When employers make an employee redundant and a ‘redundancy payment’ is made, it is easy to make the wrong decisions on the tax and national insurance (NI) position of such a payment, especially if it is made up of several constituent parts. There has been many a HMRC enquiry further on down the line which has re-evaluated the tax and NI position to the detriment of either the employer or the ex-employee or both.
Termination payments can be broken down into three categories:
- Fully taxable.
- Exempt from tax.
- Taxable in part.
Those which are taxable in full will be:
a) Contractual payments – It is stipulated as being payable within the employment contract.
If the employee is asked to work their notice period or is put on garden leave, then any payment is fully taxable.
If under the terms of the contract, the employer can ask the employee not to work their notice, the payment is known as a PILON, payment in lieu of notice. This is fully taxable.
b) Non-contractual payments where there is a reasonable expectation it will be made.
Joe is about to be made redundant. Other employees in a similar position to him have been made redundant in the past and received a £5,000 pay out. Joe is expecting a £5,000 payment and receives one.
c) Restrictive covenant payments.
Mary has been made redundant and has received £7,000 from her ex-employer on the basis that she will not approach a client within the next 12 months.
d) Services performed in the past, present or future.
Peter receives £3,000 as part of his termination payment for work finished just prior to being made redundant.
All these payments will be liable to employees’ and employers’ national insurance.
The following are fully exempt from both tax and NI:
What constitutes part taxable part exempt?
a) Statutory redundancy payments which employers must pay under employment law.
b) Non-statutory redundancy or ex gratia payments. These are ones where the employer is under no legal or contractual obligation to pay. This can include non-cash items, such as a company car transferred across to the ex-employee.
c) A non-contractual PILON. The element of the payment which relates to the period which should have been worked, but wasn’t, is fully taxable. The residue may be so subject to the £30,000 exemption limit.
Where a) + b) + the residue of c), collectively exceed £30,000, only the excess above that amount is liable to tax. The employee will not suffer any NI but the employer would incur what is called Class1A NI.
Whether you are the employer or the employee it is wise to review the tax and NI position on any termination payment, preferably before it is paid out, as in some case, the waters surrounding these sorts of payments can become very muddied. We are happy to carry out this review for you.