Termination payments: Get the details right, part 1
Sarah Bradford provides an overview of the payments that may be made on the termination of an employment contract and how they should be treated for tax and NI purposes.
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Sarah Bradford BA (Hons) FCA CTA (Fellow) is the director of Writetax Ltd (www.writetax.co.uk) and its sister company, Writetax Consultancy Services Ltd. She writes widely on tax and National Insurance contributions and is the author of National Insurance Contributions 2020/21 published by...
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It is important that terms of redundancy over and above statutory are dealt with in the employment contract. For larger payments over £30k, companies may well see a benefit in trying to pay these as pension constributions to avoid NIC.
Do you have to show redundandy payment on the payslip or can it be done outside of payroll as one off payment not going through payroll?
Can someone confirm that the taxation of termination rewards as outlined above does not come into play with settlement agreements?
I seem to remember the rules around that changing but was then surprised to see no reference to them above...
To Anonymous FD
Sarah's brief but excellent summary of the termination rules applies whether there is a settlement Agreement (SAg)or not. Typically an SAg will break down the payments between the three main elements, namely contractual, non-contractual and PENP. But even if not so broken down in an SAg, the tax treatment will in effect apply that split anyway. This is (or should be) the case both for PAYE/NI purposes and for the employee's SA return in due course.
There haven't been any recent rule changes overriding this but what you may, perhaps, be thinking of is when the PENP rules came in two or three years ago. Prior to that, to establish the tax position, one had to to look at the employment contract to ascertain whether a payment was contractual or not. Broadly speaking, a clause which gave the employer the absolute discretion as to whether to give notice or make a payment in lieu thereof (a PILON) was held by the Courts to be a contractual entitlement and hence taxable in full. Where the contract was silent on this the PILON was akin to a breach of contract payment and so qualified for the £30k tax-free slice. Since the introduction of the PENP rules, however, this distinction has been pretty well rendered redundant (pun intended!)
It was a great pity (though no great surprise) that, during the consultation process and in the subsequent legislation, the opportunity was not taken to increase the £30k limit, which has been around for donkeys years now. Even before it was increased to £30k, the limit was £25k (and I believe that this went back to the 1970s, at least) when the SRP element would have typically used up no more than about 10% of the tax exemption. As Sarah's article says, the maximum SRP nowadays is well over £16k and so uses up over the half of the £30k. Another instance of, I'm sure, wholly intentional fiscal drag.
For one man limited companies, sometimes known as PSC, who are facing the end of this arrangement from April 2021 postponed from this year because of Covid, can this £30,000 tax free redundancy payment be claimed when closing down the Limited company ?
I have discussed this previously with two accountants who looked into it and concluded it could not be utilised although I remain unconvinced because if the director is also an employee of the company, is registered under PAYE, has an employment contract and returns RTI data each month, then why should it not apply to them too?
I am interested to hear arguments for and against.
Thanks
(Replying to DS)
A one-man company with an employment contract with his own PSC? Are you quite sure? Never seen one of those in over 40 years working in tax! Might be a contract with the Agency or end client perhaps but between him and his own company?? Surely not.
When a director decides to close down a company he will normally be doing that for commercial reasons, maybe because the work has dried up, he has decided to retire, work offshore or maybe take up an employment instead. Although, by dint of being a director, this brings his directorship (and hence his "employment") to an end that doesn't, of itself, make it sufficient to justify effectively giving himself a termination award. On any objective basis, that's simply self-enrichment and an inevitable consequence of his own commercial decision to wind up the company.
I know that there have been one or two voices on here over the years who have expressed the opposite view but, personally, as an employment taxes specialist, I'm on the side of the two accountants you've spoken to. Certainly HMRC will be!
Hi raycad, Thanks for your quick reply.
An employment contract can simply be a single page with words to the effect you are hereby employed by XYZ Limited on a salary to be determined each year. Legally I understand a contract can even be made verbally.
The reason for closing down the company is brought on by changes in legislation or tax practice which makes the limited company model inoperable. The government have decided to disallow this method of working and would prefer contractors to be employed by big corporates directly and pay their taxes like everyone else, without regard for the differences in employed and self-employed conditions. I think they are making a big mistake but they have made many recently so why stop now?
It seems to be a grey area and the two accountants I think were playing on the safe side to say it wouldn't probably be allowed but has it ever been tested ? The director is a legal person managing the overall direction and legal-tax compliance of the company and could in effect be paid zero pounds for his services. The same person working for the company, and actually doing the real work which brings home the bacon, is paid a salary and to all intents and purposes is an employee who is now facing redundancy due to circumstances beyond the control of the company.
I expect in the next few months this director/employee redundancy problem will cease to be academic and become a reality.
Thanks.