Employers should take note of recent and forthcoming changes relating to the taxation of termination payments. As an overview, in April 2020 employers will be required to pay employer national insurance contributions on compensation payments above the £30,000 threshold, which is discussed in more detail below. The other change relates to one aspect of the complex Post Employment Notice Pay (“PENP”) rules which apply where there is a compensation payment, and an employee is paid in lieu of some or all of their notice period. The HMRC has changed the method of calculation where the employee is paid monthly but the unworked period of notice relates to days or weeks.
Changes to national insurance contributions (“NICs”) due on compensation payments
Currently, a payment made to an employee to compensate them for the loss of their employment (a “Compensation Payment”) can be paid without deduction for income tax and NICs up to a maximum of £30,000.
If the Compensation Payment exceeds this, the amount in excess is subject to deduction for income tax but not NICs. However, the NIC position is changing and as of 6 April 2020, if a Compensation Payment exceeds £30,000, the amount in excess will give rise to employer (but not employee) NICs, as well as income tax.
This will increase the cost of Compensation Payments for employers and should be borne in mind in any settlement negotiations. Employers should also ensure that their payroll processes are adjusted accordingly.
Changes to post-employment notice pay
The change to the calculation of PENP relates to circumstances where an employee is paid monthly but the notice period that is not being served is not a whole number of months.
HMRC has recognised that in such circumstances, the statutory formula that was introduced in April 2018 can produce unintended outcomes: if the last pay period falls in a short month (e.g. February), this can skew the calculation and result in a higher PENP than if the last pay period fell in a longer month (e.g. March). HMRC have therefore provided an alternative calculation, whereby P is 30.42 (rather than the number of days in the last pay period), which can be used if this would be to the employee’s benefit. The HMRC clarified in their December bulletin that this change came into effect from 16 October 2019.
It used to be the case that payments in lieu of notice (“PILONs”) were only taxable if an employer had a contractual right to make such a payment. However, in April 2018, this distinction was removed, with all PILONs (contractual and non-contractual) becoming taxable. In order to avoid parties labelling PILONs as Compensation Payments to avoid paying tax, HMRC introduced a statutory formula to calculate PENP.
Where an employee is receiving a Compensation Payment and is not serving their whole notice period, the HMRC calculation needs to be followed to ensure that sufficient tax and NICs are being paid. If the calculation produces a positive figure, an employer will be required to subject an amount of the Compensation Payment equivalent to the PENP figure to deductions for tax and NICs. No further tax or NICs are due if the statutory calculation produces a nil or negative PENP.
The new calculation
Where an employee is paid monthly but the notice period (or part) that is being waived is not a whole number of months, employers should use a figure of 30.42 for P, rather than the number of days in the last pay period. This means that the calculation is as follows:
PENP = (BP x D)
P - T
In this calculation:
BP = basic pay in the last pay period before (i) if the employee is serving part of their notice, the date that notice is served or (ii) if the employee is receiving a payment in lieu of their entire notice period, the last date of their employment.
P = 30.42
D = number of days in the notice period which fall after the end of employment.
T = usually any contractual PILON.
HMRC have advised that the above calculation should only be used where it is to the employee’s benefit. We expect this will almost always be the case where the last pay period falls in a month with fewer than 31 days. However, where the above calculation produces a positive PENP, we would recommend that employers also carry out the standard calculation (where P is the number of days in the last pay period), and then relies on whichever calculation produces the lowest PENP.
Click here to read the latest HMRC guidance on the change to the PENP calculation.
Other changes to PENP
On 16 January 2020 HMRC provided further guidance on the impact of PENP on non-UK resident employees and foreign service relief. This is a complex area and in our experience does not often come up in the context of PENP. You can read more about it in the HMRC Income Manual 13877 and the HMRC Income Manual 13700.