16.1 Introduction
Sometimes employment doesn't go
according to plan, whether that is because of a problem relating to employee
conduct, a cash flow issue which results in redundancy, or in the worst case
scenario - injury or even death.
It is important, therefore, to
know what action is required if you do need to make an employment termination
payment, for whatever reason, including the statutory deductions that need to
be made and under what circumstances.
Before we go on, we should mention
that having hard and fast rules for employment termination payments is
difficult and there are only a handful of definite guidelines to take into
account. The rest needs to be discussed fully with HMRC in order to ensure
everything is done correctly. Once you have the information on how much income
tax and NICs to deduct from the type of employment termination payment you're
going to make, the rest is quite simple and straightforward.
In this module, we will cover in as
much detail as possible this rather complicated and difficult subject. We
cannot provide concrete information on exactly what to do in terms of income
tax and National Insurance Contributions (NICs) for every single payment you
might make, we only offer guidance and a general overview of the
subject. It's also important to recognise that HMRC should be contacted in
the event of a query or confusion, to avoid liability for income tax and NICs
at a later date.
What Exactly is an
Employment Termination Payment?
It is important to understand the definition of an
employment termination payment in detail, to ensure that any particular payment
you make truly does fall under the rules laid down by HMRC. Put simply, a
termination payment can also be described as a severance payment, putting an
end to an employee's employment within your company, and ending the contract in
the eyes of the law. We will talk in more detail about what circumstances could
contribute to an employment termination payment; however, these can occur for
several different reasons.
Redundancy is perhaps one of the most
likely reasons for a payment of this kind to be made, as well as dismissal when
an employee's conduct has caused the termination of his or her employment
contract.
Payments are made in both situations, as well as a few others, which we will
talk about briefly later in this module. It is important to have in clear terms
why the employment termination payment is being made, because this will affect
how much income tax and National Insurance Contributions (NICs) are due on the
payment itself.
In the event of an error, the employer is liable
for the unpaid income tax and NICs on the payment, and this can cause
considerable upset and distress for both parties; the employer and the former
employee. You need to know exactly why the payment is being made because
different payments of different amounts fall under different taxation and NICs
liability levels. In terms of redundancy, there are clearer guidelines, which
we will discuss a little later in this module; however, for other types of
payment, the guidance is not so clear.
16.2 Under What Circumstances Would
an Employment Termination Payment be Made?
We mentioned that an employment
termination payment is made when an employee leaves employment for certain
reasons, e.g. redundancy or dismissal.
This payment is made to sever the contract and
there are many reasons why such a payment may be made.
For instance, an employment termination payment may
be made due to:
·
Redundancy
·
Retirement
·
Dismissal
·
An individual leaving the business because of a disability
·
Injury
·
Death
Obviously, we hope
that the last three items in that list are areas which you never have to
explore, but the first three are common situations in employment overall.
Generally speaking, employment termination payments
fall into the following areas:
1. A payment which the employee would have been contractually entitled to
should the employment have continued, e.g. salary, bonuses or commission
contained within the contract of employment, or contractual payments made in
lieu of notice. These payments are completely taxable, with NICs made from this
payment too. This is perhaps one of the easiest types of employment termination
payments to make because the rules are considerably clearer.
2. A payment which is non-contractual,
i.e. it doesn't appear in the contract of employment but is given relating to
redundancy, for example, or damages for wrongful dismissal, compensation for
unfair dismissal, or other non-contractual benefits paid to the individual upon
termination. In this situation, a large proportion of the payment is tax-free
and no NICs are made on this payment. The tax-free payment threshold is set by
HMRC and the most current figure is on their website - see the web link below.
3. A payment which is made following
termination of contract due to death, or due to disability resulting in the
individual terminating employment. Such situations are obviously tax-free and
can be up to any limit. These are the kinds of payments which may end up in
court for some reason of dispute, so having a clear definition of why the
payment is made, on what grounds, and how much for, including deductions, is
very important.
4. A payment made as compensation
against dismissal. This is perhaps the greyest area in this category of
payments because it may or may not be taxable. It generally depends on what the
payment is for. In this case, extra clarification by HMRC should be sought, in
order to avoid under-taxing the payment; this is a world of trouble and expense
in the future.
5. Payments in relation to share options
or awards. This is another complicated field relating to these payments,
however, there are circumstances in which an employee is entitled to receive
share awards or to use share options after their contract is terminated. How
much tax and National Insurance, in this case, depends on a variety of
different areas, and again, further advice should be sought in order to obtain
the correct information.
6. Payments made in relation to employer
contributions to pensions. In certain situations, these payments are tax-free,
however, if the amount goes above and beyond the annual allowance then they are
taxable, as well as if they go over the lifetime allowance - however, in terms
of a small business, this is unlikely to be something you will experience.
Up-to-date
information from HMRC on the regulations regarding redundancy pay is found
here: www.gov.uk/redundant-your-rights/redundancy-pay
16.3 Payments in Relation to Redundancy
Redundancy is perhaps the most common reason you
will come across when related to employment termination payments.
We hope this never actually happens to your
particular business, because it would be an indicator of financial difficulty,
however, generally speaking, this is the most common reason for a business to
be making such a payment, aside from dismissal for misconduct. In some
circumstances, instead of paying redundancy pay, an employer may offer the
employee suitable alternate jobs.
The suitability of the job offered will depend on:
- -The similarity of the job to their current job
- -Skills and abilities required for the new job
- -Terms and conditions offered
- -The pay, benefits, working hours and location
If the employee finds the alternative
job unsuitable for some reason, failure to give notice within the 4-week period
may result in loss of statutory redundancy pay. This must be communicated
clearly to them at the time of the offer. Redundancy payments are made to an
employee when their contract is terminated because they are in effect being
made redundant; this can be voluntary or non-voluntary, but the general rules
are the same and are actually dealt with in terms of the payment in the same
way as a dismissal payment.
Despite that fact, it is important to
get the definition clear of why the payment is being made. When an employee is
made redundant, they are given a payment as compensation for that event, and
when making the employment termination payment, it is very important to be
clear that the payment is actually for redundancy, through no real fault of the
employee, or whether it is because of misconduct, leading to redundancy. These
are big differences, but subtle in terms of payroll.
A
redundancy payment will rarely be over the tax-free payment threshold.
It is always a good idea to double-check these with
online calculators, as big problems will arise in the future if an incorrect
deduction is made, either above or beyond the correct limit. If the redundancy
payment is over HMRC's threshold, then tax comes into play. It is also worth
noting that staff facing redundancy are entitled to paid time off for job
hunting or training, as long as they have been continuously employed by you for
2 years or more. Employers are not obligated to pay more than 40% of an
employee's usual salary for this time off.
16.4 Why is the Subject of Employment
Termination Payment Such a Grey Area?
In terms of income tax and NICs
deductible from an employment termination payment, there is some considerable
debate, and there are not actually any solid, 100% guidelines, aside from the
ones we talked about in our earlier section.
The fact that this is a grey area is
not really helped by the certainty that it is so important to get the right
deductions made. If the payment is not taxed and deducted correctly then there
are consequences which need to be sorted out urgently.
For example, if the payment is not taxed
correctly, HMRC is well within their rights to recover the missing tax and NICs
from the employer, including adding penalties for the problem and adding
interest on the outstanding amount. This can add up to a costly bill for an
employer, when the problem could have been correctly handled in the first
place, by seeking advice at the right time, from the right people, i.e. HMRC
themselves.
In this situation,
the former employee would be entitled to a tax credit for the tax that should
have been deducted, but this also causes unnecessary distress for them, in a
situation which is difficult enough as it is. Because of this, it is important
for both the employer and the former employee that the employment termination
payment is done in the correct way, in a timely manner and without distress or
cost to either party. Minimising the risk of liability for unpaid income tax
and NICs is imperative, and by following guidelines and seeking advice in a
timely manner, this can be avoided.
16.5 Reporting
Employment Termination
Payments to HMRC
We know that HMRC needs to have knowledge of your
payroll system activity, and these employment termination payments are no
different.
If income tax is deducted from a
payment, then this needs to be reported in your full payment submission to HMRC
through the PAYE system, to show the deduction taken from the employee's gross
pay. You would then also need to inform HMRC that the employee no longer works
for you and that their PAYE activity is not your responsibility from that point
onwards. It is worth mentioning that NICs should be deducted from the relevant
payments, and again, this should be done through your full payment submission
when the employee is paid for the final time before termination.
If you do not run your payroll duties
yourself, then you need to keep them very much informed, to ensure the correct
deductions and payments are made, and reported in the correct manner;
communication errors can be very costly. If there is a non-cash part to the
payment, this must still be reported to HMRC, if the value of the package given
to the former employee exceeds the tax-free payment limit.
This
should be reported by 6 July following the tax year in which the employment
ended, however, it is always best to do this as soon as the occurrence happens,
to minimise the risk of unpaid tax or any issues which may arise from it.
16.6 How to Seek Help and Advice
Regarding Employment Termination Payments
Employment termination payments
overall are complicated and are an area which HMRC have long tried to make a
little simpler.
There is much guidance available for
employers on what to do in certain circumstances, but it is difficult to put
together a one-size-fits-all guide, as one size certainly does not fit all in
this case. Redundancy and dismissal due to misconduct are probably the only two
circumstances you may deal with during the lifespan of your own employment with
the business, and we hope that you never need to deal with the more serious
reasons for an employment termination payment, such as an accident resulting in
disability, or even death. The HMRC website will give you some information;
however, this is probably one of those situations where you actually need to
speak to someone, in order to get the correct information for your particular
situation.
These kinds of occurrences have
anomalies which change and shift according to the business and how the termination
of employment has happened, and only HMRC can provide 100% correct guidance on
income tax and NIC deduction in relation to the final payment you make to your
former employee. This is certainly one of those situations where you will need
to seek the firm guidance and information you need
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