With the 2019/20 coronavirus pandemic, redundancies are on a rise. As such, understanding how termination payments work is critical.
No employer is likely to implement redundancy without a dire need to do so, it’s became more expensive with additional tax charges and requires a lot of legal planning and difficult conversations.
New rules surrounding redundancy were announced back in 2018, with additional changes in April 2020.
This changes what counts within the traditional £30,000 allowance that many are familiar with. These changes have made it less generous to both you and your employees.
Our latest blog below explains all you need to know.
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What are the two types of termination payments?
For tax purpose, there are two categories of pay that can be made after you terminate an employment contract.
The first is the general employment earnings that an employee receives if they are still working within their notice period, such as outstanding salary/wages, payment in lieu of notice (PILON) if relevant, and any outstanding holiday pay.
Much of this money is referred to as post-employment notice pay (PENP) and is always subject to income tax and national insurance contributions (NICs).
A lot of this money will be classified as post-employment notice pay (PENP).
Prior to the new rulings, there were exemptions that seemed to be rather arbitrary, all depending on the wording of contracts.
The second category is termination payments. These directly relate to employment termination, including things such as compensation for a loss of office.
How is the tax applied?
When you pay an employee their final redundant termination sum, this is made up of the two category of payments explained in the section above.
If all of the money is classified as PENP, or other general earnings, such as benefits-in-kind such as keeping a company car, outstanding holiday pay, and is then taxed accordingly. No £30,000 tax exemption applies in this instance.
If just some of the final payment is PENP and other general earnings, then this part is taxed as general earnings. However, this leaves a further aspect of the payment which the £30,000 tax exemption can be applied against. So up to the next £30,000 of payment is tax-free for PAYE and NI purposes.
Is there a bad side of the changes?
As usual, any excess above the £30,000 allowance is subject to income tax for the employee.
From 6 April 2020, class 1A employer’s NIC will now be payable on the termination payment in excess of £30,000. As such, some redundancies are more expensive for some employees than in the past, since this is charged at a rate of 13.8%.
These deductions will be deducted through real-time information/PAYE at the time of the termination payment, resulting in additional cashflow pressure for the business, as usual taxable P11D benefits are payable once a year on 19 or 22 July after the tax-end.
In addition, HMRC will also charge late payment interest and penalties will be incurred.
What is the PENP formula?
PENP = (monthly basic pay (BP) x unworked notice period (D)) divided by the number of days in the last pay period (P).
Basic pay is any amounts given up in salary sacrifice agreements, although excludes benefits-in-kind, commissions and any bonuses.
The value of a contractual termination payment (T), such as a payment in lieu of notice (PILON), will be deducted but this will not include accrued holiday, termination bonuses or ‘golden handshakes’.
Chris is notified on the 15 November 2020 of your intention to make her redundant, and his last day of employment is agreed as 30 November.
Chris’s contract states he should receive three months’ notice. therefore 77 days as her contractual notice period goes up to 15 February 2021.
Chris earns £60,000 a year in basic salary, so his monthly ‘BP’ amount will be £5,000. And his last pay period was the full month of October which was 31 days – the ‘P’.
Chris will not be paid in lieu of notice but you have instead agreed to pay her £24,000 as an ex-gratia lump sum, plus £10,000 for loss of notice and £2,000 in accrued holiday pay.
In total he will receive £36,000. In order to work out how much she should be taxed on this amount, the statutory formula to work out the PENP needs to be followed.
Applying the formula gives Chris a PENP figure of £12,419. As he has not been made any taxable payments in lieu of notice, T is zero and nothing is deducted from this figure. The full £12,419 is therefore taxable as earnings. The £2,000 from accrued holiday pay also remains fully taxable as earnings.
The balance of £21,581 is treated as the ex-gratia payment and it is not subject to any tax as it is under £30,000.
If the numbers were different and the outstanding ex-gratia payment had been, say, £40,000, then further income tax would have been due on the excess above £30,000.
As this transaction happened after April 2020, you would have been liable for an additional 13.8% in class 1A NICs on the £10,000 excess.
How can you plan long-term?
The coronavirus job retention scheme is in place until 31 October, giving companies some breathing space.
It would be best to explore redundancy possibilities now, rather than later. It’s worth bearing in mind that it’s going to be more expensive to implement redundancy later on in the year, owing to the tax rule changes.
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