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Employment law briefing note: Calculating termination payments from 6 April 2018

05/04/2018

At a glance

For employees terminated on and from 6 April 2018 who receive termination payments, employers must now split out termination payments between: (i) amounts to be treated as earnings (and so subject to tax and Class 1 NICs), and (ii) other amounts which benefit from the first £30,000 tax exemption.

There are three steps to follow:

1) Calculate the “termination award”

  • The termination award is any payment or other benefit received directly or indirectly in consideration of, or otherwise in connection with, the termination of a person’s employment.
  • It does not include statutory redundancy pay and payments or other benefits already chargeable to tax (e.g. payments relating to restrictive covenants, contractual PILONs, contractual payments such as retention awards, taxable benefits).

(Note that there will be no “termination award” where all an employee receives on termination is a payment pursuant to a contractual PILON clause. Such payments will continue to be treated as earnings, as per the pre-2018 regime. There is therefore no need to undertake this three-stage process in such circumstances)

2) Calculate the “post-employment notice pay” (PENP)

  • There is a specific formula for calculating PENP: Calculate the basic pay the employee has yet to receive in respect of unworked periods of notice.
  • This is done by calculating the basic pay the employee would have received for such periods, less any sums (excluding holiday pay and termination bonuses) already paid on termination which are taxable as earnings (e.g. a contractual PILON payment).

3) Compare the “termination award” with the PENP – what should be taxed?

  • If the PENP is equal to or more than the termination award, the entirety of the termination award is taxable as earnings.
  • If the PENP is less than the termination award, the PENP is taxed as earnings. The remainder of the termination award can be paid tax-free (subject to the £30,000 threshold).

By way of a simple example:

Employee A is made redundant. Their gross monthly basic pay is £5,000 per month.

They are entitled to 3 months’ notice and required to work one of these; the employer will make a lump sum payment for the remainder.  There is no PILON in their contract.

They are also entitled to a statutory redundancy payment of £3,000 and the employer makes an ex-gratia payment of £7,000.

  • The termination award is £17,000 (it does not include the £3,000 statutory redundancy payment).
  • Of the termination award, the PENP is the notice pay for two months (£10,000).  None of this payment is already taxable (as mentioned, there is no PILON in the contract).
  • As the PENP is less than the termination award, this is subject to tax and NICs and the remaining £7,000 may be paid tax free (subject to the total £30,000 threshold).

As complicated as this may appear, the above applies to relatively straightforward scenarios. Greater complexity can be expected in relation to “sacrificed salaries”, dismissals for gross misconduct, and instances where the contractual PILON payment constitutes only a part of the overall termination award.

It is anticipated that HMRC will provide guidance on this and more soon which will be updated here when available.

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