When considering the tax treatment of a payment in relation to the termination of employment, for many the tax exempt figure of £30,000 immediately comes to mind. However, it is not that simple, as it cannot be assumed that the £30,000 exempt threshold automatically applies. Furthermore, the National Insurance Contributions (NIC) rules affecting termination payments are changing from 6 April 2020, which could result in additional complexities and costs for employers.
The Office of Tax Simplification announced in 2014 that the treatment of termination payments required change. As such during the 2016 Budget the government announced it would make changes to the taxation of termination payments. These changes have included:
- introducing Post Employment Notice Pay (PENP) rules to ensure that all payments in lieu of notice are identified and consistently subjected to tax and NIC;
- removing foreign service relief on termination payments to UK resident individuals;
- clarifying that the exemption for injury does not apply in cases of injured feelings; and
- aligning the rules for income tax and NIC so that employer’s NIC will be payable on qualifying termination payments above £30,000.
The changes highlighted at one to three above were all introduced from 6 April 2018. The PENP rules have probably been the most significant of these changes so far. The government introduced the PENP rules primarily to simplify and reform the treatment of payments in lieu of notice. The tax and NIC treatment has, since 6 April 2018, no longer depended on whether a contractual payment in lieu of notice is made, or whether payments in lieu of notice are made under a custom or practice established by the employer. Instead a complex formula must be applied by the employer/former employer to calculate the PENP. It is always taxable and liable to Class 1 NIC.
NIC on termination payments in excess of £30,000
The change highlighted at point four above will take effect from 6 April 2020 and will apply to any termination payments exceeding £30,000 paid from that date.
Up to 5 April 2020, the charge on termination payments in excess of £30,000 is limited to income tax only. The new NIC legislation which takes effect from 6 April 2020 will ensure that any termination payment in excess of £30,000, chargeable to income tax, will also attract a Class 1A NIC liability at 13.8 per cent on the balance above the £30,000.
A charge to Class 1A NIC rather than Class 1 NIC means that it is only the employer that suffers NIC and not the employee.
Class 1A NIC is associated with taxable benefits, calculated in line with forms P11D and payable by 19/22 July following the year end. However this new Class 1A NIC liability payable on termination payments will be collected through Real Time Information/PAYE and so will need to be paid and reported to HMRC at the time it arises. HMRC will also legislate to ensure that appropriate late payment interest and penalties are applied when this new Class 1A NIC charge is not correctly paid.
What does this most recent change to the NIC rules mean for employers?
Combined with the changes which took effect from 6 April 2018, the NIC changes on 6 April 2020 mean that the treatment of termination payments is becoming even more complex.
Furthermore, qualifying termination payments in excess of £30,000 are becoming much more costly as employers will be required to pay Class 1A NIC at 13.8 per cent on the excess of termination payments exceeding £30,000.
Employers will need to consider these upcoming changes as they will bring additional costs when terminations arise. Employers who are currently restructuring their workforce and expecting employments to be terminated after 5 April 2020, might want to consider bringing forward termination dates, and the dates that termination payments are made, to before 6 April 2020 as this could result in significant NIC savings for termination payments exceeding £30,000.
How can RSM support you?
We can guide you through the difficult issue of workforce separation both from an employment tax, NIC, HR and employment legal perspective. We can assist you in several ways, including (but not limited to):
- preparing employee and worker exit strategies to minimise compensation cost;
- navigating employment legal regulation requirements for people exits;
- assisting with planning from an HR point of view and managing and one to ones needed;
- achieving employment legal rights claims resolution and secure binding employment settlement agreements;
- helping you understand your tax and NIC obligations and liabilities as they apply to your workforce, and any plans you may have around the termination of employment;
- identifying the most tax and NIC efficient way of making changes to your workforce; and
- being tax and NIC compliant and establishing the correct liability to be paid under the new rules, including PENP payments.