Owner Kate Upcraft Consultancy Ltd
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Termination payments: Fond farewells

15th Jun 2018
Owner Kate Upcraft Consultancy Ltd
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The rules on tax and NI treatment of termination payments changed on 6 April 2018, but awareness is still limited and queries abound. This is not ideal for a revenue-raising measure.

Timing is key

Unusually for a tax measure, it is the date of termination that is key, not the date of payment. Termination payments made in 2018/19 will fall under the new rules if the termination was on or after 6 April 2018, but the previous rules will apply where the date of leaving the employment was 5 April 2018 or earlier.

For the purposes of this article, I will focus on the numerous grey areas in the new rules for termination payments.

The goal

The government wanted to close down the option for employers of removing pay in lieu of notice clauses from employment contracts. The absence of such a clause allowed employers to make a payment for breach of contract, for not allowing notice to be worked. Such breach payments could be classed as damages, and thus could fall under ITEPA 2003, s 403 and be tax-exempt up to £30,000, and fully NI exempt with no upper limit.

The solution was to deem an amount of post-employment notice pay (PENP) as taxable pay, regardless of the terms of the contract, that would serve to reduce any tax-exempt termination award. To make this deeming of pay more punitive, the calculation of pay used in the PENP calculation is pre-sacrifice or ‘notional’ pay.

The formulas to calculate PENP are to be found in F(no.2)A 2017 ss 402A-E, with HMRC guidance, such as it is, in the Employment Income Manual (EIM) at paras: EIM13874 to EIM13898 and EIM14000.  

Seven questions

Here are my top seven questions about the PENP calculation.

1) When don’t we need to do a PENP calculation?

There are three situations when the PENP calculation is unnecessary:

  1. If all the lawful notice due is worked, or paid for, as the employee is on gardening leave.
  2. If there is no termination payment other than taxed items such as a contractual PILON, holiday pay, bonus or untaxed items such as statutory redundancy pay.
  3. The termination date was on, or before, 5 April 2018.

2) What is the PENP formula?

The PENP is calculated using this formula:

PENP = ((BP x D) /P) – T


  • BP = basic pay
  • D = days in the notice period
  • P = days in the pay period
  • T = taxable amounts on termination other than holiday pay and bonuses

It requires you to work out the number of days in the pay period. Whilst there is no definition of ‘pay period’, it is taken to mean the period covered by the last payment of pay.


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)

              RTA = £3,000, T = £0 as all of RTA is tax-free

              PENP = £903.23 – T = £903.23 which is taxed

              £3,000 - £903.23 = £2096.77 tax/NI-free as under £30,000 limit

             £1,000 is tax-free as statutory redundancy

3) What is ‘basic pay’?

Basic pay is based on the employee’s pay before any salary sacrifice is made, but it doesn’t include:

  • overtime
  • bonuses
  • commissions
  • gratuities
  • allowances (but see below)
  • termination awards
  • benefits in kind
  • amounts treated as earnings, and
  • amounts that count as employment income, such as share-based employment income, and employment-related securities that constitute earnings under ITEPA 2003, s 62

The scope of the allowances paid for, say, housing or car costs which can be disregarded is unclear. The guidance in EIM13884 states: ‘an allowance does not include an amount which is consolidated into an employee's standard pay’. Does ‘consolidated’ mean if it is regularly paid it is no longer an allowance so is considered basic pay?

For example, a car allowance may be due every pay period contractually, so should these types of payment inflate basic pay? The examples in the EIM provide more clarity that shift, first aid, and travel allowances can be ignored.

As benefits in kind are not to be included in basic pay, the settled view is that employer pension contributions are not part of basic pay.

4) Do we need to do a PENP calculation if there is a contractual PILON?

Contractual payments in lieu of notice (PILON) will always be taxable.

The rule is: if there is a relevant termination award (RTA) as well as a contractual PILON, the PENP calculation will be needed, as it can serve to reduce the tax-exempt RTA.

An RTA is anything paid in connection with the termination that isn’t taxed as employment income or is expressly excluded, as is statutory redundancy pay. Non-statutory redundancy pay is an RTA.

If there is one payment of redundancy that includes both statutory and non-statutory pay, we assume that only the amount that exceeds the statutory redundancy calculation is classed as an RTA.

If there are no termination payments other than amounts classed as employment income and statutory redundancy pay, a PENP calculation is not needed.

5) How does the PENP affect what is taxable?

There are three rules for this:

  • If the PENP is equal to or more than the RTA, all of the RTA is taxable and subject to NI.
  • If the PENP is less than the RTA then the PENP is taxable and subject to NI. The PENP amount is subtracted from the RTA and the excess will be tax exempt up to £30,000 limit and be totally NI-exempt.
  • If the PENP is negative it is treated as being nil and the RTA is unaffected.

6) What if the employee has been summarily dismissed with no notice?

In this case, there is no PENP to calculate, as there is no lawful notice due. If there was a subsequent settlement to avoid an employment tribunal case, it’s not clear if the employer should then use the notice that would have been due, if it hadn’t been a summary dismissal, to calculate the PENP.

7) If a fixed term contract ends early, is there any notice period?

Yes, the notice period runs from the date of termination to when the contract would have ended.                      

More guidance needed

The final HMRC guidance on post-employment notice pay (PENP) was published on the day it took effect: 6 April 2018. It was also buried deep in the HMRC Employment Income Manual (EIM), so no wonder awareness of the changes is low.

Payroll professionals and tax agents need more guidance to address the areas of uncertainty with the PENP and to ensure the correct tax and NI is being collected. 


Replies (2)

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By SteveHa
15th Jun 2018 14:43

I love tax simplification, making our lives so much easier as it does.

Thanks (4)
By Democratus
26th Sep 2018 09:09

Kate, good article (and its follow up today), however:

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?

Thanks (0)