Termination payments are a popular topic in the ACCA Advanced Tax, ICAEW BPT, ATT, and CTA exams. It is dealt with in s401-406 ITEPA 2003.
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 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 the 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 in 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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