Is your business planning redundancies? With the UK economy experiencing turbulence due to the effects of the pandemic, war in Ukraine, Brexit and the cost-of-living crisis, many employers are facing difficult decisions to control costs.
In this blog, we’ll go through everything in layman’s terms to give you an idea of what to expect.
For tax purposes, 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 would have received if they were still working in the notice period: outstanding salary/wages, payment in lieu of notice (PILON) if relevant, and any holiday pay for instance. 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).
The second category is termination payments. These directly relate to the termination of employment, so they include things like compensation for loss of office.
How Tax is Applied
You might have a £30,000 tax-free figure in mind, and this broadly applies today. However, the rules changed in 2018 and more changes came into effect from April 2020, affecting what counts within the £30,000 allowance.
When you pay an employee you are making redundant a final termination sum, this is made up of these two categories of payment we have just outlined.
If all of the money is classed as PENP or other general earnings, such as benefits-in-kind – like keeping a company car – or accrued holiday pay, the cash value for it is all considered general earnings and taxed accordingly. No £30,000 tax exemption comes into play.
If only some of the final payment is PENP and other general earnings, then this part is taxed as general earnings. But that 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 both PAYE and NICs purposes.
How the PENP Calculation Works
To calculate the PENP, the following statutory formula applies:
PENP = (monthly basic pay (BP) x unworked notice period (D)) divided by the number of days in the last pay period (P) less any payments or benefits in connection with the termination already taxed elsewhere (T).
Basic pay includes any amounts given up in salary sacrifice arrangements, but excludes benefits-in-kind, commissions and bonuses among other payments. T includes the value of a contractual termination payment, such as a payment-in-lieu of notice (PILON), but does not include accrued holiday, termination bonuses or ‘golden handshakes’.
In practice, if you are already planning to tax the employee PILON and the value of the PENP is less than this or the same, there might be nothing else to tax. If this is not the case, you will need to consider what other payments are being made to the employee and their tax treatment, including whether it would fall within the £30,000 exemption
The pay and tax calculations involved with termination payments are complex, but our advisors can help you with managing costs within your business. Get in touch to speak to us about termination payments.