Termination payments: What a minefield!

Reshma Johar considers the need for extra due diligence when it comes to understanding termination packages. 

Can we still assume that termination payment will be covered automatically by the £30,000 tax free exemption?   

Where are we now? 

Since 2018, there have been numerous changes to termination payments: 

• Payment in lieu of notice (contractual or not), will be assessed to PAYE and National Insurance contributions (NICs). This has been introduced with a post-employment notice pay (PENP) calculation. 
• Termination payments over a £30,000 threshold will be subject to Class 1A NICs. 
• ‘Clarification’ that injury to feelings will not be covered by the exemption. 

• Foreign service relief will only be available to employees not resident in the UK for the tax year in which the employment was terminated. 

Understanding the package 

Whether or not the loss of an employment was expected, a termination package could include various cash amounts and benefits-in-kind, making a final payslip daunting to review.  Each element may have a different PAYE and NICs element, be subject to the £30,000 threshold or have an exemption applied.  Self-assessment returns will need to correctly report payments received.   

Relying solely on the terms applied by an employer will not be sufficient; facts need to be gathered to understand the reasons for the termination, followed by establishing what the package entails. It is not uncommon for HMRC to look beyond the wording of a contract if it can be established that there was a reasonable expectation that an employee would receive a termination payment.  

A payment or benefit may be chargeable under ITEPA 2003, s 401 if given under the following circumstances: 

• The termination of a person’s employment. 
• A change in the duties of a person’s employment.
• A change in the earnings from a person’s employment. 

Given the differing tax and NICs exposure, there are anti-avoidance provisions preventing arrangements designed to reduce or avoid the payment of tax. 

Breakdown of a termination package 

The following lists what a package could entail, split into sections to demonstrate the different rules and tax treatment. 

1. Termination payments assessed as general earnings or benefit-in-kind: 

• Contractual payment in lieu of notice. Unused holiday leave. 
• A bonus owed. 
• Non-cash benefits. 
• Anything payable under a contract of employment. 

2. Termination payment assessed under restrictive covenant: 

• A restriction into the undertakings of conduct or activities. 

3. Termination payments assessed under employer-funded retirement benefit schemes: 

• Payment made on the death of an employee. 
• Payments made on injury (excludes injury to feelings) or disability. 

• Payments into a registered pension scheme. 

4. Termination payments, within ITEPA 2003, s 401 and therefore subject to PENP rules and the £30,000 tax-free amount. 

• Statutory redundancy pay. 
• Ex-gratia payment (which is effectively compensation for loss of employment rather than a form of reward). 
• Non-contractual payment in lieu of notice. 
• Non-statutory redundancy pay. 
• Damages for breach of contract. 

• Settlement agreement. 

Changes under s 401 ITEPA 2003, effectively split the payments into what will be treated as earnings and subject to PAYE and which can benefit from the £30,000 exemption. 

Information needed to work out termination pay 

• Reasons for terminating employment. 
• An understanding of each element within the termination package. 
• Employment contract, compromise (settlement) agreement, staff handbook or other correspondences relating to employment or termination. 
• Whether employee had reasonable expectation of receiving a termination payment. 
• Days in post-employment notice period. 
• Pay period. 
• Last day of employment. 
• Date of notice relating to termination of employment. 

• Minimum notice period as set out in the employment contract. 

Advance clearance could be obtained where the payment relates to a redundancy. 

Practical tip 

HMRC’s employer’s further guide to PAYE and NICs (tinyurl.com/HMRC-EFGPN) advises when termination payments need to be reported to HMRC.