payments have become even more complex and costly to the employer.
When the above process has been followed, and the correct tax and NIC treatment of the termination payment has been identified, the information should be reported to HMRC.
However, as you will be aware having read the above article(!), there are various rules to consider when approaching a termination payment and they have changed significantly in recent years. With this in mind, we would urge you to speak to a qualified and experienced adviser for guidance before you issue any termination payments and start the process of reporting to HMRC.
Our team of experts are perfectly placed to support and advise you on all aspects of termination payments, income tax and NIC and would be happy to help wherever required. To arrange a discussion, please don’t hesitate to get in touch with me using the below button.