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Always taxable
Payments that relate to work performed by the employee are, perhaps obviously, subject to both PAYE and NICs in full. Examples are:
• accrued holiday pay; pay for work performed during worked notice
• garden leave, i.e. pay during the notice period where the employee is not required to work
• incentive payments for meeting production targets during the notice period
• bonuses conditional on remaining in the employment for a period if they are calculated by reference to any
additional service following notice of redundancy
• wages due under the provisions of a court or tribunal award.
Payments are also liable to tax and NICs in full if they relate to the period of employment rather than the termination and/or are either mandatory or discretionary under the terms and conditions of the employee's contract, including those defined in negotiated agreements, employment handbooks and even in verbal agreements.
"Golden handshakes" are one example of such payments. As these recognise the employee's service rather than the termination, they are subject to PAYE and NICs in full.
Other examples are compensation for loss of office and payments made in lieu of notice that are part of the terms and conditions of employment.
Payments In Lieu
Payments in lieu of notice are a particular problem. If an employee's contract specifically allows the employer to pay in lieu of notice instead of the employee working the notice period, even if the payment is described as discretionary, it is nevertheless remuneration under the contract and, consequently, subject to PAYE and NICs in full. Liabilities arise in exactly the same way when a payment is made in lieu of the benefits to which the employee would have been entitled during the notice period. Even if the contract says nothing about pay in lieu of notice but there is an expectation of payment because it has been routinely paid to others, that constitutes an implied contractual term and the payment will still be liable to tax and NICs.
Payments made in respect of a covenant that restricts the employee's conduct after termination are also liable to both PAYE and NICs. Restrictive covenants commonly prevent employees from poaching customers or working for a competitor within a defined period of time after termination. Excluded from liability, however, is a payment made in respect of an undertaking not to pursue an action before an Employment Tribunal.
Taxable over £30,000
Many employers have their own non-statutory scheme that provides compensation for loss of employment due to redundancy. Payments under these schemes are not taxable to the extent that the total payment, including SRP, does not exceed £30,000. The tax relief is conditional however, on the redundancy meeting the statutory definition, the employee being at least age 20 and having at least two years' service, and the total payment not being excessive relative to the employee's salary and length of service. If the combined payments exceed £30,000, tax is due only on the excess. There are not, however, any NICs due on non-statutory redundancy payments, even if they exceed £30,000.
As already discussed, a payment in lieu of notice provided under a non-statutory scheme, because it is contractual, would be fully taxable. A related payment is an anticipatory payment of damages. If an employer fails to allow an employee to work all or part of the redundancy notice, and there is no entitlement to pay in lieu of notice, there is a breach of contract that would entitle the employee to sue the employer for damages. This is commonly forestalled by making by a compensatory payment in respect of the pay that would otherwise have been due during the notice period. It may also include compensation in respect of the loss of benefits during the notice period, such as the use of a fully-expensed company car and private medical insurance. The amount of such compensation is not subject at all to NICs, but is taxable only to the extent that, along with the other redundancy payments, it exceeds the £30,000 threshold.
Some employees with redundancy payments that exceed £30,000 choose to pay some or all of the excess into their approved occupational pension scheme. As long as the payment is within the scheme's rules, it has no liability for tax or NICs.
If a redundancy package includes benefits that will continue to be provided into subsequent tax years, there is a special reporting procedure.
Dilemma
The dilemma facing many employers is that their employees expect that, in a redundancy situation, all of their termination payments will be untaxed. It is difficult to explain to them that the reason the payments are taxed is that their entitlements are defined in their contracts. Some employers try to make a contractual or established package appear to be a one-off deal for each employee but there is clearly a risk. If the Revenue investigates a number of redundancy payments and decides that they should have been taxable, the penalties could be considerable.
Some of the difficult options open to employers are:
• pay up to the first £30,000 tax free and risk a check by the Revenue (not recommended)
• gross up those elements that are liable to tax so as to leave the employee with the anticipated amount
(expensive)
• deduct PAYE and NICs and leave it to the employees to recover what they can from the Revenue
(unfriendly)
• warn the employees concerned and ask the Revenue for a decision (unattractive but sensible)
Note: The guidance in this article applies only to genuine redundancies. Payments may be made in respect of termination for other reasons, e.g. retirement, death, ill health, disability and injury. There are different tax and NICs liabilities in such situations.
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For Payroll and Human Resource Professionals
