Redundancy – Taxation of payments

Making any employee redundant is a difficult decision and potentially distressing for all involved. Getting the process wrong could result in one or more employment tribunal claims. Professional advice should always be sought.

When an employee is made redundant, various elements may comprise the final payment. Apart from the normal earnings from the employment (salary, accrued holiday pay, accrued bonuses, etc.) to the last deemed working day, payments made specifically on the termination of employment will make up the termination award. Such payments may include statutory redundancy pay, payments in lieu of notice (PILON), compensation for loss of office and non-cash benefits.

An employee with at least two years’ continuous employment when made redundant qualifies for statutory redundancy pay. The amount depends on the employee’s age and length of service capped at 20 years and further capped at £643 a week with the maximum statutory redundancy payment being £19,290. Any additional payment should be included in the employment contract.

Should there be a PILON clause in the employee’s contract then the employer must make payment of all monies that the employee would have received during the notice period and tax as earnings to include NIC. If no PILON clause exists (and there is no legal requirement for there to be so), there is a complex statutory formula known as ‘post-employment notice pay’ (‘PENP’) used to calculate the amount of payment that should be taxed as earnings. The calculation is based on the employee’s basic pay and the number of days (or months) of unserved notice. The formula ensures tax is charged on the basic pay that the employee would have received if they had worked their full notice period (statutory or contractual, whichever is longer). The system prevents employers and employees from labelling a payment as ‘compensation’ or ‘ex gratia’ or some other similar term in an attempt to obtain the £30,000 tax exemption.

Provided a payment or benefit is not a distribution (e.g., dividend) or part of a capital transaction then the first £30,000 of any redundancy payment is exempt from income tax and NIC with only the balance being chargeable. Non-cash benefits are also considered when calculating the exempt amount where the value used is the cash equivalent or ‘monies worth’ if higher, e.g., if an employee keeps a company car as part of the termination package, the car’s market value is included in the £30,000 exempt amount figure. Some benefits in kind are exempt from tax and are not taken into account e.g., the provision of a mobile phone.

No NIC is levied up to the £30,000 threshold but any excess is liable to employer’s class 1A NIC. For payments more than £30,000, companies may see a benefit in paying that excess amount as pension contributions to avoid the NIC charge.

Although the employer must assess and report packages valued at more than £30,000 to HMRC, the tax charge may not arise at the termination date because a cash payment is treated as received when it is paid or when the recipient is entitled to the payment. Therefore, a package greater than £30,000 but paid in instalments will be taxed as and when received such that tax and NIC may arise in a year later than the termination date. Non-cash benefits are received when they are ‘used or enjoyed’.

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