The way that taxable termination payments (i.e. those not covered by the £30,000 exemption) are treated for PAYE purposes is to change with effect from 6 April 2011. The practical implications of the change are that employers will no longer be able to offer a cash-flow advantage when negotiating a compromise agreement. Further, in certain circumstances the employee may suffer a number of disadvantages if the termination payment is made after 6 April and the P45 has already been issued.


At present, if a taxable termination payment is made after the termination date and the issue of the P45, the employer must use the BR tax code for PAYE purposes. This means that the employer only has to deduct basic rate tax (currently 20%), and the employee will pay any further tax due through his tax return for the relevant tax year. This can lead to significant cash flow advantages for the employee. (For example, higher rate tax on a payment made on 7 April 2010 would not require to be paid over to HMRC until 31 January 2012).


In Autumn 2010, HMRC announced that, from 6 April 2011, employers must use the 0T tax code, rather than the BR tax code if a payment which is not included in a P45 is made after an employee has left employment (e.g. a termination payment).

The 0T code is to be applied on a "non-cumulative" basis. For an employee paid monthly, this means that only 1/12th of the basic rate band (and, if relevant, 1/12th of the higher rate band) is available in the month of payment. If, therefore, the termination payment is more than the appropriate proportion of the 20% band, the excess will be taxed under PAYE at 40%, and if the payment is also more than the available 40% band, the excess will be taxed under PAYE at 50%.


The PAYE to be applied to a post-P45 payment in the first month of the 2011-12 tax year (month 1) will be roughly as follows:

  • the first £2,916.67, or the whole payment it it is less than this amount, is taxed at 20%,giving a PAYE deduction of up to £583.33;
  • the next £9,583.33 is taxed at 40%, giving rise to a PAYE deduction of up to a further £3,833.33; and
  • any excess payment above £12,500 is taxed at 50%.

Thus, if, after 6 April 2011 and the issue of a P45, an ex-employee receives a termination payment of £10,000, £3,416.66 would be withheld as PAYE (compared to £2,000 under the pre- 6 April 2011 BR tax code).

The PAYE is calculated as follows:

  • £2,916.67 @ 20% = £583.33
  • £7,083.33 @ 40% = £2833.33

If the termination payment were £20,000, £8,166.66 would be withheld as PAYE (compared to £4,000 under the pre-6 April 2011 BR tax code).

The PAYE is calculated as follows:

  • £2,916.67 @ 20% = £583.33
  • £9,583.33 @ 40% = £3,833.33
  • £7,500.00 @ 50% = £3,750.00

The practical impact of this change is that, as a general rule, employers should make termination payments before issuing the P45 if possible. This will help to ensure that the correct amount of tax is deducted and avoid, for example, a basic rate taxpayer having to reclaim overpaid tax through self-assessment if he doesn't get another job.


If an employer makes more than one post-P45 payment to an employee in a tax year, each separate payment will be subject to PAYE independently, and will not take account of the earlier payments when working out PAYE on the later payments. The key date, however, is when the employee becomes entitled to the amount. Simply delaying payment of portions of an amount to which the employee is already absolutely entitled will probably make matters worse as the employer will have to account for PAYE on the full amount on the date of entitlement.

This appears to mean that if a termination payment is paid in a series of monthly instalments then each instalment would be treated in the way described above, and so could be brought (at least in part) within the monthly non-cumulative 20% band (or 20% and 40% bands).

Further, for 50% rate taxpayers, who are likely to suffer tax on a pre-P45 termination payment entirely at the additional rate (assuming that in the tax month of payment, the employee has already received salary payments that have utilised the basic rate and higher rate allowance), if the payment is made post termination, and following the issue of the P45, the taxpayer will get another chunk of basic rate and higher rate allowance because of the 0T calculation, and this will not be reversed until he completes his self assessment tax return for the relevant tax year.


Careful consideration should be given, on a case-by-case basis, as to whether taxable termination payments are made before or after the issue of the P45.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.