As a result of the COVID-19 pandemic, the UK Government announced the introduction of the Coronavirus Job Retention Scheme (CJRS) as a measure to assist employers financially and limit the number of employees made redundant. As lockdown measures are slowly lifted and businesses resume activity, some employers may realise they are not able to continue employing the same workforce as before.
In the last few weeks there have already been a number of news stories along these lines. It is very important that employers who do need to let staff go and who plan to make termination payments ensure they get the tax and NIC position right. The related rules are complex and have undergone several recent changes. It is, therefore, vital that employers carefully consider the rules to avoid unpaid liabilities, penalties and the risk to reputation of getting it wrong.
We have only focused on the UK income tax and NIC aspects below, but clearly employment law advice should also always be sought. In addition, if the individual has worked overseas during their employment, the position will be more complex and there may be reliefs available.
What steps to take:
To help ensure the correct income tax and NIC treatment, it is helpful to consider the following:
- Why is the employment ending?
- What is the individual to be paid?
- Determine the income tax and NIC treatment of the elements to be paid
- Correctly report the termination payment and process any income tax and NIC withholding.
1. Why is the employment ending?
It is important to determine if employment is ending due to a genuine redundancy or for some other reason, for example, poor performance. Given the current economic climate, genuine redundancies may, be more common than usual. The current CJRS guidance from HMRC confirms that employers can make employees redundant while they are on furlough or afterwards. This may come into play as the CJRS scheme finishes in October and, depending on the number affected and the employment law implications of this, many consultation processes will start imminently.
For an employee to be made redundant, there must be an objective requirement for the company to no longer need the employee’s services, rather than terminating an employee’s contract only to then hire a direct replacement. As mentioned, legal advice should be sought to ensure the rules relating to redundancy, including the consultation process, establishing the notice period and the statutory redundancy pay an individual is entitled to, are met.
If employment is ending for a reason other than redundancy (e.g. poor performance or retirement), it is important to note this as it will affect the income tax and NIC treatment of the payments. This is particularly the case for an individual at or near retirement age, as termination payments made to such individuals have historically been subject to heavy scrutiny by HMRC.
Whatever the reason the employment is ending, it is crucial this is determined carefully and documented with supporting evidence.
2. What is the employee to be paid?
The key is to identify each separate element of the package – what is the employee receiving and why? The main types of payment we see make up a termination package are:
- Payments relating to the employment itself e.g., holiday pay
- Payments relating to retirement
- Payment relating to something specific, like a restrictive covenant
- Provision of a non-cash benefit or the employee being allowed to have continued access to a non-cash benefit
- An employer pension contribution or the employee deciding to sacrifice an element of their termination payment in return for an employer pension contribution
- Or, finally, payments relating purely to termination of employment e.g., statutory or enhanced redundancy pay.
It is worth emphasising that it is the substance of the payment which is relevant, not how it is being described in the Settlement Agreement or other correspondence with the employee.
As a side point, there is currently no definitive guidance from the Government as to whether statutory redundancy pay or basic pay for the purposes of calculating a payment in lieu of notice can be based on an individual’s furloughed wages at 80% of their usual salary, or their usual salary.
3. Determine the income tax and NIC treatment of the elements to be paid
Most people are aware of the £30,000 exemption which may be available to reduce the income tax payable on termination payments, and indeed there is a prevailing assumption that the first £30,000 of all termination payments will always be exempt from income tax and NIC. Unfortunately, this is not the case.
The starting point should be an assumption that income tax and NIC is potentially due, and only once all relevant legislation has been considered, should we consider whether the £30,000 exemption applies.
When determining the income tax and NIC treatment of a termination payment, we need to consider whether the payment is:
- Contractual or a specific type of payment which is taxable/NICable (e.g. a restrictive covenant)
- Exempt (e.g., in relation to disability or death)
- A payment in lieu of notice (PILON)
- Statutory or enhanced redundancy payment
- Ex-gratia (i.e., compensation for loss of employment and not a reward for past performance).
Once you have established whether the payment is either covered by an exemption or subject to income tax and NIC either fully or in part, it is only then that you can then assess whether any leftover payment elements need to be reviewed under the new termination rules.
For these payments, it is necessary to consider the Post Employment Notice Pay (‘PENP’) rules and calculation, which are applicable if the individual has not worked the entirety of their notice period. Previously, where a PILON was made, we only needed to consider whether the payment was contractual/expected by the employee. Under the PENP rules which came into effect from April 2018, all PILONs are treated as taxable and subject to NIC. Although the intention of these rules is straightforward (to tax the amount the employee would have received had they worked their full notice period), the execution of the calculation can be tricky and full of pitfalls. For example, complexities arise when an employee receives allowances, has been on sick or maternity leave, has been on furlough or has been summarily dismissed, as well as numerous nuances in the definitions of the different calculation components.
If the entirety of the notice period has been worked, or if there is still some of the termination payment remaining after the PENP calculation, the £30,000 exemption may be applicable. It is worth noting that in April 2020, a new employer’s NIC charge at 13.8% was introduced on the excess of termination payments over the £30,000 exemption. This, alongside the new PENP rules, means termination payments have become both more complex and more expensive for employers.
4. Correctly report the termination payment and process any income tax and NIC withholding
When the correct tax and NIC treatment of all elements of the termination payment package have been established, it is important to ensure that the timing of payments is noted. This is particularly crucial when a payment is made after issuing the employee’s P45.
Reporting the termination payment to HMRC can also be complicated, particularly when the payment comprises different elements, for example, cash and non-cash benefits which cannot be treated in the same way.
Points to take away
The current economic climate means unfortunately employers may have to make the difficult decision to terminate employment. Employers should consider if they are fully comfortable with how to manage the associated income tax and NIC implications.
There can be a lot of different rules to consider when determining how to treat a termination payment correctly, particularly if the payment comprises different elements. In addition, while the new termination payment rules were intended to make matters more straightforward, in our experience they have led to further complexity. Understanding the rules well and having a robust process in place to determine the income tax and NIC treatment is vital and will also help employers to manage the potentially increased costs associated with terminating employment.
If you are considering potential redundancies or other terminations of employment and would like to discuss the potential income tax and NIC implications of this, as well as any interaction with the CJRS scheme, please do contact the BDO team.