Owner Kate Upcraft Consultancy Ltd
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HMRC clarifies termination payments scenarios

25th Sep 2018
Owner Kate Upcraft Consultancy Ltd
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termination of employment

Since my first article on the new rules for taxing termination payments, I have been pushing HMRC to answer questions on the more complex scenarios which have emerged. I now have some answers.

Guidance lacking

The tax legislation defining post-employment notice pay (PENP) came into effect on 6 April 2018. Sadly, the HMRC guidance in their Employment Income Manual (EIM) was not published until that date, so there was little time to digest the guidance before applying it.  

The historical approach to guidance in the EIM has been to enhance the text with worked examples. In respect to PENP, there is only one example and HMRC has said it won’t be providing any more. This makes me question whether the tax due on termination payments made since 6 April 2018 has always been calculated accurately.

HMRC agreed to answer some specific questions, which I discuss here to help you ensure that the tax treatment of termination payments is correct.

What is a pay period?

The legislation doesn’t define a pay period, but it’s a crucial part of the PENP calculation formula. There are two conflicting views on the correct approach:

  1. A pay period runs from the day following the last payday and ends on the next payday. If I am paid on the 25th, my pay period runs from the 26th to the next 25th
  2. A pay period reflects the period that the payment represents. Say an employee is paid on the 15th of every month, which represents payment for the period from the 1st of the month to the last day of the month.

HMRC’s view is that option 2 is correct – the pay period reflects the period that the payment represents.

What allowances are part of basic pay?

Allowances are ignored in the calculation of basic pay that underpins the PENP calculation unless the allowance has been consolidated into standard pay.

Does the word ‘consolidated’ refer to the regularity of the allowance or the reason for its payment? If a car or housing allowance is paid every month even if it is shown separately on the payslip, does that mean it has been consolidated?

HMRC gave a detailed reply which will be welcomed by employers and agents once we’ve unpicked it: “We are unable to give a definitive list of the types of allowances that would be excluded from basic pay. It is a matter of fact and very much dependant on the terms of the pay/benefits agreement as to whether something is an ‘allowance’, or makes up part of an employee’s basic pay.

“Having said that, in general, and depending upon the terms of the agreement, if an employee is provided with a choice between a company car or a car allowance then the car allowance would likely be an allowance for the purpose of the PENP legislation. However, if the car allowance is provided with no option to have a company car instead then the facts might suggest the amount of the allowance is, in reality, an additional amount of basic pay and not an ‘allowance’ for the purpose of the PENP calculation.”

That means that where the employer has bought the employees out of a particular benefit, eg ceased to provide company cars and has chosen to increase salaries with an allowance for the value of the previous company car provided, that would amount to a ‘consolidation’. This would lead to the allowance being included in basic pay.

I think we can take the same view in respect to a location or market premium such as a London weighting, as those are enhanced salaries based on the cost of living. Conversely, if an employee receives a regular car allowance in place of a company car, this can be ignored as part of basic pay.

No pay just before leaving?

To calculate the PENP, you need to know the basic pay in the pay period before the day of leaving. What if there is no pay in that pay period because the person is off sick or on unpaid leave? HMRC has confirmed that if the basic pay is nil, then PENP will be nil as well.

Added back pension contributions

Basic pay is defined in ITEPA 2003, s 402D(7) as “employment income of the employee from the employment”, less any disregarded amounts. The term “employment income” is further defined at ITEPA 2003, s 7, and includes earnings, amounts treated as earnings and any amount treated as employment income.

Most employer contributions to registered pension schemes are exempt from income tax and thus don’t count as employment income (ITEPA 2003, s 309). Such payments would therefore not form part of basic pay for the purpose of PENP.

However, if the employee has sacrificed pay for an enhanced employer pension contribution, this is added back in and the pre-sacrifice basic pay figure is used. Given the size of some pension sacrifices for senior individuals, this can make a significant difference to the calculation of the PENP.


Fixed-term contracts terminated early

If such a contract is terminated early, I would treat the notice period as the number of weeks from the early termination date until the date when the contract would have ended. HMRC confirmed that is the correct approach.


Replies (1)

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By Democratus
26th Sep 2018 10:09

Kate - interesting follow up to your first article. I had a query which i place on it, but perhaps should raise it here. Relates to the PENP Formula in the article.

This example can't be right can it?

"The employee is paid monthly on 25th of each month and leaves on 8 June 2018. The previous pay period was 1 to 31 May and had 31 days, so P = 31. He has basic pay of £1,000 per month with four weeks’ notice and has no contractual PILON but has statutory redundancy of £1,000 and compensation for loss of office of £3,000

PENP = (£1,000 (BP) x 28 (D)) = £903.23
31 (P)"

No-one is paid for the whole 31 days in a month, more likely 20 - 25 days (say 25 for argument sake) and similarly 4 week's notice is 20 days.

PENP = (£1,000 (BP) x 25 (D)) = £800.00
20 (P)

Reducing taxable element. Am I wrong?


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