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March 24, 2023

Termination Payments: Are They Taxable?

What is a Termination Payment(s)?

If you're facing termination, you may be wondering what your entitlements are in terms of payment and how they are taxed. Understanding the tax implications of termination payments is crucial to ensure compliance with tax laws and regulations. In this blog, we will examine termination payments from a tax point of view. We will explore the different types of payments, how they are taxed, and the rules and regulations that govern them.

These termination payments can either be fully taxable, partially taxable or fully exempt depending on the circumstances surrounding the payment. Termination payments can be for a number of reasons, including the employee being made redundant, dismissed or choosing to leave their job.

Within the termination payments, this could be made up of:

  1. Statutory redundancy pay;
  2. Holiday pay and unpaid wages;
  3. Payments related to restrictive covenants;
  4. Assets transferred to employees;
  5. Company benefits, for example bonuses or enhanced redundancy payments; and
  6. Payments in Lieu of Notice (“PILON”).

As each of these contain different tax treatments, tax advice is paramount to ensure that you are meeting your compliance obligations as they need to be considered separately.

Are Termination Payment(s) Taxable?

This depends on what is included in your termination payment. Some parts of the termination payment may be considered earnings, therefore subject to Income Tax and National Insurance Contributions (“NICs”) whereas some termination payments are made on the death of an employee (which would be fully exempt).

When considering the tax treatment of the termination payment, you need to ask yourself questions such as:

  1. What is the reason for making the payment?
  2. What is the nature of the payment?
  3. Is the payment contractual or non-contractual?
  4. Is it fully taxable, partially taxable or fully exempt?
  5. Is it an ex-gratia payment for loss of employment?

What do you pay Income Tax and NICs on?

One of the most fundamental rules is that termination payments will only be taxed if they exceed £30,000 but this only applies to redundancy payments or ex-gratia compensation payments, including where you are compensating the employee for loss of office.

This is why it is important that an assumption should be made that Income Tax and NICs may be due and then examine each part of the termination package to see if it will be eligible for the £30,000 exemption or exempt all together.

You cannot use this £30,000 exemption if there is another reason for the payment being made, including:

  1. Payment for services performed and/or bonuses;
  2. Where a PILON is contractual;
  3. Payment for the introduction of a new restrictive covenant; and/or
  4. Payments made on or in the anticipation of retirement.

Where the genuine termination payment is in excess of £30,000, the excess could be subject to Income Tax. There are also NICs implications for the employer if these amounts are above £30,000.

What is so special about PILON payments?

As stated above, where the employment contract provides the employer the right to terminate by paying a PILON, then it will be taxable.

New rules were introduced in April 2018 which state that if you do not have a PILON clause in the employment contract, part of this payment will be eligible for the £30,000 ex-gratia exemption and part of it will not be eligible. The amount not eligible is known as the ‘Post-Employment Notice Pay’ ("PENP").

The PENP is taxable in full whilst the remaining amount could potentially be eligible for the £30,000 exemption.

What do not you pay Income Tax tax and NICs on?

The sort of termination payments that you do not pay tax on include the following:

  1. Termination payments that fall within the £30,000 exemption limit stated above;
  2. Contributions by the employer to a registered pension scheme (but tax advice should be sought on the individual’s Annual Allowance position);
  3. Legal costs contributions by the employer in connection with a Settlement Agreement (provided certain conditions are met).
  4. As stated above, termination payments made on the death of an employee.

How do I report and pay the tax to HMRC?

Your employer is responsible for making sure your termination payment is taxed correctly which is normally conducted through PAYE. However, special reporting requirements apply to termination payments in excess of £30,000 which include non-cash elements.

If you have any queries on any of the information in this article, or need help with regards to termination payments, please do not hesitate to contact me at hassan@pd-tax.co.uk

Disclaimer: This article is for general information only and is not intended to constitute individual advice. It is recommended that you seek independent tax advice to review whether your termination payments are taxable. 

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