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Fair enough. These people have probably never been through a redundancy before and their knowledge of the finer details of a termination package is necessarily limited. In fact, a lot of people would have no idea that there is normally a package with several different components. Each element of the package can have a different tax treatment. The three types to consider are:
A) Fully taxable
B) Partly taxable
C) Fully exempt
Fully taxable
These include:
· Contractual payments
· Non-contractual payments where there is reasonable expectation they will be received.
· Payments for services rendered – past, present, or future.
· Payments for restrictive covenants.
Contractual means that within the employment contract, there is a legal right to receive a redundancy payment.
Even if the contract is silent on the matter, a redundancy payment may still be contractual if there is a reasonable expectation of receiving it. For example, if employees in a similar position have always received a redundancy payment of £12,000 then the “reasonable expectation” rule would apply.
And if an outgoing employee receives a payment for giving up a right to do something (such as agreeing not to work for a competitor for six months) then this would fall under the restrictive covenant head and be taxable.
Anything fully taxable means taxed as normal earnings, just like salary. So, both PAYE and class 1 NIC will be chargeable.
Partly taxable
These include:
· Statutory redundancy payments
· Non-statutory redundancy payments
· Any other ex-gratia payments including non-cash assets
Statutory redundancy pay is a fixed amounts for each year of service that employers must pay under employment law. Employers can also top this up with non-statutory redundancy or ex-gratia payments as compensation for loss of office. Sometimes an asset (typically a car) is thrown in for good measure and the market value is included.
The first £30,000 of such payments is tax-free and anything above £30,000 is taxed. These are no class 1NIC deductions payable on the excess over £30,000 – just class 1A NIC which is payable by the employer.
Fully exempt
This is the gold, but the scope is limited:
· Payments into a registered pension scheme.
· Outplacement counselling
· Retraining
· Payments made on the death, injury, or disability of the employee.
Such payments are completely tax-free and also NIC-free. For many the key exemption will be payments by the employer to a pension scheme and this is often done in practice. Payment for retraining costs could be very valuable if the redundant employee is thinking of another business role.
What about PILONs?
Where an employee is given notice and receives his/her wages as normal these are taxed in the usual way.
If the employer honours the notice period but sends the employee home to work on the garden (“gardening leave”) payments are taxed in full.
But the employer may terminate the employee’s employment early and makes a payment in lieu of notice (PILON). Provided there is nothing about this arrangement in the employment contract ( i.e. no contractual arrangement) the PILON is treated as an ex-gratia payment of which the first £30,000 is tax-free.
And finally…
Redundancies are normally unhappy and emotional experiences. It is very important that unfortunate employees thoroughly investigate the package contents to ensure that what is provided is the best for them in their immediate circumstances. A relatively young employee may not be too interested in a fully exempt pension contribution but would be very receptive if the package included a retraining allowance, an ex-gratia payment and a car.
C & H are here to advise on all aspects of taxation.
