Termination payments

Payments made to employees on termination of employment may be subject to PAYE and NICs. A common misconception is that all payments made on termination of employment qualify for the so-called £30,000 exemption. This exemption only applies if the payment is compensation for loss of employment and not otherwise chargeable to income tax. For example a termination payment may include accrued holiday pay, bonus, contractual payment in lieu of notice (PILON), continued private medical insurance and compensation.

To determine whether PAYE and NICs will be due the charity must therefore establish what the payment is for. The nature of the payment must be determined by reviewing the employment contract, any other relevant documentation (e.g. staff handbooks or union agreements), the negotiations between the employee and the charity and any compromise or settlement agreement.

The first £30,000 of amounts falling to be taxed under ss 401-403 of the Income Tax (Earnings and Pensions) Act 2003 may be paid free from tax and NICs and the rest of the payment will be subject to tax, but can be made free from Class 1 NICs.

Thought should also be given to whether a payment falls to be taxed under other headings where different rules apply. For example, Employer Financed Unapproved Retirement Benefit Schemes (EFURBS) legislation may apply if the individual is at or is approaching retirement age (generally this should be considered for anyone who is 50+ years of age).

For example, if an employee receives a termination payment for £40,000 that meets the terms of the exemption, the first £30,000 can be paid tax and NICs free, and the remaining £10,000 must be subject to tax, but no NICs is due.

There are some changes to the taxation of termination payments from April 2018. From this date all contractual and non-contractual PILONs must be subject to tax and Class 1 NICs through payroll, i.e. employers will be required to tax the equivalent of an employee’s basic pay for the notice period if notice is not worked.

In addition, employer’s Class 1A NICs will be due on payments above £30,000 that meet the terms of the exemption. No employee’s Class 1 NICs will be due. So, in the above example, the first £30,000 can be paid tax and NICs free, and the remaining £10,000 must be subject to tax and employer’s Class 1A NICs. No employee’s Class 1 NICs is due.

At the time of writing, HMRC has not yet specified how the Class 1A NICs will be collected but it is anticipated this will be in “real time” rather than after the end of the tax year as with other Class 1A NICs charges.

The taxation of termination payments is a complex area and charities should consider seeking legal and tax advice whenever they consider making a termination payment.

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