The tax treatment of termination packages is often complicated. Some employers take an ultra-cautious approach and overpay tax and National Insurance (NI). They do this to ensure they do not face a large demand from HMRC if they make a mistake. If they do make a mistake then their liability will be made up of:

  • the tax and NI that should have been paid to HMRC
  • interest
  • penalties.

HMRC's £30,000 tax exemption

A £30,000 tax exemption may be available in respect of termination packages (or elements of them). Employers need to consider how the package is made up. Broadly speaking, the exemption should be available for set off against a termination package unless the payment or benefit is:

1. earnings (such as contractual payments, bonuses, holiday pay etc); or

2. for a restrictive covenant; or

3. a pension.

If the tax exemption is due, then there will be no NI due (without limit). For example, if a payment of £50,000 is made and it does not fall within one of the categories above then £20,000 will be taxable, but there will be no NI.

Payment in lieu of notice

This is one of the most confusing issues. Tax and NI will be due if the employee has a contractual entitlement to a PILON or payments in lieu of notice. This often applies to senior employees. Most employees will only have an entitlement to notice, rather than a payment.

Employers sometimes account for PAYE (tax and NI) on anything described as a PILON.

While an employer may wish to take a cautious approach there is a cost. If they adopt the wrong treatment they may significantly overpay employer's NI (the current rate is 13.8%). It is also likely that they will have deducted too much tax and NI from their employees.

Opportunities

There are two opportunities available to employers.

1. Future payments

Employers may obtain advance clearance from HMRC. We recently had a case where an employer was going to account for tax and NI on non-contractual PILONs for a number of leavers. We carried out a review and concluded that the £30,000 tax exemption should apply. We then obtained HMRC clearance. As a result our client saved around £50,000 in employer's NI and as the amounts paid to each employee was under £30,000 they did not pay any tax or NI.

2. Repayments in respect of payments already made

All is not lost for payments already made and subjected to tax and NI. If an employer considers that a refund is due they may apply for an NI refund and it is possible to go back up to six years.

If an employee considers the tax exemption is due they may claim tax and NI refunds from HMRC. For tax refunds they may go back up to four years.

As an employer, if you are able to answer yes to the following questions you may be due a refund.

1. Have you made any termination payments (including redundancies) in the last six years?

2. Have you made any PILONs?

3. Did you subject those payments to tax and NI?

If you are about to make some termination payments or redundancies or have done so and think you may be entitled to a refund please contact me or a member of our employment tax team.

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