Chapter 25 Termination Payments Flashcards
s401, fully exempt payments an partially exempt payments
Termination payments can include compensation for loss of office, redundancy payments, damages for dismissal, payments in lieu of notice (PILONs). Most termination payments are not regarded as earnings from employment and are taxed under the provisions of s401.
Does S401 apply – these include certain exemptions and reliefs that do not apply to income from earnings. The starting point to see if it applies is if the termination payment is contractual. If the payment is contractual it will be classed as earnings and taxed in full. If the contract makes no mention of termination payments but HMRC can prove there was reasonable expectation the employee would receive payment, this is earnings and taxed in full. If termination payment is made outside the contract it is taxed under section 401. Section 401 only applies to redundancy payments and ex-gratia payments (voluntary payment without any obligation on the part of the employer).
Fully exempt payments – termination payments made on the death of the employee is fully exempt from tax, this is the same when the employee is terminated due to injury or disability, in a physical or psychological nature that causes them to not be able to perform their job. If an employer makes a payment to a registered pension scheme as part of the termination package, this is also completely free of tax.
Partially taxable payments – termination payments are only charged to tax to the extent they exceed £30,000. The first £30,000 of a genuine termination payment is tax free (only applies to payments taxable under s401). The £30,000 exemption applies to the aggregate of all termination payments.
redundancy payments, payments in the notice period
Redundancy payments – they fall unto two categories, statutory and non-statutory. Statutory redundancy is an amount which must be paid to an employee under employment law and will be a fixed amount for each year of service. Statutory redundancy pay cannot exceed £15,750. Employers may also decide to pay an additional payment as further compensation. Both types are charged to tax under s401. Genuine redundancy payments must be distinguished from other payments which would be taxable as earnings. For example, a payable that is really a terminal bonus for meeting targets in the period leading up to redundancy is not compensation for redundancy.
Payments during the notice period – if an employee is terminated (other than gross misconduct), the employee is entitled to receive wages for the duration of the notice period. When notice of termination is given the employer has three options:
• Honour the notice period by allowing the employee to work for the period and the employee will receive the wages which will all be taxable
• Honour the notice period but not allow the employee to work (known as garden leave) and the employee gets paid. Amounts paid are fully taxable.
• Terminate the employment within the notice period, accompanied with a termination period. Such payments are called payments in lieu of notice (PILONs). If the contract gives the employer, the right to a PILON the payment is treated as earnings and taxable in full. If the payment is not contractual it will be taxable under s401. However, an element of the termination payment will be post-employment notice pay and will not be eligible for the £30,000 exemption as this element will be taxable as general earnings
Post employment notice pay, NIC implications
Post-Employment notice pay – when termination payments are taxable under s401 is made before the expiration of the contractual notice period, the payment is split into post-employment notice pay (PNEP) and amounts which are not PENP. PENP is taxable in full as earnings. This is also done for every ex gratia termination payment which is made to an employee before the notice period has ended, this is not done in respect of redundancy payments which is always eligible for the £30,000 exemption.
Calculating PENP – use the formula: ((BP x D) / P) – T where
BP – employees basic pay for the period immediately before the date on which notice is given
D is the number of days in the post-employment notice period (last day of employment to the date when the notice period would have expired if given in full)
P is the number of days in the pay period immediately preceding the period in which the termination payment was made
T is the amount paid on termination that are already taxable as earnings
NIC implications - where a payment is made to an employee under a contractual obligation this payment will be regarded as earnings for class 1 NIC purposes. PNEP is also treated as earnings for class 1 NIC purposes. For ex gratia payments there is no contractual obligation and the payment is not PNEP the payment will not be regarded as earnings and not charged to NIC.
other payments and benefits on termination
Other payments and benefits on termination – on termination an individual can keep assets, like there company car, for tax purposes we value the company car at the date of the gift and treat this as a cash payment. If the employee still keeps benefits after termination, the benefits are taxable. The £30,000 exemption is set against cash payments in priority to non-cash benefits. Employees can receive outplacement counselling after employment, this is an exempt benefit and the travel to the counselling is exempt. This is the same for retraining courses. A termination payment can include a restrictive covenant clause, for example not being able to work for a competitor for a set period of time. Restrictive covenant payments to the employee are taxed in full and the £30,000 exemption does not apply. If an employee takes legal action to recover compensation for loss of employment, the costs recovered by the employee from the employer are taxable under s401.
Miscellaneous Points – if a termination payment is taxable under s4o1 (exceeds £30,000), it is taxed as the top slice of a taxpayer’s income. It will be taxed after dividend income. Where a termination package consists of elements that are treated as earnings (eg post-employment notice pay), only the portion of the payment which is taxed under s401 is treated as the top slice of income. The element which is taxed as earnings should be included within employment income in the non-savings column.
