Termination payments is a popular topic in the ACCA Advanced Tax , ICAEW BPT, ATT and CTA exams . It is dealt with in s401-406 ITEPA 2003. It is due to come up in March 2023.

There are 3 types of termination payments

1.    Fully Taxable -payments for services past , present and future . This was established in the landmark case- Shilton v Wilmshurst. It also includes all contractual payments especially payments in lieu of notice (PILON) . Restrictive covenants or golden handcuffs are fully taxable as are unapproved payments into pension schemes.

2.    £30,000 Exemption -these are non-contractual payments which are also called ex-gratia payments. While statutory redundancy is always exempt it consumes the £30,000 limit.

3.    Fully Exempt -also called ‘shock’ payments due to death or injury of the employee . In addition , payments into a registered pension scheme are also fully exempt.

With regard to PILON , it must be apportioned between the post-employment notice pay (PENP) and the balance which is eligible for the £30,000 exemption if non-contractual.

PENP is simply the pay the employee would have received if they had worked the notice period and is based on the basic salary the employee would have earned .

Jack earns £10,000 and has a 2 month notice period . His employer pays him £60,000 and asks him to leave immediately. The payment is ex-gratia. Jack also receives £20,000 of dividends in the tax year.

Jack’s PENP is 2 months’ salary or £20,000 and is taxable in full.

The balance of £40,000 is eligible for the £30,000 exemption which leaves £10,000 taxable.

The taxable £10,000 will be subject to income tax by Jack as his top slice of income (after the dividends) .

Jack will not have to pay employee Class 1 NIC on the £10,000 but instead it is subject to employer’s Class 1A NIC like benefits in kind.

In terms of the £30,000 exemption , it is allocated to cash payments , then benefits (counselling of redundant employee is an exempt benefit ) . If the termination payment straddles two tax years , it must be allocated to the earlier tax year

If the termination payment is paid before the issue of the P-45, you must use the normal tax coding but if it is paid after the P-45 use the code OT.

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