Are you handling the PAYE contributions correctly for termination payments?

10 October 2017

In 2016’s budget the government announced that from April 2018 the exemption scope will change and rules will be aligned. As a result of this the employer national insurance contributions (NICs) will be due on those payments above £30,000, which are already subject to income tax. These rules will be tightened preventing the 'manipulation' of payments and simplified to make the process clearer.

Why do employers need to know about the taxation of termination payments?

The HMRC can recover unpaid tax, NICs, penalties and interest from the employer, so it is imperative that termination payments must be taxed correctly. If an employer does not deduct tax or NICs from a termination payment, they can incur penalties and interest as well as paying the original deductions.

The figure to remember is £30,000, this is the threshold. 

This legislation splits an employee’s termination payment into two types of payment and so the first step is to identify payments that should be treated as earnings, the remainder will fall within the £30,000 exemption threshold. Here are some examples to consider; 

  • Funds that the employee was contractually entitled to, which relate to past or future service or otherwise derive from the employment such as:
    •  salary payments, this also takes into consideration garden leave;
    • contractual bonus or commission; and
    • contractual payments in lieu of notice. 
  • Non-contractual payments connected to a termination or redundancy, with the first £30,000 tax-free such as:
    • ex gratia payments;    
    • monies paid for wrongful dismissal awarded as damages;
    • compensation for unfair dismissal or other breach of statutory rights;
    • payments of statutory and non-statutory redundancy; and
    • non-contractual benefits in kind provided on termination. 

Whilst it is important to remember that payments where termination results from death, and payments where there is a termination and payment is made on account of injury or disability are tax free without limit, care needs to be taken with these payments. Such lump sums provided on the death of an employee (Death in service), and lump sums provided on or after the death of an employee in connection with past service (commissions, bonuses or hours worked), are taxable. For injury and disability payments, this must be a physical injury/disability and so careful consideration must be taken on these payments as well. 

This new legislation does not confirm how the Class 1A charge should be collected as this will be covered in a secondary legislation in due course. It is thought however that the Class 1A charge will arise and be paid in ‘real-time’, as with other Class 1A charges.

RSM will be sure to provide updates on this legislation before its implementation in April 2018. 

If you would like to check that you are treating termination payments correctly, please contact Mark Holland or your usual RSM contact and we can support you with reviewing this.