The tax regime in respect of payments paid in connection with the termination of employment (sections 401 and 403 Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003)) was amended on 6 April 2018. Here we unveil our comprehensive guide for employers and give you our top 10 tips for navigating the new regime.
Post-Employment Notice Pay
Whilst the £30,000 tax-free threshold has been retained, the types of payments that fall within the threshold have changed. New section 402D ITEPA 2003 introduces a concept of "post-employment notice pay" (PENP). In essence, PENP is the basic pay equivalent for any unworked notice period calculated using a specified formula.
Where an individual is not employed for the full notice period, any "relevant termination award" made post-termination will be taxed as general earnings (and therefore subject to income tax and Class 1 employer's and employee's NI) in so far as it is equal to (or less than) the PENP.
We have produced a comprehensive guide for employers outlining the changes and giving worked examples of how the PENP formula should be applied in a number of different scenarios.
Our Top 10 Tips
- If you are only paying a contractual PILON there is no need to run the PENP calculation.
- If you are only paying a contractual PILON and/or a statutory redundancy payment there is no need to run the PENP calculation.
- If you are paying a contractual PILON and any other compensation amount (including any enhanced redundancy payment) you should run the PENP calculation. The amount "T" in the formula will be the amount of the contractual PILON payment already taxed.
- You must use the simplified calculation (where "P" = 1 etc.) if (i) the pay period is a month, and (ii) the minimum contractual notice is expressed in a whole number of months, and (iii) no notice is worked or some notice worked and the post-employment notice period is a whole number of months.
- If a fixed or limited term contract comes to an end and any termination payment is made, you must run the PENP calculation.
- If a payment is subsequently made to an employee whose employment is terminated where the employer was legally able to terminate the employment contract without notice, you must still run the PENP calculation.
- Where a termination payment is made after 6 April 2018 but the termination date was before 6 April 2018, the new rules will not apply.
- The PENP position is complicated where an employer makes both (i) contingent monthly contractual PILON payments to an ex-employee which cease (or reduce) if s/he gets a new job and (ii) an additional compensation payment. We are hoping for some HMRC guidance on this but in the meantime we have produced a separate note to explain how we believe this will work in practice. Please let us know if this situation applies to you.
- Compensation for unfair dismissal awarded by a tribunal or under a settlement agreement is taxable to the extent that it represents PENP.
- If you don't currently include PILON clauses in your standard employment contracts, now is the time to consider amending your standard form for future employees as there will no longer be any tax advantage of not including such a provision.
If you have any questions about the changes to the taxation of termination payments please contact Nicky Griffin or your usual AG contact.