The law relating to the taxation of termination payments changed in 2018. At the time it was initially suggested the changes were to “simplify” the law.
However, practical experience has shown that all that has happened is that the common misconceptions have changed.
Under the old law, the common misconception was that £30,000 could always be paid tax free on termination of employment and this was the case regardless of whether this £30k included notice pay or not. The position was, in fact, more complex than that.
The law post April 2018 actually says that termination payments can be paid tax free up to £30k if they are not otherwise taxable (e.g. as earnings which would be the case for holiday pay, notice pay etc.) and if the payment, or part of it, is not treated as post-employment notice pay or “PENP”.
The new common misconceptions appear to be:
- Parties can agree to forgo a notice period and therefore any termination payment can be paid tax free up to £30k;
- If the employee has worked his contractual notice period and been paid it via the payroll (and so tax has been paid on the notice pay), then any termination payment can always be paid tax free up to £30k; and
- If an employer has made a payment in lieu of notice then there is no need to calculate PENP.
To calculate PENP you need to use the applicable statutory formula. There are numerous PENP formula which somewhat makes a mockery of the idea that the 2018 changes were a simplification!
The issue in practice is that many employers, and even some practitioners have, is that they simply do not apply the relevant formulae or appreciate the elements of it. Misconception three above is a good example of this as the amount of any payment in lieu of notice would need to be known in order to calculate PENP.
Mistakes also commonly arise where an employee has resigned because the amount of notice an employee must give to resign is not a part of any PENP formula. Issues also commonly arise where an employee’s wages have been impacted by a salary sacrifice arrangement or simply by sickness absence in the period prior to their employment terminating or prior to notice being given.
In summary, PENP is not simple at all. If you are making a termination payment and you do not apply the correct PENP formulae then you are at risk of incorrectly calculating whether, and potentially how much, tax is due on the termination payment. Any underpayment of tax could be picked up by HMRC and, as well as any unpaid tax due, HMRC may also seek interest and penalties for late payment.
A final note of caution. If you are an employer negotiating with an employee you should be careful not to promise that a payment can be made tax free because, if you have not considered PENP, that may not be the case. In many cases whilst this may not scupper a deal, it will increase the cost to the employer as the employee will say that the offer was only accepted based on the promise of a tax free payment and the employer will begrudgingly swallow the extra cost.
For more information or advice on this or any other Employment Law & HR issue, please get in touch with James Symons (Director & Head of Employment) on 0115 9 100 250, or send him an email.
Posted on June 23, 2023
