Tax on Redundancy

With the furlough scheme now in the process of being wound down, each day the business news is dominated by companies shedding jobs due to the current economic climate.

There have been various changes to the taxation of redundancy payments implemented over the past few years with the most recent changes coming into effect from 6 April 2020.

The taxation of redundancy payments can be complicated because the packages given to staff will comprise of various components some of which are part of the contract and some which are not.

Statutory Redundancy

The first element to consider is statutory redundancy which must be paid to all employees who have been working with the employer for over two years. Statutory Redundancy is paid at a rate set by the government and is calculated based on the following:

• Half a week’s pay for each full year you were under 22 years old
• One week’s pay for each full year you were aged between 22 and 41
• One and a half week’s pay for each full year you were 41 or older.

Length of service is capped at 20 years and weekly pay is capped at £538 meaning the maximum statutory redundancy available is £16,140.

Statutory Redundancy payments are not liable to tax. Under ITEPA 2003 S.403 an exemption of £30,000 is applied to redundancy payments therefore Statutory Redundancy will always be covered by this exemption.

Pension Contributions

If an employer decides to contribute to your pension scheme on redundancy this is generally free of tax and NIC contributions and does not form part of the £30,000 exemption above.

Where the employer intends to make a large contribution into the pension scheme, the employee must take care to ensure that the £40,000 annual allowance (plus any carry forward from previous 3 years) is not breached as this could yield an annual allowance charge.

Payment In Lieu of Notice 

Most confusion around redundancy payments comes from Payments in Lieu of Notice (PILON) and compensation for the loss of office.

A PILON is where you will be released from the contract without having to work your notice period. The notice period could be the minimum statutory notice required or may be longer and agreed upon in the contract of employment.

If you are contractually entitled to a PILON then this will be treated as earnings and liable to tax and national insurance contributions, both employer and employee, in the normal manner. The £30,000 exemption will not apply to these payments.

Relevant Termination Awards and Post-Employment Notice Pay

In order to ensure that non-contractual PILONs are taxed, from 6 April 2018 the Relevant Termination Award (RTA) of the package offered must be looked at where the employee has not worked their full notice period. The RTA is generally all items which are not contractually approved payments (taxed as earnings in normal manner) and have been awarded because of the termination of employment. This will include items such as enhanced redundancy payments, ex-gratia payments and non-contractual PILONs. Statutory Redundancy, however, does not form part of the RTA.

The RTA must be split into slices which is as follows:

• Liable to tax as earnings.
• Subject to the £30,000 exemption and potentially taxable thereafter.

This slicing is calculated based on the Post Employment Notice Pay (PENP) and the formula is ((BP x D)/P, where:

• BP is basic pay. This will also include any salary sacrifice amounts
• D is days in notice period and is calculated by reference to the notice employer must give.
• P is days in pay period prior to notice of termination being given
• T is taxable amounts on termination other than holiday pay and bonuses i.e. contractual PILON.

If the notice period for the employee is expressed in monthly terms, the termination date is the last day of the month and the employee has not worked any of their notice period then the calculation can be made in months.

The amount which is treated as earnings will be the following:

• The entire RTA if PENP is equal to or more than the RTA
• PENP, if it is less than the RTA but not nil.

Where the employee has worked their full notice period the above calculation will not need to be applied and any items which are not related to a PILON whether contractual or not will be subject to the £30,000 exemption.

Benefits in Kind

It is common where an employee has use of company assets that the employer as part of the package will allow the employee to keep these assets. In these circumstances the market value of the asset will be added to cash benefit received to access whether the £30,000 exemption has been breached.

How is PAYE applied to a Redundancy Payment

The taxation of any redundancy payments depends on whether the employer make the payment before or after your departure date.

If the payment is made prior to cessation, then any taxable elements of the redundancy package will be included within your final payment and tax will have been collected based on the PAYE code which was in operation at that time. It is possible that tax will be overpaid at source on redundancy as the PAYE system is based on 12 months/52 weeks so if you leave during a year you may not have received all allowances.

If the payment is made after the employment ceases and a P45 has already been issued, the employer will operate the 0T tax code on a week 1/month 1 basis. An overpayment of tax could arise here as the payment is only getting 1/12^th of each banding therefore more higher rate tax could be being paid than is required.

If you believe that tax has been overpaid then it is recommended that a repayment claim form/tax return is submitted to HMRC to reclaim this as it can take HMRC a considerable amount of time to reconcile their records and make this repayment.

National Insurance

There will be no employees National Insurance Contributions (NIC) payable on a redundancy payment even if this does exceed the £30,000 income tax exemption.

From 6 April 2020 employers NIC will be payable at 13.8% on any termination payment which exceeds £30,000. This will be a Class 1A charge however will still be collected via the PAYE system at the time it arises and not via the P11D system as is more common with Class 1A NIC.

The information in this blog provides only an overview of HMRC guidance and legislation in force at the date of publication and no action should be taken without consulting the detailed HMRC guidance and legislation or seeking professional advice.  Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material contained in this blog can be accepted by the firm.

Photo by Zoe Holling on Unsplash