Any payment made to a departing employee must be appropriate to the circumstances of the dismissal and relate to any bona fide claim the employee may otherwise seek to pursue. In addition, there are now complex rules relating to the taxation of any termination payment made to the employee.
As you may be aware, the taxation of termination payments significantly changed in April 2018. From 6 April 2018, any payments in lieu of an individual’s notice entitlement (PILONs) are taxed regardless of whether or not there is a contractual PILON clause in an employee’s contract. In addition, following the postponement of the planned implementation in 2019, employer’s NICs are expected, from 6 April 2020, to be payable on the amount of any ex-gratia termination payments subject to income tax.
All PILONs are now subject to PAYE deductions regardless of whether there is a PILON clause. If an employee has not worked their full notice period, employers are required to tax an amount paid to their departing employee equivalent to their notice pay. A £30,000 exemption applies to statutory redundancy pay and approved contractual redundancy pay, as well as to payments or benefits otherwise chargeable to tax. Any other non-statutory redundancy pay, however, will no longer automatically fall within the £30,000 exemption.
These changes ultimately mean that a termination payment is likely to cost the charity or not-for-profit organisation more of their already strained resources than it may have done before April 2018. The costs are set to rise again from 6 April 2020 when the NIC changes take effect, meaning that employer NICs are payable on termination payments in excess of £30,000. However, if you can understand the potential tax costs it can be useful when putting together the termination package.
To work out the tax treatment, employers need to apply a formula to calculate “Post-Employment Notice Pay” (PENP), which is, essentially, the amount that would be paid to the employee as normal pay for the whole of their notice period if they were working it. If the PENP amount is greater than or equal to the ‘relevant termination award’ (the amount of a termination award which is not a redundancy payment) the whole of the ‘relevant termination award’ is treated as earnings from the employment. If the ‘relevant termination award' exceeds the PENP, only the PENP amount is treated as earnings from employment.
It is clearly important, when considering the taxation of a termination payment, to calculate the PENP figure correctly. As the methodology is quite complicated, we have created a PENP calculator to help you calculate the PENP amount in most common situations. The calculator takes you through a series of questions, with guidance to assist you in completing it. We hope this will aid you when calculating the taxation of a termination payment. However, if your situation is complicated or unusual, or you simply need further assistance when calculating PENP, please do not hesitate to contact our Tax Team.
The Tax Team at Birketts is happy to advise charity and not-for-profit employers in relation to all aspects of employment taxation.